October 26, 2024 - Money Matters Podcast
Navigating direct indexing, Roth conversions, real estate, and AI concerns.
On this week's Money Matters, Scott and Pat discuss the recent lawsuit against AI startup Perplexity by the New York Post, drawing parallels to the Napster controversy from two decades ago. They explore the implications of AI on copyright laws and the risks associated with AI companies' business models.
In response to listener calls from Florida, Tennessee, and California, Scott and Pat offer guidance on real estate investments, including the pros and cons of direct indexing and the complexities of managing multiple properties. They also delve into the benefits and timing of Roth IRA conversions, emphasizing the importance of personalized financial planning.
Whether you're curious about the financial world or need specific advice on your financial situation, this episode is packed with actionable insights and engaging discussions.
Join Money Matters: Get your most pressing financial questions answered by Allworth's co-founders Scott Hanson and Pat McClain live on-air! Call 833-99-WORTH. Or ask a question by clicking here. You can also be on the air by emailing Scott and Pat at questions@moneymatters.com.
Transcript
Man: Would you like an opinion on a financial matter you're dealing with? Whether it's about retirement investments, taxes or 401(k)s, Scott Hanson and Pat McClain would like to help you by answering your call. To join Allworth's Money Matters, call now at 833-99-WORTH. That's 833-99-WORTH.
Scott: Welcome to Allworth's Money Matters. Scott Hanson.
Pat: Pat McClain.
Scott: Glad you're with us today. Myself, my cohost, both financial advisors, we have our podcast and radio program here to help you make wise choices with your money.
Pat: Yes.
Scott: Answer questions you bring to us.
Pat: Twenty...
Scott: Talk about the financial world.
Pat: ...nine years of doing our radio show.
Scott: Twenty-nine, 29 years.
Pat: ... podcast, yes. So now it's us, and...
Scott: Yeah, if you're new to us, welcome.
Pat: ...4 million other people that have a podcast.
Scott: That's about, right.
Pat: Yeah. We're taping the show and at least ours is named something...
Scott: October 23rd. This will be aired on the 26th, distributed on the 26th. But Trump is sitting down with, speaking of podcasts, the number one podcaster in the world, Joe Rogan, Trump is sitting down with him, and I think they're trying to get Harris to sit down with him.
Pat: Yes, not in the same room.
Scott: That would be even more interesting.
Pat: Different times.
Scott: A free-form three-hours conversation between the two would probably be the best sort of debate format we could have.
Pat: Oh, I don't think that's possible. I don't think you could put those two in a room together for three hours. Like, the way she carved him up the last debate. Oh, she knew exactly where to poke him. Oh, it reminded me of my siblings, like my younger daughter knows how to poke Lily, like she just knows how to set her up. Because that's what happened with the last debate, it felt like. Anyway, why are we talking about this?
Scott: Okay, because it's all we can get. It's like, no matter where you turn, it's politics.
Pat: Oh, yes. Listen, I'm just hoping I'm gonna get a couple more unsolicited phone calls before the elections.
Scott: On what to do with the finances.
Pat: No, no, no, unsolicited from someone trying to get me to vote their way.
Scott: What's the point?
Pat: Yes.
Scott: So not anyway. We got a great show lined up. We have several calls, that we're gonna get to. Before we do, oh, I found this quite interesting in the...oh, I feel like I'll sneeze here. I thought you'd continue on as I'm sneezing. But anyway, you're still waiting for me. Pat's staring at me. Thank you, Mr. McClain, only 29 years of doing this together. Where are we going with it? Are we gonna cut this part out?
Pat: Anyway, so this article in "The Wall Street Journal," actually, it kind of set me off a little bit.
Scott: This is this week. It set you off?
Pat: Yeah, it kind of, it made me mad a little bit. So the "New York Post" sues AI startup Perplexity, alleging massive free-writing.
Scott: And "The Wall Street Journal." "Wall Street Journal" and "New York Post."
Pat: So this reminds me of Napster. This reminds me of Napster, right? Which is this AI comes in there, they...
Scott: So Napster, we all remember, this was 20-some years ago, they offered free music.
Pat: That's right.
Scott: Free music, just download Napster, go to their website or whatever, and you get free music until...
