Each of us has our own unique idea about how we'd like to spend our retirement years, but one thing pretty much all of us can agree on is that we don't want to spend them stressing that we're about to run out of money. To avoid that, of course, requires that we do our stressing in advance and set aside as much as we can, as effectively as we can. Motley Fool Answers podcast hosts Alison Southwick and Robert Brokamp have made it their mission to help people in that endeavor, and every month, they comb through their mailbag. For today's episode, they've invited Ross Anderson, a certified financial planner at Motley Fool Wealth Management -- a sister company of The Motley Fool -- to help out. On the agenda are questions about 401(k)s, IRAs, taxes, asset allocation, picking the right financial advisor, and more.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.
This video was recorded on July 30, 2019.
Alison Southwick: This is Motley Fool Answers! I'm Alison Southwick and I'm joined, as always, by "Rob" Brokamp...
Robert Brokamp: What? Rob?
Southwick: I don't know! Apparently I haven't tried that one yet. Got a little reaction out of you. You don't like Rob, huh?
Brokamp: I can't think of a single person who's ever called me Rob. Maybe one guy at the seminary back in... Whenever that was. 1987.
Southwick: I've got a whole list. We're just going to go through them. All of them.
Brokamp: He's not with us anymore. Just kidding.
Southwick: Uh, in this week's episode, it's the July Mailbag. With the help of Motley Fool Wealth Management planner Ross Anderson, we're going to answer your questions about dividends, and SEPs and SIMPLEs, and how to choose a financial planner. All that and more on this week's episode of Motley Fool Answers.
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Southwick: Hey, Ross!
Ross Anderson: Hey! How's it going?
Southwick: I'm good! Thanks for coming back!
Anderson: Thank you for having me!
Southwick: Man, you just keep coming back...
Anderson: That's true.
Southwick: ... and boy do we appreciate it!
Brokamp: We most certainly do!
Southwick: So Ross is a planner with Motley Fool Wealth Management...
Brokamp: A sister company of The Motley Fool.
Southwick: And he has some very strong feelings on reindeer that we learned just before kicking off the show.
Anderson: It's true. They're delicious!
Southwick: So with that, I think you want financial advice from that man. Shall we get into it?
Anderson: Sure, let's do it!
Southwick: OK. The first question comes from Joseph. "I doubt the common wisdom of holding bonds. The logic seems to be that [1] bonds provide steady income and [2] their value moves as a counterweight to the stock market. The net result is like a balancing seesaw of sorts, where your portfolio would be less volatile than not having bonds. However, I think Dividend Aristocrats or Foolish dividend-focused companies can better serve an income stream in retirement and replace that portion previously dedicated to bonds because [1] they are more likely to increase your income stream and [2] increase your portfolio value over time. What do you think?"
Brokamp: Well, Joseph, by mentioning volatility you really hit on the primary reason to own bonds, especially for retirees. But I would say there's another word that's a close cousin and that is "predictability." If you buy a five-year bond that pays 3% you know exactly how much you're going to get each and every year and how much it will be worth in five years.
[With] bond funds there's a little less predictability, but they're still really stable. Consider that since 1926 the worst year for the bond market was in 1994. That drop was a whopping 5%. So that's what people appreciate about them.
Compare that, of course, to the stock market, where it can drop 30% in any given year. You don't know when it's going to happen. It doesn't happen that often, but we've seen greater declines of 50% or more twice this century. That said, if you are willing to stick it out and you can stand that volatility, there's a lot of reasons to consider dividend-paying stocks [especially higher-quality ones] as an alternative to bonds.
While the stock market's prices will go up and down, the dividends are pretty consistent. When you look at the dividends paid by the S&P 500 since the S&P 500 began in 1958, there have only been two years when you've seen significant declines, and that was one year -- 1959 -- a decline of 12% in the dividends and then in 2009 when they declined more than 20%. And in between those, there was only six years where they declined just a little.
So as long as you can ignore the price volatility, relying on the dividends is an attractive way to create income because not only are they reliable, they tend to grow faster than the rate of inflation by about 1% over the long term; plus, as we'll talk about a little later, qualified dividends have a favorable tax rate.
The only part of me in here is the "awfulizer".
Southwick: Here we go!
Anderson: Here we go! Awfulize it.
Brokamp: Awfulize it. We're always basing this on history and there are times when the future looks different; sometimes in good ways and sometimes in bad ways. So I was thinking if we were having this discussion in 2007 and I would have talked about the historical drops in the dividends paid by the S&P 500, I would say, "The worst was 12%. They've never done worse than that," and then 2009 comes along and it's more than 20%.
So it is possible that the future will look worse. It is possible that we'll go through another stock market decline that looks more like maybe the Great Depression than what we saw so far this century. I don't think it's likely, but I think for that reason, most people should at least have a few years of the money they need -- if they're retiring in the next three to five years -- out of the stock market. But with the rest of it, if they want to go all stocks, that's fine.
And by the way, he mentioned the Dividend Aristocrats. Just so everyone knows, those are companies in the S&P 500 that have increased their dividends for 25 consecutive years, or at least paid them for 25 consecutive years. I think it's increased, though. Maintained them or increased them; so, those are high-quality companies. And you can buy those companies in ETF form if you really want a diversified, easy-to-purchase way of getting high-quality dividend payers.
