Taxes, Backdoor Roths, Options, and How to Max Out Your Childrens’ Roths

Mindy:
Welcome to the BiggerPockets Money podcast show number 163 where we interview Steven Hamilton from Hamilton Tax and talk about the specifics of retirement accounts.

Steven:
It’s a lot of fun and there’s no specific right answer when we’re planning. It’s all about what’s going to be best from your situation. Everybody comes and we say, “What do I do, what do I do?” Well, what are your goals? Where do you want to be… How do foresee the future go? You could win the lottery and it can change our entire plan in an instant but we could inherit funds that you would never expected to inherit and it can change that situation altogether.

Mindy:
Hello. My name is Mindy Jensen and with me as always is my paying his fair share of taxes cohost Scott Trench.

Scott:
I’m just going to just defer to comment on that on.

Mindy:
That was good. Scott and I are here to make financial independence less scary, less just for somebody else. To introduce you to every money story because we truly believe that financial freedom is attainable for everyone no matter where or when you’re starting.

Scott:
That’s right. Whether you want to retire early and travel the world, go on to make big time investments and assets like real estate, start your own business or simply learn the ins and outs of pre and post tax retirement account contributions. We’ll help you reach your financial goals and get money out of the way so you can launch yourself towards your dreams.

Mindy:
Today is a super boring episode unless you’re a financier.

Scott:
Unless you like saving money.

Mindy:
Unless you like money, unless you like making lots of money, unless you like your retirement accounts to be as fat as possible and then it’s going to be a super fun episode where you learn all the things about the Roth IRA, the backdoor Roth, the mega backdoor Roth, 401(k)s, how they transfer in and out…. Last week we spoke with Brandon, the mad fientist to get you interested in the concept and plant a seed. Today, we’re speaking with Steven Hamilton who is an enrolled agent, which is someone who can represent taxpayers in front of the IRS for audits and collections and appeals and basically he is a super tax nerd and he comes in to share with you all the information that he knows but he is not boring.

Scott:
She called him a super tax nerd?

Mindy:
I did call him a super [crosstalk 00:02:17].

Scott:
That’s your intro?

Mindy:
I’m sorry. Do you think he’s not a super tax nerd? I say that with a high level of admiration.

Scott:
I think he’s highly informed.

Mindy:
He is highly informed to the level of being so obsessed that he’s kind of a nerd about it.

Scott:
I think I wrote in the show notes while we were recording to Mindy I’m like, “This dude’s a whole other level,” as we get going with this. Anyways, I don’t know how you listened to the BiggerPockets Money podcast. Maybe listen to it on your commute, maybe you listen to it while you’re working out, maybe you sit down and pay rapt attention to us on YouTube or wherever. This is one of those episodes where I would suggest that listen to it maybe once, twice, maybe sit down and just listen or pull out the YouTube and watch us live because we’re going to go over a lot of stuff here and this is not the kind of slower pace that we sometimes take with the show where we ask more deep questions and try to really build that whole picture. We go rapid fire through pretty advanced topics and we’re not shying away from the jargon on this episode.

Scott:
We’re calling things what they are called and using the abbreviations that they use in these professions. I would pay crap attention to this episode because if you do, it could either save you a lot of money this year or get the wheels spinning and the process started of saving a lot of money this year or build a lot of wealth downstream or will be applicable to you downstream and you should be thinking about these things even as you’re working to get to the income levels where you can begin taking advantage of some of the things we talk about today.

Mindy:
Scott, I think that’s a really good point. We do get into some pretty heavy jargon so we have a transcript of all of our episodes but I am going to go through this transcript and make sure it is absolutely perfect. And while I’m going through the transcript, I’m also going to pull out all the little things that he talks about that maybe people who aren’t in the know don’t necessarily understand. I’m going to make a dictionary, a glossary on biggerpockets.com/moneyshow163. If you are thinking about this and you’re like, oh, this is exciting but I have no idea what they’re talking about, hop on over to the show notes and check them out because I really do want you to understand this. I was going to say 10 years ago I wouldn’t have but I would have. I’m trying to think, I’m so old. 30 years ago, I might not have understood any of this jargon either so I want you to understand it because you can really change the trajectory of your financial life by taking some of the advice that Steven shares today.

Scott:
Yeah, these are big dollars that are at stake but by at least understanding these concepts and having a plan that works for you around them, there’s not one size fits all as we’re going to discuss but there’s themes and there’s awareness that you may lack about these things. I certainly did coming into today’s conversation that I think are worth really paying some rapt attention to today.

Mindy:
Oh, I learned a ton this episode.

Scott:
Well, should we bring him in?

Mindy:
Stephen Hamilton from Hamilton Tax, welcome to the BiggerPockets Money podcast. We’re going to talk about some kind of boring ideas today but I’m so excited to talk to you about it because this is not going to be a boring conversation at all unless you don’t like money.

Scott:
And saving more of it.

Mindy:
If you don’t like money why are you listening to our podcast called BiggerPockets Money?

Scott:
If you love taxes, this is not the episode for you.

Mindy:
Yeah, if you love paying taxes.

Steven:
Well, it’s combination of both because sometimes paying taxes can be a good thing now.

Mindy:
I do want to pay my fair share but I also want to avoid anything that I legally can which I think all Americans should do.

Steven:
I completely agree, completely and totally agree. But there are cases for example, Roth IRAs, where sometimes I want to pay a little bit more in tax now rather than getting a tax deduction so that way I can go ahead and fund that account and pull it out tax free later so sometimes I do want to increase my tax burden or maybe a conversion.

Mindy:
What a great segue.

Scott:
Yeah. Let’s jump right into it and start talking about the Roth IRA. This is obviously following up a pretty strategic or higher level discussion we had last week with the Mad Fientist, Brandon the Mad Fientist and so the goal today is to get to the specifics and answer the questions that our audience and me and Mindy selfishly have about Roth IRAs and the specifics of all this kind of good stuff. Let’s start off with the very basics. What Roth IRAs you can’t contribute to them if you make over a certain amount of money. If you do, you have to begin doing a backdoor Roth. Can you tell us what those contribution limits and income limits are?

Steven:
Sure.

Scott:
Let’s kick things off there.

Steven:
Definitely. I’m going to start with 2020 contributions. Yes I know we’re into 2021. However, we have until the due date of the tax return, April 15th, to make our contributions to that IRA. We may not know what our exact bottom line income was so we will have a little bit of time in order to make those decisions and make those contributions. For 2020, it was a $6,000 maximum contribution. However, if you’re over the age of 50, there’s a $1,000 additional contribution you can make for a total of $7,000. Now, that doesn’t sound like a lot of money. Over time, it can start to add up, but we want to make sure that we make as much in contributions as we can when we’re eligible. Now you asked about the income limits. I’m not going to go into the exact specifics in all of the income limits because if you make X, I have to prorate it [inaudible 00:07:57] over a phase out.

Steven:
I’m going to talk about the numbers if which it’s completely phased out for any Roth IRA. In this case, you’re going to be looking at for 2020 $206,000 for a married couple. If you’re over $206,000 you cannot make any type of Roth contribution directly. You will have to go into a backdoor Roth which we will talk about later. If you are single or head of household, that’s $139,000 which some people can get to pretty quickly. And if you’re married, filing separate, that limit is only $10,000. They do not reward you whatsoever if you’re married and filing separate.

Mindy:
Hey, you can only make $10,000 in income if you are married and filing separately to contribute to a Roth IRA?

Steven:
That’s correct.

Mindy:
Oh. Well, okay. I will be married, filing jointly. I’m going to put in my personal question now. I have a job. My husband is retired but has blogging self-employment income. Are we married filing jointly or are we single head of household?

Steven:
I’m going to tell you 99 times out of 100 and I’m being generous when I say only 99 times, you’re going to want to file it jointly.

Mindy:
Okay.

Steven:
Any married couple is pretty much going to want to file jointly.

Mindy:
Is that an option that I check, married filing jointly or single head of household?

Steven:
[inaudible 00:09:15] jointly. When you guys prepare your tax, [inaudible 00:09:17], you’re going to compare joint versus separate. We do this with all of our married clients. We want to look at the numbers to see what’s going to be more beneficial. In some cases, in very specific circumstances, it can be more beneficial to file separately. However, most of the time you’re going to want to file jointly. The tax brackets pretty much double in the very beginning so if his income is way down here and yours is up here, you’re going to average that out over those tax brackets so that way you’re not looking at as high of a tax burden because you might be in the 24% tax bracket by yourself but he might only be in the 10 or 12% bracket or 0% bracket is always possible but I’m going to pull a number out just as a quick example for you guys.