Pat: And their point was, "Oh, we're not really actually taking it from the artist. What we're doing is we're taking it from other people's servers. So we're not really breaking the law here because we're just kind of facilitating it."
Scott: That's right. And they got slapped down. Napster no longer exists, but Apple came out with their music platform...
Pat: But they pay the artist.
Scott: They figured out how to pay the artist. Now we've got Spotify, that is an...[crosstalk 00:03:52.778]
Pat: Correct, and Amazon and the rest of them, but this sort of thing just bothers me, and it's...
Scott: But it was in the same way that Amazon, with the books, like, they just scanned the Library of Congress. I mean, they just took...
Pat: Well, those things were out of copyright though. There's a difference doing something out of copyright than in copyright, right? So Amazon, anything out of copyright is absolutely it's fair game, right? That's copyright law. But the mere fact that, you know, AI it goes and scrubs...
Scott: The internet.
Pat: The internet, and it's not really making anything up, you know, well, it makes some stuff up. There is shadow stuff in there, but it's collecting information from all kinds of things and putting them in...
Scott: Including...
Pat: Including articles that other people have...
Scott: That they sell.
Pat: Yes. And they're monetizing. It's the same thing and like, I have two kids that live in...three children that live in Southern California. You'd walk down the streets and you'd see these scooters, Lime, and I said, "Who are these people to think that all of a sudden, any street in America is a retail store for them, that they could just throw this scooter out there on the street and they don't have to pay anything for it, and..."
Scott: Well, that's why some cities have...
Pat: Banned them.
Scott: ...banned them. They got rid of them. They realized it's...
Pat: But it took a while. It took a while. So this AI...
Scott: This is Perplexity. I don't know what other companies have been doing this, but just grabbing their content.
Pat: Grabbing content.
Scott: And using it.
Pat: Right?
Scott: Without paying for it.
Pat: And so now they're getting sued. Without getting paid for it, without paying them for it. I don't even know how you'd price it, but it doesn't work in a fair market environment where we can just go and take other people's stuff and resell it as our own.
Scott: On my iPhone, I pay I think it's 9.99, maybe it's 12.99 a month now for Apple News. Do you use Apple News?
Pat: I don't use Apple News.
Scott: They curate articles from a bunch of different sources, and so I can read articles from all these other magazines and newspapers that I'd otherwise have to pay for, and they pay them a little bit for it, right?
Pat: That's right.
Scott: So I pay Apple...
Pat: And Apple gives it to them.
Scott: They get a nickel.
Pat: Yes. So this AI, and the reason I found this, sharing this with you is, watch this AI is not without risk. This AI will end up...there will be massive, massive suits, lawsuits against many of these AI companies for stealing content, as there was Napster 20 years ago.
Scott: Well, I think, look, we all need to be careful about which applications we're using. If you think you're using ChatGPT to do some research, they're also getting research from you.
Pat: That's right.
Scott: So if you're using it at work and having some trade secrets and all that stuff, and using some program, an AI program, to put together ladders or whatever, unless it's in a closed system, which there are some that companies have employed, but if you're just using the public ones, or there's a program that now people are used to it dictates all of their conversations. "So It's just free, isn't this free? And it's nice. All my meetings, I just have it running in the background. It's free dictation." Like, well, I don't think so.
Pat: It's not.
Scott: No, they're taking your data.
Pat: If you can't figure out who the customer is...
Scott: You're the customer.
Pat: You're the customer. If you can't figure out the revenue source, you are the revenue source.
Scott: Yeah, I know, this will be interesting, because it does feel like, Pat, it's like some of the early days in the internet and what was happening. And the music is a prime example.
Pat: Oh, the Napster thing, I always thought this is just terrible, right?
Scott: But even now, like Facebook, I think "The New York Times," so, "Facebook, you're gonna have to pay us, like, you can't just take repurposed articles."
Pat: Yeah, I don't care who posts it. And Facebook says, "Well, I didn't post it. Someone else posted." And you're like, "Yeah, I don't think that's the way it works, right?" I don't think there's...
Scott: And another thing, you know, you mentioned Napster, they were the early leader in streaming music.
Pat: That's correct.
Scott: They were the big early leader. They're gone. They didn't make it.
Pat: That's right. And many of the AI companies that are the early leaders here will not make it.