Anderson: The only thing I would add, that I think is interesting here, is that if you're going to live off the dividends, the likelihood is that you're underspending what you could be and that your portfolio is going to continue to grow, and that's a great thing. I'm looking at the Vanguard High Dividend Yield ETF because it's a ticker I know off the top of my head. It's yielding about 3.3%.
So if you can live off 3% of your portfolio annually, that's a very safe way to do it and you're right. You're likely to see the portfolio continue to increase and that should be a fairly stable payout. But it's going to mean that your portfolio keeps growing and I'm not sure that most of our goals, if we're retirement-focused investors, is to have a portfolio that keeps ballooning as we charge into our 90s. I would rather live on a safe but comfortable portion of that portfolio on an annual basis.
That's the other question there. Is that enough money for you or could you be living a better lifestyle if you chose to treat the portfolio a little bit differently?
Southwick: Our next question comes from Dakota. "What are your thoughts on margin investing; i.e., investing with borrowed money? The current interest rate for margin investing on Robinhood is 5% yearly. My thoughts are if my portfolio does better than 5% -- for example, 7% -- I would be making a full 7% on my actual dollars invested and 2% on my margin investing after the 5% interest is paid."
Anderson: The question, here, I think, is a good one. It's one that I've pondered as to how you could structure this. I think there's a couple of moving targets, here, that make this really difficult to execute. The first is that when we say the stock market typically yields 7-9% or somewhere in that range, that is a very erratic 7-9%. In the last 39 years -- if you look at the S&P 500 and look at how many times it has actually returned between that 7-9% -- even though we think of that as the range and the average that it stays in, it's only been two years.
Most of what we're seeing is big up years, big down years, flat years; so, you don't necessarily have that predictability to say, "Yes, I'm going to put my money in. It will earn 7% and I'll pay 5%. That's cool." If I could do that, predictably, I'd be very comfortable doing that and everybody would do it.
Let's take a year like 2018. The U.S. stock market lost 4.38% on the S&P. If you had made a $50,000 investment -- and you'd taken it up to your typical margin limit at 50% and bought $100,000 of the S&P with it -- through that year you're going to pay $2,500 in margin interest at 5% and then you're going to lose $4,380. You've got a 14% loss on your capital that you invested relative to the market losing 4%. You exacerbate those losses in an unpredictable market. So you've got to be really tolerant of risk to be willing to take that on.
The flip side of that is that if you had ridden that same train all the way through this first half of 2019 you would have made money and that's where this is kind of tough to tell people not to consider it. But you want to be very, very careful using margin because it's going to cut both ways just as fast and when you're losing that money it's tough to hang onto that ride.
The other thing I'll say is that margin interest is generally going to be a floating rate interest. It's not going to stay stable at 5%. We're in continued historically low interest rate times, but I would expect your cost to borrow, there, is going to continue to rise in the future. It may not be this year because we're looking at Fed decreases in rates maybe this year, but long term it's unlikely that you're going to be able to hang on at 5% forever.
I understand the math. I understand why you would be thinking that way, but I think it's much better to play a long game with the stock market and not to invest more than what you actually have to lose.
Southwick: I've never invested on margin. Would Robinhood ever, for example, be like, "Oh, you've lost too much. I'm sorry. We're closing this."
Anderson: Yes.
Southwick: You can't just ride it out and be like, "I know the stocks. This is a bad period, but I know in five years' time this stock is really going to pay off."
Anderson: Most of the time you're going to have an initial margin limit which is normally 50%. You could basically buy double what you have in there. That's why I used the example of you could have $50,000 and buy $100,000 in stocks. Then your margin call limit, I believe, is normally at 30%. And if you get less than 30% equity in the account they're going to start selling for you.
Southwick: Lock in those losses.
Anderson: You're not going to get to choose the day. It is going to be a violent experience because they're going to protect their money more than yours. They do not care if you lose money in that process. That doesn't make them an evil company. All brokers treat it that way.
You basically end up in a position where they could say, "We're going to sell your positions unless you add more money right now, because you've lost too much of our money." It's a very risky proposition. I would not recommend it unless you're very, very comfortable with a lot of risk and you consider yourself a pretty sophisticated investor.
Southwick: The next question comes from Bernie. "I am 50 and want to make sure my wife and I are doing everything we can for our financial health." Isn't that awesome?
Brokamp: That is nice!
Southwick: "Starting with listening to Answers." That's not what he said but I'm putting those words in his mouth.
Brokamp: It's implied. It's implied that's what he's doing.
Southwick: He's keeping good company. "With that said, who should we see? I assume a financial planner. If so, what credentials should they have and what fees would be considered reasonable?"
Brokamp: Well, Bernie, I would start by asking yourself what kind of help you're looking for. Are you looking for someone to just manage your investments? Are you OK doing that on your own? Are you looking for someone to help you with your retirement plan? Or are you looking for someone who wants to look at every aspect of your finances and look at the whole thing comprehensively?
I would start there -- knowing what you're looking for -- and then look at fee-only financial advisors that are in your area or elsewhere if you're comfortable working with someone online or over the phone. The places we often say you can go find a fee-only financial planner are the Garrett Planning Network, National Association of Personal Financial Advisors [NAPFA], or our very own Motley Fool Wealth Management.