Steven:
For a married couple, the 22% bracket goes from 78-9 to about 168. I’m looking at 2019 numbers in front of me here so it’s gone up just a little bit. But for a single person, that 22% bracket caps to 84 so if let’s say you were over $84,000, you would be looking at a 30… Sorry, 24% tax rate but let’s say combined you guys are at 120. Well, that 120 would only put you about midway into that 22% bracket.

Mindy:
Okay, that’s-

Steven:
You’re going to get the advantage of some of those lower rates with it.

Scott:
Now, when we’re thinking about… Let’s say we’re taking a married filing jointly example and you’re phased out completely at $206,000 but that doesn’t mean that if you make $206,000 in income or on your W2 that your AGI is $206,000. Can you walk us through briefly how that AGI is calculated?

Steven:
That depends. If we’re talking about AGI, modified adjusted gross income, there’s a bunch of different variations of modified adjusted gross income as well. The short version, we’re going to take your income minus a specified list of adjustments. Now those are going to be things like IRA contributions, HSA contributions, if you have an alimony deduction, those types of items. It’s self-employed health insurance. That was the big one I was forgetting. Those are going to end up adjusting into that calculation for your AGI. Now, my favorite example is actually to pull up the 1040 with clients and show them exactly what it looks like and here’s your adjustments and here’s how this flows. And I like to show a year over year comparison. Since they changed the tax law, you’re going to be looking at what used to be a two page form suddenly became a two page form plus a whole pile of schedules that get attached to it, paperwork reduction act to its finest. That schedule one is going to show all of our additional income items and our adjustments.

Steven:
And those adjustments, we’re looking at educator expenses, certain expenses for reservists, half of self-employment tax, self-employed health insurance deduction, student loan interest, IRA deduction, all of those will get incorporated into that calculation and that’s where we get into our adjusted gross income. I include all of my gross income items minus those and I get my AGI.

Scott:
Let’s simplify it because if you’re self-employed or have a lot of business assets that you probably have some good problems and you need to be talking to a CPA to I think file your taxes appropriately. It’s something that I need personally for example. But if you’re a W2 employee where 95% or more of your income is coming from your W2 job, what’s a simple way to think about it?

Steven:
Your income minus IRA contributions, minus HSA contributions.

Scott:
What about the deductions?

Steven:
Your mortgage interest, et cetera, those are going to be deducted below the line. You often hear above the line, below the line and that line is your adjusted gross income.

Scott:
Okay.

Steven:
And a lot of those are based on a percentage of your income or they’re subject to additional limits. It’s not simple one word answer but I’m going to jump back to what Mindy said about, what about self-employed contributions to retirement accounts. A solo 401(k) would be another deduction. We end up with a big difference between that W2 employee and that self-employed person and our planning is going to be completely different. I had somebody call me yesterday, they have a W2 and nothing else. What can I do for tax savings? Do you want the good news or do you want the bad? There’s not a whole lot to work with. I can’t take a home office, I can’t adjust items because they didn’t have any income for me to offset it with and it’s great to have a break W2 income. Take the money, bank it, save, do what you can. We’ll get your employer deductions, whatever pre-tax benefits you can take or post tax benefits such as putting into a Roth 401(k).

Scott:
Okay. Well, let’s talk about… Let’s say you’re over that limit with your AGI. How would you describe the mechanics of the backdoor Roth and mega backdoor Roth and how they might apply to the W2 employee earning above that AGI limit?

Steven:
Great question Scott and sorry for not simplifying that other one there.

Scott:
That’s all right. Some of them can’t be simplified so I’m talking to you.

Steven:
[crosstalk 00:14:31] I keep saying.

Scott:
Yeah.

Steven:
As far as being over that $206,000 limit for say a married couple, what will end up happening is we will look at things that we can do to lower that W2 income so maybe we make some traditional 401(k) contributions or we make extra contributions into a flex spending dependent care account, et cetera in order to bring that taxable wage down. We do that first, but only to the extent that they’re going to actually use those benefits. And then if you’re still over that limit, then what we’re going to do is that backdoor Roth, if we can. There’s cases where we may run into a situation where I don’t want to do a backdoor Roth and I’ll explain what that really entails. If you go from one employer to another and you take your old 401(k) and shove it into an IRA, we will run into proration rules for converting those funds from traditional to Roth.

Steven:
I will end up in a position where I may not be able to do that backdoor Roth without incurring a tax burden. I can make non-deductible contributions into my traditional IRA. Yes, I’m putting post-tax dollars into my traditional IRA. Later on when I pull that out, whether it’s going to a conversion or coming out to me directly, I end up having to prorate my pre-tax dollars and my post-tax dollars over that total balance. I’m going to use a simple example. If I have $95,000 in a traditional IRA of all pre-tax dollars and then I contribute $5,000 of post-tax dollars that are non-deductible into that IRA, I now have 5% that is post-tax. If I were to take that full $100,000 and either withdraw it to me directly or convert it into a Roth IRA, I would be looking at a tax bill on that pre-tax percentage. However, every dollar that comes out, 95% of it is going to be pre-tax, 5% it’s going to be post-tax and that’s of every dollar that comes out.

Mindy:
Is there any way around that rule because that sounds, no. Come on, give me some ideas.

Scott:
[crosstalk 00:16:52] second 401(k) with-

Steven:
There are some ways that we can get slightly around that and the biggest one that I use is I have my clients roll that traditional IRA into their company’s 401(k) where possible or if we have a form of self-employment, we may open up a solo 401(k) account so now the balance in that IRA we no longer have any pre-tax dollars in it. And then after I do that, I make my contribution into that traditional of non-deductible dollars and then I can convert it.

Scott:
Great. If I have a simple position where I’ve got a 401(k) at work, then I just open a another IRA and I can begin doing that.

Steven:
Clockwork, all day long.

Scott:
Okay, great. It sounds like it’s a pretty workable solution for most people unless you have a lot of different accounts or want for some reason to contribute those post-tax dollars to an existing 401(k) with the tax deferred dollars.

Steven:
That’s exactly it. And I’m actually going to bring up something while we’re on that conversion proration. A lot of people don’t realize that you can put additional dollars into your pre-tax 401(k). You can actually put after-tax dollars into that 401(k) account and there’s a play. We talked about the backdoor Roth. There’s also what’s called a mega backdoor Roth. Our contribution limit to a 401(k) for last year was about $57,000. Well, if I take my $19,500 match and then my employer matches let’s say $5,000 into there, I can then take that remaining portion and make after-tax 401(k) contributions. I won’t get a deduction for that extra dollar that I’m putting into my traditional account and I end up with that same kind of proration. However, if I am closing out that account or rolling it all over, I can choose to roll just those post-tax dollars into a Roth 401(k) or if I’m leaving the employer into a Roth IRA but that has to be done at the time that I’m leaving that employer or pulling all of those funds out.

Mindy:
Okay. Can you clarify the $57,000 contribution limit that you just mentioned because I know what you’re talking about, but I know there’s people who are like, “No it’s 19.”

Steven:
Okay. There’s different parts of your 401(k) contribution limit and there’s elective deferrals and then there’s room for matching contributions. That total limit last year was $57,000. Now $19,500 of it was elective deferrals which I as the employee can choose to make into my retirement account. My company can then provide matching contributions. If I earn $500,000 a year and my company matches 5%, well, that’s an extra $25,000 that’s going to get matched into that account as a profit sharing contribution, that’s great. I’m almost at that $57,000 limit. But let’s say I earn $1 million and they put in 5% of my salary. Once I hit that $57,000 total contributions, I’m cut off. Now, my employer’s contributions are going to go to traditional. Go ahead, Mindy, sorry.

Mindy:
No, I was going to say with the after-tax is now confusing as well but continue your… Don’t let me interrupt you. This is your show.

Steven:
No, you’re great. Let’s say I earn around $100,000 a year and I take that $19,500 elective deferral and I put it right into my traditional 401(k) or maybe my Roth 401(k), either one, it doesn’t matter. My company matches 5%. Well, 5% of my $100,000 they put it in a traditional contribution so now I either have $24,500 traditional or I have $5,000 traditional and $19,500 Roth or any probation that you might choose to contribute. Some people do 50, 50, 75 to 25, it doesn’t matter. I have the ability, depending on your employer, some don’t allow this. You have to check the plan, but you can put in your own dollars and say, “I want to make excess contributions to that account until I get to that limit.”

Mindy:
A combination of my contributions to my 401(k), my company’s contributions match to my 401(k) and anything after-tax can’t total more than $57,000 for the last year, okay.

Steven:
That’s correct. The combination of all of those cannot exceed that $57,000.

Mindy:
Okay. Let’s say I put my after-tax dollars in there.

Steven:
Mm-hmm (affirmative).

Mindy:
Does the same pro rata rule apply to my after-tax 401(k) dollars as my after-tax IRA dollars?