Scott: Will not make it. There's so much money flooding into that space. I just read an article, like, they question, like, there needs to be so many billions of dollars, trillions of dollars of productivity that comes out of it, like, some people are already kind of questioning, like, "Are we ever gonna get a return on the investment that's being put into them?" And what's even more fascinating...
Pat: Is the power.
Scott: That's exactly what I was gonna say, the amount of power.
Pat: The power plants behind it, right? We see, was it Microsoft or Google? Which one was it? Was it Google that...
Scott: Microsoft.
Pat: ...was taking Three Mile Island, lighting it back on fire.
Scott: Well, I don't think that's how they...
Pat: Whatever.
Together: Powering it back up.
Scott: All right, firing it back up, maybe not lighting it back up.
Pat: Was it Google or Microsoft?
Scott: I don't know. One of the big ones.
Pat: Yeah.
Scott: And they need the power.
Pat: They do.
Scott: Yeah, it's interesting. Even the data centers, the massive amounts, so much of our power generation goes to...
Pat: It does. Have you used it? I used it. My wife were and I were gonna go for a weekend up in the Sierra foothills, and I went to ChatGPT and I said, "Give me a three-day trip on through this area, moderately priced hotels." We didn't go.
Scott: I was gonna say, some old ghost town at some flea-ridden place.
Pat: Yeah, it's only 69 bucks for the night.
Scott: All right, let's take some calls here. We're gonna start with Martha. Martha, you're with Allworth's Money Matters.
Martha: Good morning, Pat and Scott.
Scott: Good morning, Martha.
Martha: Long-time listener to your very enjoyable financial program. I love the banter.
Pat: Thank you.
Martha: My question is, what is your opinion on direct indexing and the appropriate fee for this service?
Pat: So first of all, is the money inside of an IRA or outside of an IRA?
Martha: Both.
Pat: Who are you talking to about this direct indexing?
Martha: My wealth manager.
Scott: So I'm actually a big fan of direct indexing in the right circumstance.
Pat: Yes, I like it a lot, too, when appropriate.
Scott: And so what direct indexing is, and these were created, really over the last few years because of a couple things. One is the elimination of trading fees when someone buys themselves a stock, right? It used to cost money. There was a transaction cost. Now there's essentially nothing. One could argue there's actually some cost in there, in the system, that you don't see, but essentially it's so low, it's negligible. The second thing is, with technology, now there are tools, technology, tools that can create their own indexes with very little work essentially, the machine does it all. And so with a direct index, let's say you wanna mimic the S&P 500, direct indexing technology would go out and purchase, they're not gonna purchase all 500 companies of the S&P 500.
Pat: They could, but they don't need to.
Scott: They can get highly close, maybe a 99% correlation by owning 250 or 300 of securities. And here's where they work great, and here's where they don't work so well. They work great if you have some new cash that you wanna invest. So in other words you're not triggering capital gains to come up with the cash. You have some cash to invest, a sizable amount, and you've got some capital gains that are either occurring soon or will be in the future, number one. Number two, you are highly charitably motivated, and you plan on gifting substantial amounts to charity in the future. Okay? If those are the case, what's wonderful about these, with direct indexing, you can set up a certain aggressiveness on tax-loss harvesting.
Pat: Can I stop you, Scott?
Scott: Please.
Pat: In brokerage accounts outside IRAs is where these are mostly used. Inside of an IRA...
Scott: I don't see the benefit.
Pat: I can't see it at all.
Scott: It's cheaper just to get an indexed ETF for almost nothing.
Pat: Correct, correct. That's why I pointed that out.
Scott: Yeah, so inside a retirement account makes no sense whatsoever, but on the outside, so you put some money in each fall, or actually throughout the whole year, the technology is looking for opportunities for tax-loss harvesting. And if you look at, say, the S&P500 in any particular year, even a year that it's up 20%, there's gonna be a number of stocks that are down in value. And so they will sell those stocks that are down and buy something very similar.
Pat: So let's say sell Pfizer and buy Merck, right? The way the index looks at it is like, "Oh, these things are roughly equivalent, maybe not market value, but we can adjust through that through our algorithm. And so they can generate a substantial amount...
Scott: ...of capital losses.
Pat: Even while you're making money.