You can go online, look at profiles, see who's offering what you're looking for. I would say choose, maybe three and then just meet with them. Most of those folks will offer a free meeting. At Garrett they call it the free "Get Acquainted" meeting. You talk about what you're looking for. They can tell you whether they provide it and then you can choose a fit. If you want someone to manage your money many firms have minimums; so, you have to bring over maybe $250,000 or $500,000 of investments, so that's something to keep an eye on.
The next question was how to get paid. Generally speaking, if you want them to manage your money, you're going to have to pay a percentage of your assets each year. The average, these days, is about 1%. And then if you do that, they will often throw in the financial planning services with that. If you just want the financial planning, they usually pay by the hour or by the project. The hour these days, is around $150-300 an hour. Project is $1,500 to $3,000. I've heard upwards of $5,000.
What determines the price? Partially the experience of the financial planner. Someone who's more experienced can charge more; but, also the complexity of your plan. If you have businesses, if you have real estate, if you have a lot of assets scattered all over the place you're probably going to end up paying more.
When it comes to credentials, I'm a little biased, but I would say the gold standard for financial planning is the certified financial planner designation which just so happens to be something that both Ross and I have -- the CFP designation. We had to take six classes, pass them and take a test.
Anderson: I think it's seven classes now.
Brokamp: Is it now?
Anderson: Yes, it's gone up.
Southwick: When you say it like that, though, it doesn't make it sound that hard.
Anderson: Well...
Southwick: Could you make it sound a little harder? "We had to take seven whole classes and pass a test!"
Brokamp: Well, I don't know about your test, but when I took the test it had a 55% pass rate.
Southwick: There we go.
Brokamp: There we go. Does that sound a little better?
Southwick: Yes, thank you!
Anderson: It's a 10-hour national board exam, basically; at least when I did it, and they've shortened the exam time, now, too. No, it was a brutal experience.
Brokamp: Right. If you are looking for investment expertise, you'll often see the CFA. That's the gold standard there. That's really tough. That's three tests. That is a tough designation. Neither of them I would say are necessary, but what they indicate is that it's someone who has taken the time to learn as much as possible about their profession and take their profession very seriously.
A couple of things I'll point out, though. Make sure when you find someone to do a little background check. You can look up something called BrokerCheck and see if anyone filed any complaints against someone. If someone's been in the business for a long time, they probably do have a few complaints. What you want to see is how it was resolved.
And if they say they have a designation, make sure they actually have the designation and when I say this, I bring up a recent Huffington Post article by Casey Bond. It asked the question "who is Patricia Russell, CFP?" She's mentioned in many articles. Quoted all over the internet. It turns out that after Casey Bond looked into this, this person doesn't exist.
So not only is this person not a CFP practitioner, it's not even this person's real name. If you look on her LinkedIn page, it says she went to MIT and Oxford. It's a pseudonym. It seems to me, based on what I read in the article is it's just a front to send people to this credit repair company.
So as you come across someone, do a background check and don't take everything they say for granted.
Anderson: The other place to look is the SEC's website. It's AdviserInfo.sec.gov and "advisor" is with an "er." I think we still disagree in the industry on how to spell advisor, but that's the investment advisor public disclosure search, because somebody like myself is a registered investment advisor. I'm not a broker. I used to be. I used to have that brokerage license, but FINRA BrokerCheck would say I'm not registered, even though I'm still licensed through the SEC.
Brokamp: I'm going to add here that if you go to the CFP website and look up my name on Find a Planner, you're not going to find my name because I don't offer any services. There's another site where you go just to verify, and both Ross and I are on both of those. You're also in Find a Planner, by the way. Just so you know in case anyone checks up that Bro is a big liar.
Rick Engdahl: Maybe you need to take another test.
Anderson: Yeah.
Brokamp: Could be.
Anderson: Can't wait!
Southwick: The next question comes from Chuck. "I am 61 years old, retired, and receiving a pension from both the Federal government and the military. My wife and I have significant amounts in IRAs, a 401(k), and the Federal Thrift Savings Plan. We also own commercial real estate in San Francisco and an annuity that pays me until I turn 69 and a half, just in time for Social Security, which will be twice the amount of the annuity. The income from the pensions, real estate, and annuity is enough to make our living expenses.
"My question is when determining how to allocate our portfolio between stocks and bonds, can we consider the pension as equivalent to a very safe bond or long-term annuity? If so, should we feel relatively safe allocating everything in our IRA, TSP, 401(k), and brokerage account to stock?"
Anderson: Chuck, I appreciate the question. I appreciate your military service. It sounds like you put yourself and your family into a really great position. When you've got enough income coming in from essentially guaranteed sources or sources that are very stable, you can really choose to treat the investments however you'd like.
Now, I don't think of a pension identical to a bond in the sense that you can't rebalance out of it. If you thought of yourself as being the kind of guy that would have had a 60/40 portfolio or even an 80/20 -- meaning 80% stocks and 20% bonds -- that pension isn't a replacement for the bond because if the market has a crash you can't sell the pension and buy more stocks, so you've lost the ability to rebalance.