Steven:
It can, it definitely can. And that’s why we have to be very careful about how we’re putting those in or when we’re putting those in. And when we roll over, we want to make sure that we split those balances appropriately. We often do what’s called an in-service rollover so I’ll put that money into the traditional and then roll it right over to the Roth.

Scott:
It seems to me that a way to simplify this, if someone hasn’t set anything else up, I have my 401(k) at the company. Let’s pretend it’s all in the 401(k) pre-tax, I’m sorry. And I have my maxed out contribution plus a match and I’m at that $24,500, it’s $100,000 income in play. If I want to put the remaining what $23,000 or so, however much we need to get to $57,000 or is that $33,000?

Steven:
Probably about $30,000, yeah.

Scott:
Yeah. I should probably shouldn’t do that in my 401(k). I should probably open up a separate post-tax IRA where I’m only going to contribute post-tax dollars if I want to do a mega backdoor Roth, is that right?

Steven:
Can. But you can also simplify it by keeping it in that 401(k). I want to put $6,000 extra into my 401(k) account and then I can convert that over in-service while I’m still working for the employer, I can move those after-tax dollars and just those after-tax dollars if I want into that Roth. I can contribute it then convert it right away just like I would convert from a traditional IRA to a Roth. Now, you’re asking why I might want to do that. There’s a big reason I might want to do that. Later on, if I know I’m planning to leave my employer and I’m going to 100% self-employed, I may want to open up a solo 401(k) for myself. I can roll that Roth 401(k) and that traditional portion into their own components later on. And by doing that, I will actually be able to invest in things without tax that I may not have been able to do before without incurring tax.

Steven:
If I’m in a Roth account, Roth 401(k), if I invest in a syndication, I’m not going to be subject to any taxes such as UBIT or a debt finance tax, UDFI, inside of that account. If I did that in a Roth IRA, I would be subject to those taxes. Now, I didn’t explain what UBIT and UDFI are here but I’m going to do that right now for you guys. UBIT is unrelated business taxable income. That means if I am operating a business or I am investing in a way that is not the typical manner, I will end up with tax on that income in that retirement account. It’s a way to level the playing field from everybody just opening up businesses inside of their retirement accounts. Now, UDFI is unrelated debt-financed income. Almost every syndication is debt-financed so if it’s 70% debt finance, 70% of my net profit could end up being taxed inside that IRA.

Steven:
We look at that plan for trying to keep funds in a 401(k) wherever possible because there’s a small little rule and that little rule says that there is no UBIT or UDFI so we’re not going to [inaudible 00:24:53] with any tax on real estate transactions inside of that retirement account. This is why it’s very, very important to one, get qualified help and two, talk to your accountant before you make a move. There’s nothing worse than being a Monday morning quarterback. I just rolled this all over and once it’s in a Roth IRA, I can’t move it out of a Roth IRA.

Mindy:
Okay. You’re reading my mind because that was going to be my next question is, we’ve just dropped a ton of information that could be relevant to somebody, could not be relevant to others. Who is the person that I want to talk to, to get the proper information because I know you’re an enrolled agent which is I wrote it down because I don’t even know,

Steven:
I wrote it too.

Mindy:
I wrote it down.

Steven:
No, you’re employed, you’re good. I’ll do a quick explanation for you. There are three people that can represent you in front of the IRS. A CPA, an enrolled agent and an attorney. CPA is a certified public accountant. They’re licensed by each individual state. They can sign off on a financial statement. We don’t sign off on financial statements but we are licensed nationally. I don’t have a jurisdiction issue. If I move to Florida or I move to Texas, I don’t have any issues with licensing. I can just open up shop, operate from there however I want. That’s why we have clients in all 50 States and I can hop into any state, work with someone or partner with someone without any problems. And then your attorneys, CPA enrolled agent attorney. By all right we all have the same representation rights with the internal revenue service so I have 25 to 50 open audit cases with the IRS at any given time. We do more representation work in one year than the average CPA does in their career.

Scott:
Wow. What I’m gathering here is that you specialize in certain types of accounting and finance but are not limited to specific states with this designation.

Steven:
That’s correct. I like to explain it this way. The CPA designation is an inch deep and a mile wide. You have people that specialize in different areas. Some might work as a CFO. I have CPAs that are clients because they don’t do tax.

Scott:
Got it.

Steven:
Make sure that the person you’re talking to specializes in tax. We on the other hand as enrolled agents, what we focus on is tax. Less accounting, more tax so we’re that inch wide and mile deep.

Scott:
Okay, got it. If I’m a W2 employee and I’m approaching some of these limits for these types of things, you’re thinking about moving into business in general, what would you kind of say is it… Besides talk to a CPA or enrolled agent or a professional about this, is there a person I should talk to?

Steven:
I think I know what you’re trying to ask and I’ll jump into it a little bit more. Now that I explained what an enrolled agent is because a lot of people don’t know and we get called CPA all the time and even if I correct them, it still comes up. What you’re aiming at here is, who am I going to talk to about this specific topic to get more information? And in reality, you’re going to talk to either an investment broker who probably isn’t necessarily going to steer you towards the self-directed retirement account because they want to collect fees. Your accountant may or may not know any of this. I teach a class on these topics and two other accountants and it’s a very convoluted topic and very specialized when we’re getting into self-directed retirement accounts. You may get some information from a nonprofit accountant but ultimately at the end of the day, I’m going to be honest with you, you’re going to run into needing to talk to somebody who knows what they’re talking about.

Steven:
Now, as you know, I’ve been very, very active on BiggerPockets. We have a couple of specialists that are on there. I’m not going to mention names. I don’t know if I’m allowed to do that or not here but there’s a couple of specialists on there who I can definitely recommend to talk to but if you want to talk about this tax strategy side, I’m the only one of my friends that I know that specializes in this to this extent so it’s a whole other world. It’s a whole other world than the average 1040.

Scott:
Oh, I love it here. Let’s talk about some other specific cases here and questions from the audience. One of the big things that we’ve come across in some of our finance reviews and those types of things are about borrowing from your 401(k) or Roth and those types of things and well in general, Mindy and I think are really comfortable with the strategy of like, don’t do that if you’re going to finance a long-term investment with a short-term loan in any form regardless whether they ask for your 401(k) or home equity line of credit or whatever, but can you walk us through the specifics of where you see that being a really valuable case, a really valuable use and where it might not apply.

Steven:
I can. I’m going to start with, if it doesn’t make dollars it doesn’t make sense. Okay, I think I just quoted Ludacris there but that’s a whole other story.

Scott:
Nice.

Steven:
I use it all the time because when we make our decisions, what’s our risk, what’s our reward? And we have to really look at, what are the odds of this being successful? I can’t borrow from an IRA. I can do a one rollover a year that’s indirect and that’s every 12 months so I can take those funds out and within 60 days, I have to put it into another IRA account. That gives me a very tight timeline to finance something or to invest it in a business or anything that might turn over. That’s not even enough time necessarily to do a flip, there’s no guarantee it’ll close. With your 401(k) though, you can take a loan of 50% of the balance up to $50,000 and I can stretch that out typically over about a five-year period and I’m paying that interest right back into my retirement account. I think the 401(k) is superior over the IRA until I get further in years in which they send me to roll those over for retirement purposes.

Steven:
But my initial goal is really going to be to try to find something that’s going to be worthwhile in that timeframe. If I can borrow it at 5% from my retirement account and make that investment happen, I may want to consider otherwise, maybe I should make that investment with my retirement account or inside of it. That’s always a possibility too but facts and circumstances are really going to [inaudible 00:31:42] that as far as some successful options, I have a client he borrowed $50,000 from his 401(k) plan and he just lends it to people that are building tiny homes. The [inaudible 00:31:55] 14% interest rate.

Scott:
See, I like that because I think that fits in with the philosophy that Mindy and I have around that. It’s like, it’s a short-term loan that you’re borrowing and you’re just arbitraging an interest rate, you’re getting a higher rate of interest to finance those types of things. And I bet you, even though you tell me, but I bet you that your client could find other sources of liquidity to repay that loan in the event that one of his tiny home builders or she defaults on that payment, right?

Steven:
I think in that specific situation, yes, they’re doing pretty well. They also do some other lending out of their 401(k) account, solo 401(k) account.

Scott:
That’s the problem with this is I feel like borrowing from the 401(k) in a lot of the cases that I understand to be successful is when you don’t need the money but you’re using it to juice some of your returns in general rather than that’s the key, you have no other source of liquidity to get access to.