Scott: Even while you're making money. Now, eventually you got to pay the piper, right? So there's no such thing as a free lunch. So let's say you put in a million dollars into a direct index and it triggered $100,000 of losses, and it grew to 1.2 million. And let's say over time, that portfolio grew to $2 million but your cost basis might be $600,000 because they've captured $400,000 of losses over the years. If you go to sell in the future, you will have to capture much more gain than you would have otherwise.
Pat: Unless you die under current tax law, it receives a full step-up in basis.
Scott: That's correct. Or you gift, you cherry pick and gift those that have performed the best, to the nonprofit or donor-advised fund.
Pat: So that's how they work. Tell us about your situation.
Martha: Well, I think what they were talking about was doing it not from my IRA, but from my other portfolio funds. And they wanted to... I do have a tax loss that I've been carrying forward. I think about 200,000 of...[inaudible 00:14:37.251]
Scott: Of tax loss already?
Martha: Yes. And they wanted to sell some stocks so I would have enough to invest 250,000 to go ahead and start this direct indexing.
Pat: And if I looked at your overall portfolio, what's the size of the overall portfolio?
Martha: About 4.7.
Pat: Okay.
Scott: So why wouldn't you have more of it in direct indexing? But if you already have $200,000 of capital loss, but I question the efficacy of this.
Martha: Well, I don't have the cash to do it, so I'd have to sell some stock.
Pat: I understand. So is most of the bond portfolio... How much is in the IRA and how much is in the brokerage account?
Martha: Oh, boy. I think the IRA has about 600,000 and the brokerage has about...
Pat: 4.1 million?
Martha: Yeah, the other accounts have about that in it, yeah.
Pat: And is IRA all bond?
Martha: No, it is not...[crosstalk 00:15:53.130]
Scott: How is it that you have $200,000 of capital losses that you're carrying forward?
Martha: Well, because I can only take 3000 a year. Is that correct?
Scott: No, no. But where did the losses come from? Why do you have $200,000 of losses? Like how?
Martha: Oh, it came from all the stocks that were tax-loss harvesting and all the stocks that had been sold throughout last year, and in previous years.
Scott: Got it
Pat: And so what they wanna do is use those as offsets and make the portfolio more tax-efficient going forward. Does that sound correct?
Martha: I believe so, yes.
Pat: Yeah, I like it.
Scott: I kind of I mean, I don't know, but ...
Pat: I like it.
Scott: I like the intent. But part of my...I'm just questioning, like, what gains are you gonna have in the future? They work well. This strategy works...tax-loss harvesting works really well. If we're gonna realize some gains in the future. If we have a rental house that we wanna sell, that can work fantastic. If there's a business transaction some of their capital gain. If there's a stock that we're over weighted in that we wanna sell.
Pat: But, Scott, this is better than not. You don't know...
Scott: I agree.
Martha: There are a couple stocks that are overweighted in that I should be selling something then off and then I'll have capital gains in that. Yeah.
Scott: Good.
Pat: Okay, I mean, that's where you want to use it.
Scott: Yes. I like this better than owning ETFs.
Pat: Oh, no, I think it's a good idea. I think it's a good idea. It works best with fresh money. But this works pretty well. I mean, it works pretty well.
Scott: Yeah, I would agree.
Pat: Especially if you've got some over, highly concentrated positions that you want to turn back on. I mean, you could build an ETF. You could build a portfolio around those highly concentrated positions as well.
Scott: Which is another thing that direct indexing can do, which I didn't bring up that. Let's say you already own...
Pat: Let's say you retire from Microsoft, and of this $5 million, you've got $2 million in Microsoft...
Scott: You're gonna have a direct indexing that owns no Microsoft.
Pat: Yeah, and maybe even underweights of many of the techs that look like Microsoft.
Scott: That's exactly, right.
Pat: Oh, I think it's....
Scott: So it gives you flexibility, though.
Pat: I like it. I like it. And what are they gonna charge you?
Martha: One-tenth of 1%.
Pat: Yeah, that's the going rate. Yeah, that's cheap.
Martha: So that's...
Scott: Plus a management fee, I'm sure. But yeah.
Pat: That's the tick. You pay a little.
Scott: It's worth the cost.
Pat: Oh, I like it.
Scott: Yeah, I agree with Pat.
Pat: You should put more in, as much as you could push every year. You just have greater flexibility, greater control.