But in terms of the amount of risk and volatility that you can accept, it's really up to your own stomach acid, because at this point it doesn't sound like you're relying on a distribution from the portfolio assets to support your lifestyle. At that point, it really becomes a determination of how comfortable are you with risk? What are your goals in terms of growth on those assets? If you want to be all in stocks, I think you can afford to be.
Brokamp: I would say the same thing. Now obviously his situation is that he has a very secure pension. With the federal government and the military he's going to be fine. I'll just say to anyone else out there, you want to make sure that you have a safe pension before you go all in on that and have everything else in the stock market.
Anderson: The way I think about it is we're going to look at your portfolio and ask, "How much do we need to take from the portfolio on an annual basis to support your lifestyle?" For some people, if they don't have any pension assets and it's purely Social Security, for example, we might be needing to take that 4-5% withdrawal rate, and so the amount that they're going to need to protect if there's a market downturn is going to be at least three to five years of that amount.
So a 25% bond allocation might mean that you can go through a four or five-year drought in the stock market. The less that you're relying on the portfolio and the more pension income you have covering those needs you can be a little bit more flexible with how aggressive you get.
Brokamp: And Chuck, if you're looking for someone else who agrees with you -- and this actually touches on Jonathan's question about bonds -- The Globe and Mail recently interviewed Harry Markowitz, who is the Nobel Prize-winning father of Modern Portfolio Theory [MPT]. He's almost 92 years old. They asked him how he is investing these days and he said, "I own very few bonds because I've got my teacher's pension, I've got my Social Security, and frankly I have enough in the stock market so that even if it drops I still have plenty of money." So he has very little in bonds and he's not going to be interested in bonds until they get to at least 4%.
The other aspect I would add about that is that he's almost 92 and he's still working. He's still writing books, he's still consulting, he's still on the faculty at UC San Diego, so that's a whole other aspect for him. He's got his situation taken care of.
Anderson: That's always my favorite Buffett fact. People want to invest like Warren Buffett and I'm like, "Do you realize he's in his 80s and still working?" That's the first thing to growing your wealth by a lot...
Brokamp: Yes, that's true.
Anderson: ... is that you don't stop at 65.
Southwick: The next question comes from Brent. "I know if you make zero to $38,600 your capital gains tax rate is 0%. Does that include your capital gains dividends? For example, I made $37,000 last year but received $3,000 in dividends and capital gains.
Because I'm now over $38,600 will I owe tax on the dividends and gains? Additionally, is this income amount before or after deductions and credits?"
Brokamp: Let me clarify a few things, here, for you Brent. I'm sure you understand this, but I want to make sure everyone else understands it. When he's talking about these lower rates on dividends and capital gains, we're talking about qualified dividends. Most people who hold onto a stock for more than 120 days means your dividends are going to be qualified. I just want to make sure everyone knows that. And we're talking about long-term capital gains, so stocks that you hold onto for at least a year.
And he highlights something that is really interesting, in that if you are under a certain income threshold, your qualified dividends and long-term capital gains are tax-free. You don't pay any taxes on that. Now he has the number from last year --2018. The number for this year, 2019, is up to $39,375 if you're single. If you're married filing jointly, it's up to $78,750.
And part of the answer to his question is that is your taxable income. So you start with your gross income and you take away your deductions and all that type of stuff. So you could be a married couple of earning almost $100,000 and still have some of your long-term capital gains and qualified dividends be tax-free.
Now, what happens in his situation is he had $37,000, but then he had $3,000 in dividends and gains. The part up until that threshold will be tax-free. The part over that threshold you will be taxed on, but not the whole part; just the part that is beyond the threshold.
For anyone who is in this situation -- who's in a lower tax bracket this year -- it makes sense, actually, to even just sell the stocks up until the point where you're not paying any taxes and then you can buy them back immediately and reset your cost basis. It sounds a little like tax-loss selling, but this is tax-gain selling, in a way. With tax law saying you can't buy the same thing back in 30 days, it's not true with tax-gain selling. Sell it, recognize just enough capital gains so it's tax-free. Buy it again immediately and you reset your cost basis.
[...]
Southwick: Our next question comes from Collin. "I'm 26 years old and my credit history is comprised solely of student loans and a car loan. No missed payments for either, resulting in a fairly decent credit score of 730, apparently held back mostly by my age. Could my credit be improved by signing up for a credit card? How about security when shopping online, and if so, how do you recommend shopping around for a credit card?"
Anderson: Collin, I love that you asked this question and I love the framing of the question; that it wasn't, "I've got some extra stuff that I want to buy, so should I get a credit card so I can buy it?" You're asking it the right way. You're looking to improve your credit.
Let's talk about what goes into that credit score first of all, because there's a couple of big factors. The biggest piece of it is your payment history, so by continuing to pay on your student loans and your car loan -- no missed payments, don't be late -- that's a huge part of it.
The next really big chunk is what's called a utilization ratio. This is, I think, poorly understood, but it's basically how much of the credit that has been extended to you is being used. It's a very big deal.
The next is going to be how often are you checking your credit? How many hard inquiries are against the credit? How many times are you letting people ping it and see if you're creditworthy?
And then the final thing is going to be your length of accounts and how long they've been open, so that account history and then also the credit mix. They look at how many different types of accounts do you have? Is it just a student loan? Is it all credit cards?