Steven:
I will agree to a certain point. There’s also the side of it. Maybe I need some extra cash on my end and I’m trying to use those returns to help fund my next down payment. That’s a reason why my borrowed so I have that income outside of that retirement account and it’s not a perfect solution but it’s a solution. Some people are 401(k) heavy and they don’t have a whole lot of cash liquidity and that can be a problem. If you have too much in your retirement accounts and not enough access to cash so you really have to be very careful about it. Some people, especially [inaudible 00:33:28] Roth, Roth, Roth, Roth, Roth. That’s great but if you’re in a position later on and you want to make some donations, well, I might want some traditional funds to do that with and let that be pre-tax. Get an induction now for it. Let it 10X later on and then contribute that 10X tax-free to that organization.

Steven:
On my end though, I know a big thing that we talk about with financial dependents movement is conversion ladders, the Roth conversion ladder. I know you guys had a bit talked about that a little bit pre-show with me but that Roth conversion ladder can be really great and what we do is in those lower income years, we convert from traditional to a Roth IRA because prior to retirement, I can pull out my Roth contributions and they’re not subject to penalty, they’re not subject to tax. There’s an ordering limit for that Roth IRA for when I take out my contributions or take out any funds. First, it comes out of my contributions, then it comes out of earnings. And if I pull out of earnings before $59,500, I’m going to be subject to that 10% penalty and it’s going to be taxable. Now, a big common question that I get is about that five-year seasoning. Yes, funds need to season for five years inside of a Roth IRA in order for them to be considered Roth funds and post tax.

Steven:
Well, if I’m 59 years old and I just start contributing to a Roth IRA for the first time at that point, I will still need those funds to season for five years. That account has to be five years old in order for me to get that Roth treatment.

Mindy:
Can I borrow from the principal in my Roth and then repay it back?

Steven:
Only in that 60 days scenario that I mentioned before and you can only do that about once every 12 months.

Mindy:
Okay. And that’s my Roth IRA. Okay, because I had used the 401(k) loan. I have self-directed income, I’m sorry, self-employment income so I have a self-directed 401(k) and I have borrowed from that. Well actually, my husband and I both do so we borrowed 50 from each account when we bought our most recent house. I didn’t want to invest this house with my 401(k) because then I couldn’t live here and I do the live-in flips. We borrowed the money and then we refinanced into a mortgage and paid it back.

Steven:
That’s a perfect example of a situation where it might be worthwhile and in addition to that, if you’re borrowing from your 401(k) for primary residence, there’s actually an increased payback timeframe in some plans of up to 10 years.

Mindy:
Oh.

Steven:
Instead of that normal five years, sometimes it might be up to 10.

Mindy:
That’s good to know. Okay, you mentioned the backdoor Roth and the mega backdoor Roth but I didn’t hear what the difference was.

Steven:
Okay. The mega backdoor Roth is a strategy we use with your 401(k) plan. The backdoor Roth is what we use for our IRA.

Mindy:
Okay.

Steven:
Mega backdoor Roth has a higher limit than [inaudible 00:36:29]. I can effectively put almost up to $57,000 into a Roth account in that year if I use that strategy fully.

Mindy:
And can I do that every single year if I had the funds?

Scott:
At any income level.

Steven:
Every year, every income [inaudible 00:36:47].

Scott:
Wow.

Mindy:
Okay. We’re recording this in January. Do I have until April 15th to make these contributions for last year’s account?

Steven:
Yeah.

Mindy:
Wow. Because I had a lot of real estate income last year. Scott, does our plan allow it after tax contributions?

Scott:
I have not personally done a mega backdoor Roth so I don’t know.

Steven:
You can ask me me after the show and we can either look at the plan together or what we can do is we can you talk to your provider about it. I don’t know who helps set up your plan but-

Scott:
I wasn’t looking at that when I set up the plan so yeah, I don’t do this for a living. All right. Moving on from mega backdoor Roth. Can we just go back to basics for a second here? What is a Roth 401(k) and the difference between a Roth 401(k), a Roth IRA and a 401(k) there, if any?

Steven:
Do you want the short and quick version because I can give that to you very easy.

Scott:
That sounds great.

Steven:
It’s just like your Roth IRA but with the higher income limits or higher contribution limits with no income limit.

Scott:
Is it typically only available to someone through their employer?

Steven:
That’s true.

Scott:
Okay.

Steven:
That’s correct. It’s going to be your 401(k) but post tax contributions, that’s it.

Scott:
It’s basically, does your employer offer a Roth 401(k) option. If so, fantastic news. You now have the option to contribute $19,500 to your Roth instead of 6,000, right?

Steven:
Correct. Now keep in mind that $19,500 [inaudible 00:38:30] referral is between traditional and Roth combined. Sometimes we’ll split that difference in between them, half Roth, half traditional or maybe 75, 25 and we can adjust that percentage even year over year or change it throughout the year.

Mindy:
Okay. You’re saying I can’t contribute $19,500 pre-tax and then $19,500 post-tax?

Steven:
Into the Roth, exactly. But what you can do is that $19,500 pre-tax and then make your after-tax contributions into that traditional high rate bucket or the traditional 401(k) bucket, sorry.

Mindy:
Okay. I’m going to make after-tax to my 401(k)-

Steven:
Your traditional 401(k).

Mindy:
And then my traditional 401(k) and then I’m going to immediately pull that out and put it into my Roth IRA.

Steven:
Into your Roth 401(k).

Mindy:
Oh, so I can’t take 401(k) and put it into IRA?

Steven:
You can but there’s limits on when you can do that.

Mindy:
Okay. Then I need to start… Now, I have a self-directed solo 401(k). Can I do a self-directed solo Rock 401(k)? Wow, that’s a mouthful.

Steven:
That will depend on your plan. I like to look at it this way. We have a traditional Roth IRA but then we have a traditional or Roth 401(k) and they operate exactly the same function. Your Roth in traditional IRAs function that way, your Roth in traditional 401(k)s operate that same way up here.

Mindy:
Okay.

Steven:
And that is the kind of flexibility but once funds end up in a Roth IRA, I can not roll them over. Out of curiosity, can I share my screen on here with you guys real quick?

Mindy:
I might have to give you permission, but go ahead and try.

Steven:
I want to show you guys a rollover chart here. It is disabled. I want to show you the IRS’ rollover chart for where we can move funds. All right, here is our rollover chart directly from the IRS. This sums up where we’re really from and where we can roll to. One of the things I want to point out is in this top row, if I have money in a Roth IRA, that’s this column right here, the first one on the left, I can contribute to a Roth IRA or roll that to a Roth IRA but I can’t move it to a traditional or a simple or a SEP or a 457 or even a designated Roth 401(k). I can’t roll that anywhere except into another Roth IRA. Now on the other side there, if I go to my very bottom, I’ll see a designated Roth account.

Steven:
I can roll that from that Roth account to a Roth IRA but not a traditional, simple or SEP or 457 et cetera, but I can roll it over to this last one here, another designated Roth account. I can move Roth 401(k) to Roth 401(k) but only in the case of a direct trustee to trustee transfer. I have to move it from that account to another account and I can’t touch it. Now, this is where we start to get into some complex items where we have to talk about it, we have to plan and make sure that we’re not going to accidentally violate these rules but I’m going to jump into our second category on this chart.

Scott:
Can I just interrupt for one second here?

Steven:
Go ahead.

Scott:
What would be a situation where I’d want to move money out of a Roth and back into a pre-tax account?

Steven:
I can’t.

Scott:
But what would be a situation in which I would desire to do that?

Steven:
The only desire I can think about that would be if I’m going to incur or want to have some income at some point in time and when we want to have income would be items such as charitable donations that we can use on pre-tax basis. A lot of my clients who have very heavily funded Roth accounts will go back and put funds into the traditional account just so later on when they know that they get towards retirement, I don’t feel like taking that check but I want to leave that over to charity.

Scott:
Okay. Yeah, we’re just talking about the concept of flexibility with this but it seems to me that the goal in a general sense with limited specific exceptions is to get as much money into the Roth IRA in the end state as possible.

Steven:
Theoretically, yeah.

Scott:
Yeah, okay.

Steven:
Theoretically, yes. 99% of the time we’re going to want those Roth funds. Now there’s going to be situations though as we run into contributions limits or higher earning years where I’m going to want to put it into a traditional so I can lower my tax burden.

Scott:
Yes.

Steven:
Let’s say I’m right at the cusp of a threshold, I may want to put into a traditional IRA or 401(k) in order to get below a phase out like say indexation credit phase out.

Scott:
Yeah. If you’re at a high income tax bracket, then you want to defer the taxes, yes, but ultimately I’m just saying, if you’re listening to this and you’re watching this and you’re like, “Oh shoot, I’ve already put a lot of money into the Roth IRA,” you haven’t really hosed yourself or done anything wrong. You could be maximizing a larger opportunity if you’re putting it all into the traditional IRA or the 401(k), one of these pre-tax accounts because you have more flexibility and can do more with that but it’s not bad to have the money in a Roth. It’s just a small percentage difference that will be difficult to calculate in terms of opportunity.