Scott: And this didn't even exist a few years ago.
Pat: No.: It was unheard of and the reason is because of the transaction cost. And there is still transaction costs. Ask Ken Griffith of Citadel about that. Which is the...
Scott: Most people don't know who Ken Griffith of Citadel is.
Pat: Well, they can look it up, but there's a little bit on the market maker side that no one really sees. But it's relative to the benefits of direct indexing. It's great. Yeah, I think you should do it.
Martha: And have you ever heard of Aperio?
Pat: Yes, yeah.
Scott: I think that's the technology we use.
Pat: Yeah, yeah, yeah.
Scott: Look, I have a direct index. I believe it's Aperio's the technology running...
Pat: Yes. That's great. We run on Aperio, as well as, I think one or two other platforms.
Scott: I believe so, yeah.
Pat: Yeah, it's gonna be commoditized.
Scott: It is commoditized.
Pat: Not as much as it was going to be.
Scott: Yeah, that's probably fair. The cost will only come down.
Pat: The cost will come down.
Scott: That's right. And your advisor will be looking out in your best interest, I would assume, they should be. I imagine they are looking at your best interest. And if there's another technology provider other than Aperio, that can do it for less expensive, they will swap out technology, but you won't even know the difference, because it's yeah, kind of...
Pat: Yeah, it kind of all runs in the background. So I like it. I like it.
Scott: I agree. Sounds good.
Pat: Sounds like you have a good advisor too. Appreciate the call.
Martha: I appreciate your advice. Thank you so much.
Scott: Yeah. Thanks, Martha. And obviously Martha was just calling for a second opinion on this, right? She's got advisors she's been working with.
Pat: And so if you wanna a second opinion...
Scott: It sounds like the advisors have been doing a good job and are continuing to do a good job.
Pat: Yeah, I tell you, one of the hardest things is actually taking tax loss to a client, many clients. It's hard for them to understand, because you're saying to them, "We made some bad choices here."
Scott: We lost money. Yeah.
Pat: And they're like, "Well, wait, but the account is up, the overall account is up." And you're like, "Yes, it is, but we're gonna harvest these losses. Even if we don't use them this year, we're going to put them in our loss bank for...
Scott: Which works well. If you have a portfolio with other things that have gains in them today that you know at some point in time, you're gonna be reducing some exposure there, or selling some off. So you don't necessarily need to have selling a rental house or having a business transaction.
Pat: Yeah, and it's okay to take losses. Look, even in my own portfolio, last month, I went through and harvested losses, and I harvested losses. I don't even know when I'm gonna use the losses against the gains. Maybe I'm not gonna use them this year, maybe I'm not gonna use them next year, but I will use them at some point in time. Under the current tax code, as I always qualify.
Scott: That's correct.
Pat: Under the term current tax code, always qualify.
Scott: That's right. We're in Tennessee talking to Amanda.
Amanda: Hey, guys, how are you?
Scott: Wonderful.
Amanda: Awesome. So we are very blue class, working collar folks. I grew up and my grandparents always had a little bit of rental property, so I've been very much drilled into like, you're never gonna go wrong with real estate, within reason. I mean, there's bubble crashes and all that kind of stuff. I get that.
Scott: If you don't have much debt, you're never gonna go wrong.
Amanda: Right. And that's kind of what we're working on. So I got four properties that I wanna run down. The one house in Wellington, which is in Palm Beach County Florida, was my grandparents house. I bought it. I remodeled it. I'm using it as Airbnb. It's not doing fantastic this year. It's worth about 713,000. I owe about 206.
Pat: What's the interest rate?
Amanda: Five-ish.
Scott: What'd you pay for it?
Amanda: Two eighty.
Scott: And do you use it for your vacation home, or is it just a rental?
Amanda: It's a rental, but it's somewhere that I anticipate living in the future. It's my "retirement home." My husband and I are both 51, new-ish marriages to each other.
Pat: Okay, and how long ago did you buy this?
Amanda: '18-ish.
Scott: Okay, right after the financial crisis is my guess.
Amanda: Well, it was...I don't know.
Scott: Well, that's irrelevant.
Pat: Why is the interest rate 5% if you bought it in 2018?
Amanda: Because I'm a face painter and I don't make a lot of money, and my DTI was high, and I did it by myself. So that's why.