In this case I think it is going to improve your credit. It may not be immediately in the short term, but I would have you get a credit card and I would be very careful with it. So a couple of things to note.
No. 1 on that utilization ratio, the number they really look for there is 30% or less. If you get a credit card and they give you $1,000 limit, you never want to have the balance sitting at more than $300 on that credit card. Being very responsible with the amount that they give you is going to improve your credit.
No. 2 is you're going to start the clock on that credit history so that you've got a longer length of time that you leave that card open. That's going to help. And again, it's going to help the credit mix a little bit.
Where you may take a hit in the short term is because they're checking it, so you're going to have a new hard inquiry on your report. That's not a big deal. Again, I think over a couple of months' time you're going to see it tick up from a 730 to maybe even higher than that, assuming that you're using the credit very responsibly. Pay it off every month. Don't pay interest. I think it is a good idea for you.
There's a bunch of resources online. The Motley Fool now has one called The Ascent. If you go to Fool.com, under the personal finance tab there's a bunch of resources on rated credit cards. I would probably look for one with no fee. You're not necessarily in the points game, yet.
If you ultimately start spending more and traveling, you might want to get into a points or rewards credit card where you're probably have an annual fee in exchange for some nice perks, but for your first one I would definitely go no annual fee and try to get a low interest rate. Don't carry an interest-bearing balance on it.
Brokamp: He also asked about the security of buying things online. In the handful of times that we've had problems, including maybe two months ago we were charged around $700 on our credit card from Nordstrom. The credit card company has basically eaten that cost. You just have to stay on top of it and keep an eye out for it.
Anderson: As long as you open up a case with a fraud department, what they will normally do very quickly is shut down the card and send you a new one. Most of these companies -- I don't know of any that don't -- are not going to hold you responsible. That still doesn't mean to be crazy with your data. Don't put it out there on your Facebook posts. Don't put a photo of your credit card number anywhere on social media. I've actually seen that.
Southwick: Look! I got a new credit card!
Anderson: Be as responsible as you can. Try and work with merchants that are reputable. Look for the security lockbox thing on your web browser if you're going to put your number in, but most of the time you're not going to have a lot of liability there.
Southwick: The next question comes from Elise. "Can you please explain the logistics of how a 401(k) can be both a traditional and a Roth? IRAs can only be one or the other, so how does the 401(k) work? Is it true that all your contributions go in one place and are just broken out on paper or can you invest in some things with your pre-tax money and other things with Roth money? And what happens when you leave the company and roll over the money to an IRA?"
Brokamp: Elise is absolutely right in that when it comes to the 401(k), it's not an all-or-nothing decision. You can make both traditional and Roth contributions. Furthermore, even if you just choose to make Roth contributions but you get a match, the match is going to be traditional and when you take that money out in retirement, you're going to be taxed on it.
How does a 401(k) account for these two buckets of money? Well, the answer is it depends on your plan, so you should contact the administrator of your plan directly. However, for most if not all plans, it's handled proportionately and to use Elise's words, it's really broken out on paper. You don't have two separate accounts, like a Roth account and a traditional. It's really just an accounting thing that's just coded in the account.
Let's consider an example. Let's say you contribute $1,000 a month to your 401(k) and you decide that 50% should be traditional and 50% should be Roth and, furthermore, you're choosing to put half of it in a stock fund and half in a bond fund. You usually cannot say, "I want my Roth money to go into the stock fund and the traditional to go into the bond." It's going to be split proportionately.
Furthermore, when you pull up your account online, chances are it's not going to break it out right there. It's just going to show you your overall balance and you're going to have to dig a little bit, to find out exactly what is Roth and what is traditional. Just as an example, for The Fool 401(k), to figure out how your account breaks down between Roth and traditional, you have to click on View Account, then Account Activity, and Search Options, and then Source as in what's the source of the funds. So you do have to do some digging, but it really is just on paper. They don't have two separate accounts.
When you leave the company and you roll it over, then you can separate it. You can roll the Roth portion into a Roth IRA and the traditional portion into a traditional IRA. In fact, that's the way you have to do it and that's one of the benefits of it, because then you can let the Roth keep growing for as long as you want because there are no RMDs -- required minimum distributions -- on a Roth.
Southwick: The next question comes from Dave. "I consider myself pretty well informed when it comes to retirement savings, so it surprised me to learn there was another retirement savings vehicle that I was unaware of: the simplified employee pension. Can you talk about why someone would open one? While doing research, I also learned about the SIMPLE IRA -- Savings Incentive Match Plan for Employees. Is this something I'm eligible for as someone who is self-employed? My business is classified as an LLC."
Anderson: First of all, I appreciate that Dave said the name of the acronym because I so often just see the acronym of a SIMPLE or a SEP, which is typically the simplified employee pension. I was going to have to look up what the actual full name of it was again just to talk about it, so thanks, Dave!
Yes, as a self-employed person there are a number of plan options, and I'm going to try and give you some guidance on how to think about it, but I don't know that I've got enough information about your business and what you're trying to accomplish to give you a perfect answer.
The SEP IRA is really attractive in a number of ways, because No. 1 they are super easy to administer. They're very low cost to set up. There's not a big hurdle. It's pretty much the same as opening a brokerage account.