Steven:
That’s correct. And the reason why we want to look at this plan, it has more to do with our options. The reason I like that Roth 401(k) account so much is because if I decide I want to self-direct it later on, I don’t ever have to worry about tax on real estate transactions. That’s probably one of biggest frustration that my clients end up having is they come to me and I have all this money in a Roth IRA and I want to invest it in a syndication. You’re going to end up with a tax bill on it and then they’re upset and, “Can’t move it anywhere?” Well, unfortunately, no, I can’t move it anywhere.

Scott:
Got it, okay. That I think is the biggest… It sounds like there’s a case to have a substantial amount in the pre-tax IRA but also be thinking about strategically how do I at the end state shift that into the Roth ultimately whenever I want to withdraw it, if I can.

Steven:
That’s correct. I would rather keep it in a 401(k) as long as possible until we start doing say our Roth conversion ladder. At that point in time, that’s where I will really want to make those adjustments but a 401(k) plan is far superior to an IRA at first when you’re working or if you don’t know what you plan to invest in later on.

Scott:
Here’s an interesting one, a case where this could… Where if you’re listening and you’re into real estate at all, suppose you’re a high income earning W2 or whatever and you don’t really have much you can do about shielding your income from taxes besides the 401(k), you put all this money into a 401(k) or a tax-deferred retirement plan and then you retire a few years later and you begin investing in syndications after tax. Well, let’s say you get your real estate license hypothetically and you’re now a real estate professional. You’ve retired from W2 and you begin investing in syndications. Can I use that syndication loss? A lot of these syndications lose money in the first year as they encourage transaction fees or whatever to maybe have negative income in one year, transition my 401(k) over to Roth to a certain extent and then use the remaining funds to invest in other syndications where I don’t incur that long-term tax. I will incur of course, tax in this syndication ultimately over the whole period if they do well.

Steven:
And if you’re in a low income tax bracket, later on, I’m not worried about.

Scott:
Great. Okay, just personally curious.

Steven:
It’s a lot of fun and there’s no specific right answer when we’re planning. It’s all about what’s going to be best for your situation. Everybody comes in and they say, “What do I do? What do I do?” Well, what are your goals? Where do you want to be? How do you foresee the future go? You could win the lottery, it can change our entire plan in an instant but we could inherit funds that you’d never expected to inherit and it can change that situation altogether.I had a client who inherited about $2 million in an IRA. Well now she has to distribute that out within the next 10 years. Well, when she has that nice lovely tax bill from that traditional account, it’s going to hurt. We’ve had to plan our distributions. Well then she got a nice, lovely new job with [inaudible 00:46:53] stock options so now she’s in a higher bracket than we had planned and getting limited on what we can do at that point as far as shielding or sheltering income.

Scott:
It sounds like the goal is not necessarily if you’re in a high income tax bracket to still contribute to a Roth then. It seems like there’s just so much more advantage from what you’re saying here. And it’s probably like a moving target, but maybe like 70, 80% of folks in that higher income threshold to really just go with the 401(k) rather than the Roth.

Steven:
Actually, I find that more contributing to the Roth. They’re [inaudible 00:47:33] set up in that [inaudible 00:47:35] limit and they’re going to be there for a while. I’m going to give you guys a story and I’m sorry for going off on a tangent here, but I had a client who rolled over about $328,000 at the end of 2012. That $328,000 is now worth about 2.2 and we converted that from a traditional 401(k) to a Roth 401(k). Now, he was in the higher tax bracket. He made about $143,000 in federal income tax that year. He’s turned that into 2.2. Let’s say hypothetically, I did that same thing in traditional or Roth account, when I withdraw that 2.2 from a traditional account, unless I am in the 22% tax bracket, that’s going to be about 440 in income tax that I’m going to pay as I withdraw that in that bracket, 440. let’s look at the other side of it. If I pull those funds out of a Roth account, I’m going to incur zero tax. He wrote a check for $143,000 so he never had to write a check on those funds again and that’s why the emphasis on Roth is so important. And by the way, he still has another, more than a decade and so he’s 59 and a half.

Scott:
Well, I guess the fundamental question I’m trying to get at here is like, I’m sitting here and I’m listening to this podcast and I’m asking myself, “Should I be contributing to my Roth IRA, my Roth 401(k) or my 401(k)?” And so in that situation-

Steven:
If you can contribute to Roth, I would do Roth first.

Scott:
Okay, that’s awesome to hear because I was thinking the other thing, the other way based on what we’re talking about with all the flexibility you’ve got with the 401(k).

Steven:
Well, keep in mind, when I say Roth it could be a Roth 401(k) or a Roth IRA. I would rather have fund be in a Roth 401(k) because I can later move into a Roth IRA or I can move into a self-directed 401(k) later on. My goal being that I can move those funds and invest how I see fit. That’s why I try to avoid the direct step into that Roth IRA until we’re really looking at things like that conversion ladder.

Scott:
Yes. [crosstalk 00:49:54] For example, this fellow you just mentioned with the 300 or so who wrote the $443,000 check. If he had just contributed that to a Roth and apples to apples it’s not always apples to apples, but if that had just already been in Roth he would have the same effect, maybe paid even less taxes because he would have contributed some of that in a lower income years prior to that buildup, right?

Steven:
Exactly.

Scott:
It would have been better to just have it in the Roth to begin with than to have rolled it over and paid the check. Is that fair?

Steven:
That is correct.

Scott:
Okay. I’m trying to get to… Fundamentally, all this boils down to like, I have extra cash. Do I put it into the Roth, do I put it into the 401(k)? And then, how do I put more into if I have that extra cash available and to what extent do I do that?

Steven:
Now, some people are going to rely depending on cashflow, they’re going to rely on that immediate tax benefit and I like to use those traditional contributions to a traditional 401(k) or traditional IRA is a tax planning measure more than anything. I can maneuver myself into certain income limits or thresholds or phase outs but I’d rather Roth all day long.

Scott:
Okay. And you’d rather Roth even with the caveat that you really can’t invest in some of those real estate things through your IRA without incurring UBIT or the-

Steven:
Correct. And that’s where if you’re self-employed, I would be trying to put that into that Roth 401(k).

Scott:
Love it. Okay. And that’s to kind of [inaudible 00:51:24] I’ve personally been doing so maybe I was lucky rather than smart because personally, I have a Roth 401(k) through our employer, BiggerPockets and I have the 401(k) option and in spite of being in a relatively high tax bracket, I still just dump all of the money into the Roth 401(k) and have for a long time because I personally feel that even though I’m in a high tax bracket today, I’ll be in a high tax bracket tomorrow and next year and the year after and perhaps if I am arrogant enough to think so, I will be in a higher tax bracket at the time when I reach traditional retirement age and for me it seems like it’s a safe bet to assume the tax brackets will be high and my asset base will grow enough to keep me in that high tax bracket long-term and that they’ll probably go up one day.

Steven:
And that exactly… And there’s no crystal ball. We can’t see the future and know exactly what it’s going to look like. Trust me, if I could I would, but what we can do is we can plan for it today. We can plan what we anticipate our income to look like next year. If you’re really in a higher income this year, substantially higher than next year, I might say, you know what, let’s contribute to traditional this year and roll it over next year when you’re going to be in slightly more of a tax bracket.

Scott:
Yeah.

Steven:
That’s the section where I’ve been planning out because I have a one off-year or a slightly higher bonus and I know the next year is probably going to drop, I will plan [inaudible 00:52:45] that.

Scott:
Okay. Let me ask you this. I’ve got money in a Roth 401(k) or a Roth IRA and I eventually leave the workforce and build a self-directed plan or something like that. You just mentioned that real estate and some businesses you can’t invest through the Roth IRA to avoid taxes with that. What are some great alternative investments that you can do with a Roth IRA that you’ve seen effectively applied besides maybe just stocks?

Steven:
Hard money lending is going to be one of the big ones, private lending. You can invest in different joint ventures. Really, the sky’s the limit on it as far as far as what we can do. The big key is just avoiding things that are specifically active. I don’t want to actively split in my retirement because then I’m going to be subject to those taxes. I don’t want to debt finance a rental in that retirement account if I can avoid it because I will end up with a tax bill on that full range of percentage. That’s really where that planning side is going to be a little bit more convoluted and confusing as far as how those numbers are going to end.

Scott:
Okay, great. What I’m hearing, I’m an employee right now listening to this which I think is going to be many of the folks listening and I’ve got a Roth or 401(k) option and it’ll vary depending on the year which one I’m going to contribute to more. But in general, I’m going to favor the Roth, and one day when I’m no longer doing that through my employer plan, I will have all of these other options potentially to invest those funds through. I usually can’t do that through my employer plan, is that right?