Scott: Okay, so that's one property. Run down the other ones.
Amanda: Okay, so that's the house that we wanna live in. So the house that I'm currently living in was the house of my prior husband and I just outside Nashville, Tennessee. So basically, my idea was to sell that house...
Scott: What's that worth?
Amanda: Hold on a minute, 450 to 500. And I owe 205 on it.
Scott: What's the rate on that one?
Amanda: Couldn't tell you. It's probably not fantastic. I don't even know how I've gone to properties that I've gotten with the money that I make. It's a sheer act of God. I don't even know. I'm not gonna look at it, I feel like it gives [inaudible 00:24:09.382]
Pat: Okay, and in the Nashville property, you're living in it?
Amanda: Correct.
Pat: Okay, all right. So next property?
Amanda: We plan on, if we sell that one, which is what I'm planning to do, like dollars to donuts, I will pay off the Wellington house completely, and then we can live in the Wellington house in Palm Beach County, debt-free at 51.
Scott: Yep. Okay, I like that. Yeah, I like that a lot.
Pat: We're pretty much on the same page.
Scott: And then my guess is your vocation could be transported to just about anywhere.
Pat: I'm guessing there's little kids everywhere?
Scott: Maybe less in Florida.
Amanda: Yeah, and Palm Beach County is great for throwing parties. I mean, there's a lot of little kids in Florida and a lot of parents with money.
Pat: All right, which is actually probably the most important thing, not the number of kids.
Scott: Parents can afford to hire. "Let's have a face painter over the party too. Why not?" We'll have Barney show up in the face painting.
Pat: You've been to those parties where they have the face painter that is the...
Scott: Oh, I know we've had the hula dance lessons at my house.
Pat: Actually, Scott, I went to a...off subject, but still, one of the funniest things I think I've ever heard from you, when your daughter was probably three or four, we were at your house, and there was this purple dinosaur named Barney.
Scott: It was a fake Barney, I think, yes.
Pat: But reeked of cigarette smoke.
Scott: That's right.
Pat: The whole room reeked of cigarettes.
Scott: The costume stunk.
Pat: And you looked at me and said, "The real reason the dinosaurs went extinct."
Scott: Yeah, yeah, yeah. That was it.
Pat: Okay, to the third property.
Amanda: Okay, the third property will go with his home in northwest of Nashville. That was his prior marital home that we now have as an Airbnb, and it's doing really good. Also, there's a mother-in-law that houses the mother-in-law.
Pat: On that same property.
Amanda: On that same property.
Pat: What's the value of that property?
Amanda: Between 500 and 600.
Pat: And what do you owe on it?
Amanda: Two-hundred-and-six.
Pat: Okay. And is there another property?
Scott: Does the mother-in-law pay a rent?
Amanda: Hell, no. No. Sorry, no, she does not. No, I mean, no, no, she doesn't.
Pat: Oh, that's nice. We're not gonna cut that out either.
Scott: We're not gonna cut that comment out.
Pat: And you said there's one more property as well?
Amanda: And there's one more property. It's in North Florida, in Palm Coast, which is, you know, it was very retirement-y. Everybody is kind of dying off, and then new folks are coming in, so that's looking pretty good. So it's probably valued around 450 and we owe 256 on it.
Pat: And it's a rental?
Amanda: It's also an Airbnb, yeah.
Pat: Okay, I like the idea of selling the number two property outside of Nashville and using the proceeds, there's no capital gains...[inaudible 00:27:05.090]
Scott: Is the Airbnb rent from that, is it covering the mortgage cost?
Amanda: Yeah. So Palm Coast, and my husband's house with a mother-in-law on it, they are doing really well. They are just little [inaudible 00:27:19.514] outside. Although, and this is where my thing is, like, well, if we pay it off, then we could have retirement money and we can have something to back up. But my husband says it's gonna be so long before we pay it off, because, you know, our working balance in the banks are about 10,000 and we don't take any money out of it. We don't actually use the money from it because in case of whatever, the air-conditioning goes out...
Scott: I mean, are you guys prepared to move to Florida now?
Amanda: I am.
Scott: Well, from a financial standpoint, it clearly makes the most sense.
Pat: Yeah, but how about your husband?