Brokamp: I think it's literally a one-page form.
Anderson: Yes. We work with them and support them. There's two extra questions from a typical IRA, which is what's the name of the company. What you're allowed to put in there, as a self-employed person, is up to 20% of your earnings or if you're paying it as compensation to employees, it's 25% of the employee's comp. That is a very easy plan to use.
Now, if somebody has been with you as an employee for three out of the last five years, you have to make a contribution for them, as well. For an employer that has a bunch of people working for them, if you're trying to contribute 20% of your compensation to the plan, that can get fairly expensive pretty quickly, so these tend to work really well for small companies where it might just be you. If you don't have any employees, they're a great option. Really easy to use -- or if you're also looking to make a nice contribution for your employees as a retention benefit or whatever you're going to do there.
The SIMPLE is also going to be fairly easy to administer. They're set up for companies with less than 100 employees. You can also put in a lower amount of money than the SEP. So on the SEP IRA you can put in up to $56,000 for the year. On the SIMPLE, you're going to be capped at $13,000 for 2019 so you've got very different contribution limits there, and the amount that you have to put in for the employees on the SIMPLE is going to be a lot less. It's either 2% that you're immediately doing for them, whether they put anything or not, or it's a dollar-for-dollar match up to 3%. So you've got different kinds of levels that you're going to have to contribute.
Now if your head just started spinning as I went through those numbers, what you really need to step back and think of is what you're trying to do. How much income are you trying to save? How many employees do I have and are you willing to or able to do something for them, as well? And then if you're working with an accountant or somebody for your business already, I would ask them this question, because they're going to know how profitable your business is or how much you're trying to put away, and they should be able to guide you into a correct plan.
The other one that comes up with us when we're talking to clients is the solo 401(k). You can do a 401(k) that's just for a single-person entity. There are reasons that that could be attractive. For example, if you've got a business that you make $20,000 a year on the side, as a 401(k) you can do a salary deferral of up to $19,000 this year with the catch-up.
You could literally defer almost all of your income for the year and put all of that money away; whereas in a SEP IRA you'd only be able to do the 20%. So the amount that you're trying to save vs. how much you want to maximize those savings gets really hairy pretty quick. Somebody that has an intimate knowledge of your business and how much it's earning, I think, is going to be in the best position to give you a really good answer.
Southwick: Our next question comes from Ben. "We've all heard a lot of concerns about the next big recession, bubble, or drawdown; so a lot of people are preparing for this event. Given that previous bubbles -- such as the internet bubble and the financial bubble -- were caused by irrational, unprepared exuberance, what might the next recession or bubble be? Would it mean a faster, sharper drop or might it not be not much of a drop at all?"
Anderson: It sounders like Ben has been reading some Robert Shiller.
Southwick: Has he been an "awfulizer" lately?
Anderson: Well, he wrote Irrational Exuberance. I was just relating to the use of that "exuberance" word.
Brokamp: So the answer, Ben, is nobody knows.
Southwick: Nobody knows...
Brokamp: But I do want to address the question. It is coming up more because, as we talked about in a previous episode, we are now in the longest economic expansion in U.S. history, or at least since the 1850s when they started marketing these things. Leading up to it, people are like, "Oh, boy, this is getting pretty long in the tooth. Maybe I should play it more defensively." But it probably didn't work out so well, because this year has been pretty good.
Anderson: How many years have you been asked this question?
Southwick: 10.
Brokamp: Since the first day we started doing this podcast.
Anderson: That's the tough part about this question. You could say, "Well, it looks a little long in the tooth. Things look a little pricey." You could have said that since 2012 and you'd still be right.
Brokamp: And I have been, probably since 2014-2015, referencing the Shiller CAPE, the 10-year cyclically adjusted price-to-earnings ratio which looks very high. For years people like me -- and many others -- would say, "Well, the stock market is high and historically when the stock market is high, future returns are not quite so good." But it just hasn't come through, which is why one thing we have always said is you're just never going to be able to time these things.
I do find it interesting to read about them. For example, there's a company called Osterweis Capital Management. They came out with their July report. And they basically suggested that maybe the economic cycle is somewhat dead. It used to be caused by inventory. What would happen is during the beginning of a recovery people would have some money. They'd go out and buy stuff -- actual stuff -- and the company would be like, "There's more demand. We're going to hire more people. We've got to make a lot of stuff." It would be this cycle until eventually they had too much inventory and people weren't buying all of it, so companies had to start laying people off and dropping prices.
Anderson: Dropping prices.
Brokamp: But these days so much of our economy isn't inventory.
Anderson: Services.
Brokamp: It's services. It's data. It's the internet. And technology, itself, is very deflationary, so it keeps prices down, which is another thing that can cause a recession; too much inflation. So do I really believe that the economic cycle is dead? Probably not. I do think things are different and I do think that there's no way to predict how any of this is going to happen.
There is another interesting article by Mark Hulbert in CBS MarketWatch. It basically showed some data and said what we do know is that the severity of a bear market is not historically related to the length of the bull market beforehand, but the severity is somewhat related to the valuation of the market before the market tanks. This would suggest that when the bear market eventually does come, it will probably be more severe than average.