Steven:
That’s correct.

Scott:
Now, with the employer plan, do you see any specific things that I can do with the money wallets in my employer plan in the meantime or is really that limited?

Steven:
It could be that limited. It depends on also dollar threshold. Sometimes you might be at a dollar threshold where it might open up more investment options. I do have some clients who their 401(k) plan is actually actively managed by their broker and they’ve just chosen to invest it in that way and have somebody manage it for them but not every plan offers that ability so it’s really going to be the employer dependent.

Mindy:
Okay. Last week we spoke with the mad fientist and he has an unbelievable article about accessing your retirement funds early. We talked to him way back on episode 18 about how to access your funds early and a quick recap is the Roth conversion ladder which we’ve talked about a little bit, the 72T substantially equal periodic payments or even just paying the 10% penalty. Do you, Stephen Hamilton as Mr. Tax have any additional ideas for accessing retirement funds prior to age 59 and a half?

Steven:
In reality, there aren’t any other ways that we can specifically access those for our personal use. And we’re going to run through that headache over and over again. These are our major options and when we plan those out, we want to plan gracefully because we could end up actually costing ourselves more accidentally. If you come to me in December and say, I’m thinking about withdrawing or pulling these funds out, well, I would’ve told you let’s look at the numbers and possibly prorate over two years and then even if you have a 10% penalty, it’s going to put you in a position where you’re not going to end up all in one tax bracket or maybe some of it’s spread out over two different tax brackets.

Mindy:
Okay.

Steven:
Planning is in all of those.

Mindy:
Kind of hoping for some amazing other offer that you just have.

Steven:
[inaudible 00:56:26] unfortunately.

Scott:
Well, let’s move on to kids. One of the challenges here and this is… Some parents will have different philosophies on this whether they want to give to their kids or not, but supposing that you do want to build a lot of wealth for your child early in life, how can I use retirement to do that? I believe you have to have income to contribute to a Roth but you mentioned something about maybe not earlier-

Steven:
You’re correct. They do have to have some type of earned income in order to contribute to that Roth and that’s really going to be dependent on what activities they’re doing. I have clients who are in the marketing business or in the real estate business and they use their kids to help them paint, help them cut grass. He goes to the property to do maintenance, he has the kid cut the grass while he’s changing out a faucet or a door handle, et cetera. And he pays the kid for that actual work or I have clients who they’ve used their kids in marketing materials and they pay that a small licensing fee for it. You have to document activity actually done by the child and paying a reasonable wage for that work or let’s say, they start umpiring baseball and softball, babysitting, cutting grass in the neighborhood, that’s earned income.

Steven:
Well in that case, self-employment comes through a lot of those but they’re going to be able to use that earned income in order to contribute to a traditional or a Roth IRA. More than likely we’re going to want to use a Roth IRA, more than likely we’re going to want to use a Roth IRA [inaudible 00:57:55] tax brackets because that gives them an access to pull those funds out later on.

Scott:
What’s the extent of this? For example, can I pay my newborn baby $5,000 for marketing because I photograph them and post them to my company’s Instagram page to get to that income limit? What have you seen is the extent to which this is deployed?

Mindy:
I’m going to jump in here because I want to quote Stephen just a moment ago. He said you have to pay them a reasonable wage and how I have seen that mentioned, referenced in the past is, would you pay somebody else $5,000 to do that same job?

Steven:
Correct. That’s exactly the way would to put it. Would you pay somebody else that amount for that job?

Scott:
My baby is definitely cuter than all those other babies which makes them… Sorry, I’m getting [crosstalk 00:58:44]

Mindy:
You’re really going to have a baby.

Scott:
I know.

Steven:
Everything’s negotiable. I’ve seen situations where children have been paid per view or per thousand views and that’s what their contract states. The more exposure, the higher the compensation. Think like a royalty. How do you expect to negotiate it?

Mindy:
Oh, nice. My kids are older, they were darling babies and I should have gotten them into modeling but I didn’t. They are older now and they do pet-sitting for friends and my friends… My kids, I don’t want pets. I don’t have time for pets, I got bit as a child by a dog.

Mindy:
I don’t want to have pets and please don’t email me at [email protected] to tell me why pets will change my life, I don’t want pets but my children are in love with animals. They want all the pets and I’m like, “When you’re 18 and you move out, you can have all the pets you want.” But we have a lot of friends who have pets who also travel. When they’re traveling, my kids will watch their animals. We were doing it for free but then people would leave them money and over, when was it? Last year, they were doing three different dogs and had $10 a day, that’s $30 a day times 10 they’ve got $300 times every single holiday and walking dogs for people who were at work and on and on and on, they could have quite a bit of income.

Steven:
Yes they can.

Mindy:
That’s earned income.

Steven:
Yes it is and it’s taxable. I know too many people choose to not file a tax return on it which technically is incorrect.

Mindy:
Okay. We’ve got like 50 questions in this. What is-

Scott:
And costs you money because it costs you wealth long-term because you can’t use that to put into a Roth.

Steven:
Bingo, I’m going to jump into that.

Scott:
And what’s the difference to that?

Steven:
If you earn over $435 of self-employment income, it’s reportable because in some states [inaudible 01:00:42] filing requirements so I’m going to use the federal filing requirement which is about $12,000 and then we have a state filing that will require… For example, I’m in Illinois. Our filing requirement is about $2,000. If you have over $2,000 in income, you have to file a tax return. So just because the [inaudible 01:00:59] might be another. Now in cases where I may want to do that, I am going to want to report that income through that child so I can say it was her own income so I can fund that Roth IRA.

Steven:
Even if they pay a tiny little bit of state tax, it’s worth it for me because of that long-term growth. You can contribute that $6,000 into that Roth IRA year over year or run it into retirement calculator and see what it’s going to look like by the time they’re retirement age or you can even look at what’s it going to be by the time that they’re 40. And they will have that principle that they can pull out in case of an emergency, if they need a house or a car or whatever it might be and they could use that as down payment money by the time that they’re 19 and out of the house.

Mindy:
Okay, I’m going to throw some things at you now and I’m not trying to get around my legal obligations. Do I want to create an LLC? I do have two kids and they’re going to be not necessarily 50, 50 on the animals. Do I want to make an LLC for them so they are officially earning income?

Steven:
Can I be honest with you? You don’t need the LLC in order to report it.

Mindy:
Okay.

Steven:
I decide to start washing windows, that’s a business, it’s just a sole proprietorship. But if they’re engaged in it together, advertising together, et cetera, that would be considered a partnership which would not necessarily need an LLC to be a partnership, it’s just a general partnership. And then you could get an EIN number, report it. Ultimately at the end of the day, if they each pick and choose their own jobs, I would just report it on a schedule C for each of them if that’s the case. But if they decide to start marketing this business together, then it becomes a natural partnership.

Mindy:
Okay. And then do they have to give 1099s to the people that are paying them?

Steven:
No. There’s some businesses that might have an office cat or something like that if they’re going to be gone for the week, they may have somebody come in to pay them. That business would issue them a 1099. You don’t have to [crosstalk 01:02:59] 1099 to the person that’s paying them.

Scott:
I think if the issue get 1099s as well if the amount is over a certain threshold, right?

Steven:
That’s correct. Over $600 for services.

Scott:
Yeah.

Mindy:
Do we want to submit invoices to our clients or we can just say-

Scott:
If it’s over $600 maybe, but maybe not.

Steven:
You can chose to, you don’t have to.

Mindy:
Okay.

Steven:
By all right it could just be handshake agreement. They write you a check and go.

Mindy:
Do they need to pay us in checks or can we take cash?

Steven:
Deposit it all into the business account, that’s number one.

Mindy:
Oh, okay. That was going to be my next question. Do I need to deposit it into my businesses account?

Steven:
I don’t care if it’s cash, check, charge, whatever. Good record keeping is key. A log or a business checking account and go from there, that’s all that matters.

Mindy:
Okay. Now, as the mom who has more money than they do and understanding that they are going to work for this money and then find it really awful to have to put that all into a Roth IRA, can I gift them money?

Steven:
Yes.

Mindy:
That makes up the fact that they didn’t get the money because they had to put it in the IRA, okay.

Steven:
That’s correct. You can do that up to that $15,000 threshold for the annual gift exclusion.

Mindy:
Do I have to keep any records of the gift?

Steven:
Write a check to their account and be done and just list it as a gift or [inaudible 01:04:25] as a gift so you have it for your records.

Mindy:
Perfect.

Scott:
What if I’ve got a kid who would like to spend the money and is not very amenable to the Roth stuff. Can I have them earn income, 5, $6000 and then just gift them $6,000 as well on top of that so that they’re able to move to the Roth IRA?

Mindy:
That’s what I just asked.