Amanda: So we're looking between six months and a year. The problem is here's a hook. The mother-in-law wants to come with us, and she would have to come with us if we sold Ashland City. So she wants her own little house built on my property in Wellington, Palm Beach County.
Pat: Okay. And how do you feel about that?
Amanda: I'd rather her out than in, like, have her own space than under the same roof.
Pat: I'd love to, actually, I'd love to rent an Airbnb with a built-in mother-in-law. I don't have one. And you're like, on the listing, you go to an Airbnb and it says, "This comes with a mother-in-law."
Amanda: It comes with the actual mother-in-law, not just the building.
Pat: Are you thinking, "We could use it for bachelor parties?"
Amanda: Yes.
Pat: So are you thinking of getting married? I can see a whole marketing campaign around this. Are you thinking of getting married? This is a test. She comes into the house every morning after these bachelors.
Scott: I had the best mother-in-law in the world, so I had a different than most.
Pat: Let me just go on this riff, Scott. So she comes in the morning. Okay, I've got this whole marketing, call me afterwards. I'll put together this bachelor.
Scott: So all right. So look, if your mother-in-law stayed in the house that she's in, that's like an ideal situation, because, from a financial standpoint?
Amanda: Right, absolutely. And then we still have the money coming in from the main house, and that's a property that we could keep, and she'd have her own space, and if she wanted to come down, she can come down for...
Scott: Is there room on your property in Wellington to build a mother-in-law unit?
Amanda: I can build up to 795 square feet extra.
Pat: Okay, I think you should do that.
Amanda: Okay, so here's the other thing. My husband wants to sell Palm Coast, which we don't have that much equity in. He thinks we should use that to push in our move into Palm Beach County, and he likes the idea of the S&P500. I don't like stocks at all. My parents lost their self on it. So we have a very like...[crosstalk 00:30:14.165]
Scott: Whose house is that?
Pat: Yeah. So one of the things that I'm concerned about is what Scott just said, who owns these properties, and what kind of estate planning did you do?
Amanda: I haven't done a darn thing.
Scott: How long have you been married?
Amanda: We had a civil union last year. We're getting married-married in a couple weeks.
Pat: How long have you known him?
Amanda: Six years.
Pat: Kids from previous marriages?
Amanda: Me, two. Him, one.
Scott: Okay, I think the most important thing is having this structured, because you're each coming in with assets, right, and different viewpoints on how to manage money going forward.
Amanda: That's also a thing.
Scott: And having something structured now, like, what happens if one of you dies?
Pat: What happens if...
Amanda: Right. Well...
Pat: Or what happens if the marriage doesn't work?
Amanda: I mean, that's something once bitten, twice shy kind of thing with me paying off my house, selling my house, and paying off my house, then there's no...
Scott: That's right.
Pat: That's right.
Amanda: There's no mingled money.
Pat: Well, look, there's going to be mingled money. You're talking about actually taking certain assets from one and the other and combining the two.
Scott: Which may be the right thing, but everyone needs to come in with eyes wide open, number one. Number two, to think about the kids, right?
Pat: So you need to have a trust that is structured. So you need an estate planning attorney. And by the way, your opinion of the market is wrong, it's just flat-out wrong.
Amanda: Listen, I know nothing. I'm doing my own prejudices.
Scott: And your own experiences. You've learned from your own experiences.
Pat: That's right. And whatever your parents told you about the market, they may not have... Everyone pretends like stock is all the same thing. It's not all the same thing, right? It's not.
Scott: I mean, the S&P500 is only the 500 largest companies in the United States.
Pat: And by the way, if that fell by 100%, your real estate would be worth nothing. Just gonna throw that out there.
Scott: If every company became worthless.
Pat: Yeah, your real estate becomes worthless, every economy, everything becomes, then we'd be talking about moving to Northern Idaho and buying guns and...
Scott: Getting a bunker.
Pat: ...and a bunker. So you need an estate planning attorney first. And I think you're pushing this timeline, was a little aggressive. You're not even...
Amanda: Well, the problem is that the Palm Beach County... Okay, the other two properties that we share, we share one property 50/50 partners, that's in the North Florida. His house is 100% his.
Pat: Okay, that's why you need an estate planning attorney.
Scott: Well, you need to talk this through. If we sell the house in Nashville and go to the Wellington that you owned before, how do we structure it? And what happens if one or two things, one, one of us dies, how's it structured then?