But as was discussed earlier on the show, history is a very imperfect guide, so we don't know. The bottom line is the same stuff we always say. Have enough cash on the side. Also, the big thing I think people need to think about when it comes to a recession is not just your portfolio. Your job is threatened, so always be focusing on making sure that your human capital is doing well. Your job is secure. You have a back-up plan if something happens.
Southwick: I don't remember the internet bubble, not because I'm so young, but maybe because I'm so young. Do you remember during the internet bubble that you were thinking, "This is a bubble. This can't last." I remember during the housing bubble thinking, "This is unsustainable. Housing prices are bananas. This is not going to last." But I wasn't working at The Motley Fool back then.
Brokamp: I was. I started in 1999. Rick was here, too. I would definitely say that I personally thought that this time was different. We are living in a new world. The internet is such a disruptive technology. Investing has become more democratized. All these things I certainly bought into.
In talking about things being different, if you had said to anyone at The Motley Fool in 1999, "Oh, by the way, the next decade will be the worst decade for stocks since the 1920s, including the Great Depression," we would all laugh at you. But that's what happened. From 1999 to 2008, the S&P 500 for the first time ever lost money every year on an annualized basis. So things can be different than the past.
Engdahl: We were right about everything being different because of the internet. We were just a decade off. Now it's different.
Anderson: And it really has changed everything. It's changed how we do business. How we do banking. How we get information, but it didn't necessarily change that valuations can go absolutely bonkers and be sustainable.
Brokamp: We've talked on a previous show that Australia hasn't had a recession since I think 1990. Can we do something like that, too? I don't know. I don't think it's likely, but I wouldn't mind it.
Southwick: I think we need to do some on-the-ground research in Australia to really find out.
Brokamp: I think that is a great idea!
Anderson: On location.
Southwick: Let's get a boondoggle set up. Can we make this happen?
Engdahl: Let's take this show on the road.
Southwick: Last question is from Elton. "I have a question about something you discussed on your May 28th episode. You remember that, right, Ross? That there is an exception regarding moving employer stock into an IRA. Can you tell us more about that? This is the first time I've heard of it and if true, it sounds like it could be a way to reap some tax benefit by not having to sell appreciated stock."
Anderson: My first question -- just going back to that actual episode -- was that a discussion about net unrealized appreciation, because that's what it sounds like the question is related to.
Brokamp: Yes! [Whispers] I don't remember exactly.
Anderson: I'm going to assume that's what the question is about, Elton, because I think you're dancing around that. So net unrealized appreciation is essentially a strategy -- if you've got employer stock in your 401(k) -- to move that employer stock out as part of a rollover, but you'd deal with it differently in terms of your taxation. For the purposes of the discussion, let's pretend that all of the money is pre-tax. Let's ignore Roth 401(k) entirely.
If you've got a stock in there, let's say over the years you've put $50,000 into that stock and it's now worth $250,000 of value inside your 401(k). If you roll all of that money into an IRA, it's going to move over. There's no taxes as part of that, but what does happen is they liquidate everything. They take you to cash, they send you a check and you put that check in your IRA.
At some point, when you start taking withdrawals, either because you need the money or because there's a required minimum distribution, all of that money that comes out is going to be taxable as income to you.
NUA is a little bit different. At the point of the rollover, if you said, "Hey, listen, I want to take my company stock for XY&Z. I'm going to pay ordinary income taxes on the $50,000 of basis and then I'm going to move that entire piece of stock into a brokerage account." It's like you bought the stock for $50,000 and just held onto it. So it's still worth $250,000 and the $200,000 of unrealized gains are ultimately going to be treated as long-term capital gains.
So the difference, there, is you're going to accelerate some income in the year that you do this, because you do have to pay taxes on the basis when you do it, and then you're ultimately going to treat that stock as a long-term holding in a brokerage account. So you're not moving the stock to an IRA. You're moving it to a taxable brokerage account or just an ordinary brokerage account, but if you have highly appreciated employer stock in your 401(k) plan, this is a pretty powerful strategy that could potentially save you a lot in taxes, because paying income taxes on $250,000 is very different than paying income taxes on $50,000 and capital gains on the other $200,000.
So I think what's what you're talking about. If you've got highly appreciated employer stock, that's a huge opportunity. Make sure you don't roll over that 401(k) without talking to somebody or going through it with a financial professional to see if that makes sense for you, because I think that's a big deal and once you lose the opportunity there's no going back.
Brokamp: I would second that, too, because not every company stock plan is the same. There are different versions of it, different rules, and you definitely want to talk to an expert before you make a major decision about such a big chunk of change.
Southwick: All right. That's it for the questions! Ross, thank you so much for joining us!
Anderson: I love being here! Thank you guys for having me!
Southwick: We'll have you back again and get more of your hot takes on elk meat, which most of the audience didn't get.
Anderson: Reindeer meat.
Southwick: Sorry, reindeer meat. Not elk meat.
Anderson: I was in Northern Finland. It tastes like beef.
Southwick: Oh, really?
Anderson: Not gaming?
Brokamp: That is the home country, right?
Anderson: From my mom's side, yes.
Southwick: So next time it's just going to be an all wild game-related mailbag. How does that sound?
Brokamp: Try a different piece of meat in between each question.
Southwick: Different kinds of jerky. Let's make it happen.