Scott:
Sorry.

Steven:
That was exactly what she was just asking [crosstalk 01:04:52].

Mindy:
Because that’s my plan because I totally recognize that they are going to be like, “Mom, I do not want to put this in a retirement account.” I was talking to them the other day and they’re like, “Mom, I’m not even listening.”

Scott:
Yeah.

Mindy:
Wow.

Scott:
Okay. Well that sounds like me then because I was looking through to our next question here which was that while you were answering that so, oopsies.

Mindy:
Oh yeah. This is a personal question for a friend and I think that there could be people… I mean, especially with the crazy stock run-up that we’ve had. I have a friend who has an extraordinarily large position in one stock. Let’s say he bought it for a nickel. His cost basis is nothing compared to how much it’s grown. It split, it split again, it’s split seven times, it’s split… I don’t even know how many times this thing has split.

Steven:
Did he buy it or did he inherit it?

Mindy:
He bought it, he invested. Yeah, there’s no good way. Is there such thing as a 1031 exchange for stocks?

Steven:
There isn’t.

Mindy:
I don’t like that answer.

Steven:
There’s opportunity funds, there’s things like that. One thing I will point out, is he somebody who likes to donate a lot?

Mindy:
He would probably consider donating some of it I mean, it’s a really large position.

Steven:
Regardless, I’m going to get into that. I’m looking at the pre-tax options that he has.He can actually chose to gift that appreciated property without necessarily recognizing the whole thing as income. If he gives a part of it, he can do his donation out of that to replace what he would normally do on a given year and that’s where we’re going to use, I’m looking at it this way is what things can he do off of that? With that one position, is he wanting to divest from that position?

Mindy:
It’s such a large part of his portfolio which is part number two of the question that he would like to be slightly more diversified but I think he just opened up his account once and was like, “Whoa.”

Steven:
Okay. Here’s my recommendation. There’s no 1031 for stocks but we have things like opportunity zones that they can potentially work out. The opportunity zone that benefits [inaudible 01:07:07] as we keep moving here but that large position, I will be doing two things. Number one, I would be looking at some planning with options in order to help protect his position in case of the bottom falling out of that stock and protected from [inaudible 01:07:25]. Think like a stop loss. If it goes up a whole lot, he can set an auction where someone else would probably ended up buying it for that negotiated price and the same thing on the bottom side. Both of those are definitive options that we have for protecting but as far as avoiding the tax on it, he can start chunking away annually on that stock.

Steven:
I’m assuming he has dividend reinvestment in it but he can look at some of those shares that maybe have a higher cost basis and choosing those and selling those tax loss in order to help prorate those gains and sell it in chunks. Alternatively, my final option in reality is he may want to consider possibly [inaudible 01:08:10]. And you’re going to say, why would he want to take a loan on it? There’s a reason he might want to take a loan on it. He may be able to take a very low interest loan on those shares and use those proceeds to invest somewhere else and that will help stopping that blow. He still has that volatility of it, but if he pairs that with an option, it’s going to help… Use it as a stop loss so that value drops well, X amount. It’ll trigger the sale of who’s [inaudible 01:08:40] and we just deal with the tax bill on it at that point in time.

Steven:
He’s one I’d want to sit down with, review over income and review everything to see what we can plan for it but I would use an option and then to protect my position and then I would be looking at possibly borrowing against that holding and in some cases, a margin loan… I have a client who was just paying 1%, 2%, even at 3% it’s still may not be that bad and he can take those proceeds, invest into something else or he can take it and invest it into other shares.

Mindy:
Okay. You mentioned income and dividend reinvestments.

Steven:
Yes.

Mindy:
His position is so large that his dividends are paying him so much that he doesn’t have any room to sell under the income limits, to not pay capital gains. I mean, it’s a great problem to have, totally first-world problems, such a great problem to have, but he’s looking for creative ways to get around that. With the dividend re-investment, is that considered income if you reinvest it?

Steven:
The dividends are still income regardless of whether or not they’re reinvested so he’s paying tax on those dividends that are issued.

Mindy:
okay.

Steven:
And then they’re getting reinvested so he’s not actually getting a check for that, but that new stock that he bought has a new basis about higher rate so that’s why I’m saying those newly purchased shares… Let’s say he gets $50,000 in dividends this year and that buys him 50 shares. Well, once it hits [inaudible 01:10:16], it’s long-term capital gains, he may be able to sell that even though in the last year he might’ve only had a 5% gain. He’s only going to recognize that 5% gain, but then he can reallocate that 50 some thousand dollars. We can start looking at selling our newly acquired shares instead of our old shares that have that nickel cost basis.

Mindy:
Okay, interesting. Okay, this is really, really helpful.

Steven:
It’s a whole [inaudible 01:10:41] plan.

Mindy:
And then my final question for you is in my own personal portfolio, I have a very large position in one stock like 33% of my portfolio is in one stock. How do you know when to sell a stock? It’s performing very well, I don’t want to sell it. Why would you get rid of a well-performing stock? I don’t want 33% of my portfolio in one stock. Where’s the balance and how do you make decisions?

Steven:
Great question. Let me ask this real quick. Is it a stock or is it a fund?

Mindy:
It’s a stock. It’s Apple, it’s Tesla.

Steven:
Perfect, that answered that. I like to lock in games with options. I really do because then I can sit on that position and if it drops, I don’t remember what Tesla is at right now but, Tesla for example is the time that we’re recording this is about $700 and just shy of $770. I might sell an option that triggers at $760 or $765 and that way, if that goes below that or closes at that time below that, I’m guaranteed that I’m getting my $765 share.

Mindy:
But what if I believe it’s going to go to $1,000?

Steven:
Then guess what, you should be fine.

Scott:
Unless you give us down short temporarily below $765 and then shoots back up.

Mindy:
Yeah, if it bops down and then shoots up, I’ve missed that and it’s the whole like-

Steven:
It depends on the options that we’re looking at and that’s a discussion way beyond the scope of what we’re talking about today but-

Mindy:
When you say options, you mean puts and calls.

Steven:
Correct.

Mindy:
Okay.

Steven:
Correct.

Scott:
Index funds don’t have this problem.

Mindy:
Yeah, what did your index fund game last year Scott? Did it match my Tesla shares and this is where I say mine, I should give full credit to my husband. I would never have invested in Tesla.

Scott:
That’s right. I made way less money so I have way less problems.

Mindy:
And I still totally believe in index funds. Everything I put in is in index funds except little bits into Tesla and Apple but, yeah.

Steven:
By all right, I would be looking at what I can do to secure my position from dropping and that’s really going to be that solution. We can get into that a little bit off camera here for you and we can go through a couple of different scenarios, but there’s some things we can do to help secure that position.

Mindy:
Okay. But puts and calls please. Now who can advise about puts in calls because you’re saying options and I think people who aren’t familiar with puts and calls could hear the word option and think you’ve got different ideas around but it’s two specific things.

Steven:
Yeah, correct. And I’m talking about puts and calls. I definitely am talking about puts and calls here and not your stock options either. Puts and calls, which I can both buy and sell puts and calls, will help insulate that position depending on selling the right one. I can take your protective strategy to insulate myself from decreases and that may cost me a little bit of money but I have different options. And I say options, I got a myriad of choices for what I can do or how I want to view that. And there’s some things we can do to stabilize that position. And if it goes below it, I’ll give you an example. I have a client who set one. The share price was at $115 and I said, “Give yourself a little bit of room. What’s the lowest price you’re willing to watch it go to?” And he set a price of about $110.

Steven:
Three days later, it triggered. And then in that phase, it really was a position that he didn’t as much gain. He had about $40,000 in gain on the shares that we ended up selling and [inaudible 01:14:56] be long-term capital gains, 15%. That really was a big deal.

Mindy:
Okay. Lots to think about. Who do I go to for advice on puts and calls? Your CPA and tax [crosstalk 01:15:09].

Steven:
If you want an education on what puts and calls are, your accountant may be able to help you with that. Usually we jump in with the consultation with a broker on that position. For example, I’d partner with brokers all over the country because I have clients with different needs. Someone needs a broker, some don’t. Some go to them and they will just pay them for advice on a situation, on a position. What do I do with this plan? What we do is we take on that CFO role and we bring in the insurance agent, we bring in the attorney, we bring in the broker and we’ll sit down and say, “Here’s our problem and how do we solve this?”

Steven:
And that puts us all on the same page for tax consequences, legal, et cetera. I like a hub and spoke diagram where I explain that and we can bring it all into one place, look at the whole picture, make sure that the client is getting the best thing possible. You may not need to go move your whole portfolio to a broker, I’m not saying do that. What I’m saying is you may want to hop on a phone call and say, “Look, I need a consultation on this. I need to review what I should do.” And there are brokers that will take consultations on that.

Mindy:
This is mind blowing. This is so awesome and I really hope that people who are listening this isn’t their first money podcast episode because this might be a little bit mind blowing.

Steven:
It’s intense.

Mindy:
Yeah, it is intense but it’s so helpful. Planting these seeds, even if you’re not in a position to take advantage of literally anything that Steven talked about today, having it in the back of your head so when you are in that position or so you can work towards getting in that position can be so helpful. Bookmark this episode, come back and listen to it again, go to the video on YouTube and we also have a transcript and I’m going to go through and make sure that everything is really, really… Sometimes the transcription service transcribes the words differently. I’m going to make sure everything’s perfect on this one. Sometimes it’s helpful to see it in writing because we threw out a lot of numbers, we threw a lot of concepts and I’m so excited. Scott, you got to open up the plan so that I can make after-tax contributions to my 401(k) through work because I’ve got some to make.

Scott:
I got to find out if we have that first.

Mindy:
I can only do for 2020 and 2021, correct?

Steven:
For 401(k) you’re stuck with 2021 now.

Mindy:
Oh, I can’t go back and make after-tax contributions to 2020. Oh crap. Okay, nevermind Scott. We’ll open up for next year. Oh, and one last question that is totally personal to me but maybe somebody else’s listening to it too. I contributed to my Roth IRA on January 1st, 2020, I dumped in all $6,000.

Steven:
Yeah.

Mindy:
If I made more money than… And looking at your number, I didn’t, but if I made more money than the married filing jointly, what happens to that $6,000? I had a lot of gains last year. Do I just pull the $6,000 and that’ll be done or do I have to go back and-

Steven:
It gets a little more complicated than that.

Mindy:
Yeah, I didn’t want that answer.

Steven:
If you’re over that threshold and you weren’t finding to be over that threshold, what happens is we have to pull out our contribution plus our earnings on that contribution. There’s a mathematical formula for calculating that and it will prorate your percentage or returns, et cetera, in order to create that allocation. Now, when we pull those excess contributions out and the earnings on those contributions, you are not going to be subject to a penalty.

Mindy:
I get that money back?

Steven:
You get that money back. It’ll be cash in your pocket, correct?

Mindy:
If I put in $6,000 and then I pull the $6,000 out and that $6,000 grew to $12,000, I get that $12,000 back with no taxes.

Steven:
No. You put $6,000 back, there’s no taxes.

Mindy:
What happens to the other $6,000?

Steven:
[inaudible 01:19:10] $6,000.

Mindy:
Wow, okay then.

Steven:
But it’ll be this year for when you pull it out now at this point [crosstalk 01:19:18]. Right, if you don’t catch it during the year, it will be when you actually pull it out.

Mindy:
Okay. Well, but still… Okay, well, that’s good to know. I’m not trying to get around it. That would be a fun example like, “Oh, I put $6,000 in. Oh, shucks, let me pull that $6,000 out.” But I kept the growth or I… But then you get taxed and it doesn’t matter.

Steven:
I had somebody win about $300,000 end of December one year.

Mindy:
Wow.

Steven:
It messed up a few pieces of our plan.

Mindy:
Yeah, I bet.

Steven:
It messed up a few pieces.

Mindy:
Okay Steven. Like I said, this is so mind blowing. I’m so excited and I cannot wait to sit down with my husband and write out our big plan for 2021. Where can people find out more about you if they have questions?

Steven:
Well, I’m actually very active on BiggerPockets. I’ve been on BiggerPockets actually just looked it up the other day, my anniversary is coming up. January 11th of 2011 is when I first signed up on BiggerPockets.

Mindy:
Holy cow.

Steven:
Yes, I have almost 5000 posts, I was actually a BiggerPockets moderator for a while. I don’t know if anybody remembers that far back and then my practice grew and I stepped away and I hop on there, answer questions here and there and I’m active on the BiggerPockets. Facebook groups. Yeah, I stay very active in all of those and you can always tag me if anything comes up. We have a website, Hamiltontax.net. You can call our office, email us. We’re more than happy to sit down with someone and review a situation. I have a great team.

Scott:
Awesome. Well thank you for sharing all this wisdom. Thank you for the 5,000 times that you’ve contributed to our forums over the years and countless other interactions you’ve had with folks around the community. You’ve probably contributed to a large incalculable amount of wealth that you’ve helped people build over that time and thanks for all the wisdom today. I learned a tremendous amount.

Steven:
Thank you guys for having me. This is always fun. Ironically, this is my first BiggerPockets podcast.

Scott:
All right. Well, thanks for having it on the money podcast. We appreciate it.

Mindy:
Yeah. We’re going to have to have you back.

Steven:
Anytime. Just let me know.

Mindy:
Steven Hamilton talks about tax, tax talk with Steven Hamilton. There we go.

Scott:
That’s right.

Mindy:
Okay, awesome. Thank you so much Steven and we’ll talk to you soon.

Steven:
Thank you guys for having me.

Mindy:
Okay Scott, that was Steven Hamilton from Hamilton Tax. Holy cow, I am so excited, I’m so pumped for all of the opportunities that I am going to have this year just based on what I learned from this conversation.

Scott:
Yeah. What a privilege to learn from Steven. Let’s just remind ourselves about his credentials here. He’s an enrolled agent, right, which is a very legit accreditation that he’s got and he spent the last nine years posting 5,000 times over the BiggerPockets forums, dealing with a tremendous amount of nuance, specifically dealing with a lot of people who have built wealth, invested in real estate and invested in a variety of real estate and ventures not just rental properties, not just hard money lending, All these different types of things he’s seen mistakes made, I’m sure he’s made a few mistakes and he’s been around the block and done this and we got a chance to learn from him and have him digest and bring his frameworks to the questions from the community here and I think there were some great questions.

Scott:
I learned a ton I’m doing it wrong and my eyes are open to this and it’s one of those days where you kind of go, “Man, I do this every week with you, not twice a week, and I don’t know what I don’t know about this kind of stuff,” and that’s a humbling state to be in. You’ve got to go from don’t know what you don’t know to knowing what you don’t know before you can, whatever. Know what you know or I don’t know, whatever, moving on.

Mindy:
You’re not so confused.

Scott:
That’s right. You’re not so confused and helpless, yeah.

Mindy:
I have been doing this forever, I have always been conscious of money and frugal and I learned so much this episode and I’m like, whoa. Every time he would open his mouth, I’m like, “Holy cow.” And a couple of times he gave me answers I didn’t want to hear, but I like to know that I can’t do that.

Scott:
I can’t believe you called him a nerd in the intro.

Mindy:
I called him a nerd in the intro. He’s so excited about this. I am so excited about this. I’m super… This is just like… Somebody told me, I used the word excited too much. I’m like, yeah, but that accurately conveys my feelings. What’s better than excited?

Scott:
I love it. I think you would say it every week and that’s what makes you so great Mindy.

Mindy:
I’m excited. I’m excited all the time, but this was like… You said, you do this twice a week and you’re still learning. That’s why we’re here Scott because we don’t even know everything there is to know. I recorded a podcast earlier today and we spoke with Megan Gorman who was on our show a few, two years ago, and she was talking about some tax concept I’m like, I didn’t even know about that. I mean, she’s talking about tax concepts that apply to people who have $30 million plus so I don’t really need to know about it now but it’s good to have.

Scott:
That’ll be all of our listeners within 10, 15 years, if you keep listening to BiggerPockets Money.

Mindy:
Exactly. It’s good to just plant that seed and then when I do get $30 million, I can call her up and say, “Hey, what do I need to know?” Yeah, there are a lot of options available for you if you just know about them and that’s why we’re here. Scott, we didn’t tell a joke today because we did go a little bit long and it wasn’t really that kind of show but I have a joke for you.

Scott:
Oh, what is it?

Mindy:
I got this from Eric. What is the difference between a hippo and a zippo?

Scott:
A potamus?

Mindy:
One is little heavier. One’s a little heavier and one’s a little lighter.

Scott:
That’s so fantastic, I love it. well done, yeah.

Mindy:
Yeah.

Scott:
Bravo. All right. Well, thank you and guys, we really appreciate you spending some time with us today. We obviously enjoyed ourselves, we hope you enjoyed it. If you did enjoy it, please come join us on Facebook and be a part of the community or we always like these reviews that we can get on iTunes, on YouTube or comment there or wherever you listen to the show. Please go ahead and give us a review if you enjoyed the episode. If you didn’t, [inaudible 01:26:04] you’re still out here so we won’t talk about that.

Mindy:
Okay. From episode 163 of the BiggerPockets Money podcast, he is Scott Drench, I am Mindy Jensen saying adios hippos, see because it goes with the joke.

Scott:
Ah, yes.

Mindy:
Okay. Bye.