Anderson: All you need to get me here is add food.
Southwick: Let's head to the other part of the mailbag.
Brokamp: The post mailbag?
Southwick: Where people say stuff rather than ask stuff. First off, I want to thank the people who left some reviews on iTunes. Did I ask recently for this? Because we got four new reviews on iTunes.
Brokamp: Well, that's very nice!
Southwick: Oh, they said the nicest things. You should go read them. I'm not going to read them all, but I do want to say thanks to [I-O-Ish] and Bruce and [AV44308] and Isaac for leaving some really kind reviews. It warms our hearts.
Brokamp: It certainly does!
Southwick: And for not saying that my voice is obnoxious.
Brokamp: Or mine. Too nasally. Too mumbling. Whatever. [laughs]
Southwick: [laughs] Let's head to the postcards. First off we have Michael, who delivered his postcards via the David Gardner Delivery Service. So David was in China and Michael gave him a postcard for each of us from Tianjin.
Brokamp: Dang! These are cool!
Southwick: They're like slides, almost.
Brokamp: They are.
Southwick: You can look through it and see a boat going down a river. We also have Becky from Phoenix who sent a card from Cassis, France. She's taking in the lavender and sunflowers and vino. Lou sent a card from Baltimore, but not the Baltimore you're thinking. Did you know there was a Baltimore in Ireland?
Brokamp: I didn't know that!
Southwick: Look how cute that is! Almost as cute as our Baltimore. Chuck sent a card from Fountain Hills, Arizona, which he says is the epitome of a retirement community so maybe we have another option outside The Villages to check out at our retired age.
FiftyBillionCent is back on the road -- stocks! -- and sent in a card from Johnson Space Center. He was down there rebuilding homes that were destroyed by a hurricane. Shoots sent a card from Mount Rushmore.
Brokamp: Very cold! Wow, look at that!
Southwick: He says he puts us on the Mount Rushmore of financial podcasts.
Brokamp: Oh, isn't that nice?
Southwick: And he also sent a card from Pompeii Stiller, Montana. PT sent a card from Guam. I think it's our first.
Brokamp: Oh, that's pretty! Wow!
Southwick: Isn't that pretty? And also sent a card from Honolulu where he perhaps rhetorically asked, "What's the deal with timeshares? Socks!" He put socks on instead of stocks. David sent a card from Poland and also yelled, "Stocks!"
Brokamp: Ooh, Krakow! Oh, Krakow is such a pretty town!
Southwick: Is it?
Brokamp: Yeah.
Southwick: I've never been to Poland. A guy named, again, Rob Brokump, I think is his name, sent a couple of cards from Alaska.
Brokamp: One from Mount Rainier, actually. Thank you very much!
Southwick: Oh, sorry. One from Mount Rainier.
Brokamp: And then one is from Alaska.
Southwick: One's for me and one's for you, by the way, Rick And our face is on the stamp, because this is delivered via the front desk woman.
Brokamp: That's right. Why spend money on a stamp when I could just drop it off? Stamps!
Southwick: We have Christian. Remember him? He works just down the street at the old PO office.
Brokamp: Oh, yeah.
Southwick: He sent us a card from Banff, where he just ran a marathon. Can you imagine?
Brokamp: And that's gorgeous!
Southwick: Isn't that gorgeous? I need to go there sometime. You're going to recognize this face. This is Don and he sent us a picture from Custer State Park with goats. You remember Don.
Brokamp: Oh, yes. And he's wearing his Motley Fool short with a goat.
Southwick: Yes, with a goat. And then we also have [Eddie and Tiera]. You remember Eddie. They are from Hawaii. They are doing their 50-state tour and so they sent cards from Death Valley, Arizona and Joshua Tree. And also, Eddie, if you are listening -- and you probably are at some point -- our address is 2000 Duke Street, not 200 Duke Street.
Brokamp: Did it get misdelivered?
Southwick: No, they made it here, but someone keeps furiously writing "2000!" on it instead of 200. So Eddie, 2000. And for the rest of you, for that matter. Please send us a postcard. We love it.
Brokamp: 2000 Duke Street...
Southwick: Alexandria, Virginia, 22314. And feel free to send us cards from boring places, because those are the states that we need to tick off the list.
Brokamp: Do we have an official list?
Southwick: Yes, I keep a list.
Brokamp: Do you?
Southwick: Not well, but I do.
Brokamp: The same way you keep score when we have games?
Southwick: Maybe a little better. So that's the show! It's edited "globetrottingly" by Rick Engdahl, who's about to head off to San Diego, too. And he just got back from Boulder.
Engdahl: All over the map.
Southwick: You are all over the map and not sending postcards.
Brokamp: Mmm.
Southwick: That's OK. I don't think I'm going to send you guys one from Yellowstone.
Brokamp: Why not?
Southwick: Because I don't care.
Brokamp: I love Yellowstone.
Southwick: All right, fine. I'll send you guys postcards from Yellowstone.
Engdahl: I'll send one from San Diego if you send one from Yellowstone.
Southwick: Deal! Again, our email is [email protected] and our address is 2000 Duke Street, Alexandria, VA 22314. For Robert Brokamp, I'm Alison Southwick. Stay Foolish, everybody!