Amanda: We have two houses in Nashville, one's down there...
Pat: I understand. Yeah, we get all that. We get all that. The bigger issue is you're trying to commingle assets that don't have equal value, without any clear understanding about how things will be divided if someone dies and/or the marriage doesn't work out, right? The weird thing about marriages is they're so easy to get into. It's like a timeshare. You get there, it's all super exciting, you know, a couple drinks.
Scott: You're only seeing the good parts.
Pat: You're only seeing the good parts. And then, bam, and you're like, you're calling up a commercial where someone's trying to get rid of it. They're very, very difficult to get out of, especially if you have commingled assets without a clear exit path on the way out. So if you were sitting in my office, better yet, you'd be my younger sister, I'd say, "Are you out of your mind, Amanda? What are we talking about here? You're talking about selling this house..."
Scott: You would. You'd be all over your sister. Man, if you were a client, would be the same thing.
Pat: Correct. If you were my sister, I'd call you today. I'd call you tomorrow. I'd call you the next day, until you went to a qualified estate planning attorney to figure out what the exit looks like if it doesn't turn out.
Scott: Or if you die. Otherwise, kids get disinherited.
Pat: And then I would tell you, slow down on the horse-trading. Just slow it down. You haven't even been married...you're civilly married, I get that. But look, it's too fast, it's too soon. You need to go through the estate planning process first, settle it down for six months, nine months, a year. There's no hurry, and then revisit the issue.
Amanda: Well, the problem is that Palm Beach County is getting more expensive [inaudible 00:35:17.894]. So I need to do something...
Pat: No you don't.
Scott: There's no rush today.
Pat: You think you have to do something.
Scott: Whatever short-term economic cost you're talking about the next six months is negligible compared to the economic cost, you guys get married and suddenly you get hit and get killed in a car accident, and your assets go to your new husband, and your kids get disinherited.
Pat: How's that look?
Amanda: I 100% see where you're coming from. I need to pay the house in West Palm. But listen, listen, listen...
Pat: No, not going to. I'm just telling you, Amanda, you're my sister.
Amanda: That house is losing money.
Pat: I am not going to listen to this. You're giving me excuses about a real estate property, and what you think is going to happen in the real estate property, by the way, which you don't know whether it's gonna go up in value or downward value. You don't know.
Amanda: Well, what I do know is...
Pat: What I do know is I have sat in rooms with people that are in the process of divorce and I help them decide what came into the marriage, what left the marriage.
Scott: Look, you don't always decide. You mean the attorneys, or there's a mediator, or I've sat down with people have been widowed, and I've talked with kids who've been disinherited, not because mom or dad didn't love them and didn't want their assets to go to them. It's because it was a future marriage.
Amanda: And that is something that we're totally planning on doing is the estate planning.
Scott: Yeah. So I would do that first. So we can't talk about the other stuff.
Pat: We can't talk about until that time.
Scott: Not to be rude, Amanda.
Pat: When that is done, call us.
Amanda: Thanks.
Scott: All right, there you go. I just feel like she didn't like our answer. Sorry.
Pat: You called. It was an opinion, and it was a biased opinion.
Scott: Based upon our experiences, whatever short-term rental.
Pat: Come on.
Scott: Rentals, not renting is good enough for it to share something.
Pat: It's going, it's doing, we know it did. Remember, your investment, already dead. It's not doing...
Scott: And we have no idea what comes tomorrow.
Pat: No, none.
Scott: All kinds of things can happen.
Pat: Like what happened during COVID, Scott, what we do know is at some point in time, death will happen. We do know that.
Scott: Yeah, we know that, 100%.
Pat: And without the proper estate planning in that...
Scott: We know that and we've seen what happens. We'll talk now with Jim.
Jim: Hello. This is Jim.
Scott: Hi, Jim, glad you joined us. How can we be of help?
Jim: Question in reference to, I have a 401(k) plan that I've been contributing to, and I've been considering putting some money into a Roth 401(k). And what's the pros and cons on whether I do the current contribution as a Roth or if I leave it go in as traditional and then just do a Roth conversion from my 401(k) into a Roth 401(k) within the same plan?
Pat: Well, great question, maybe we should ask it a little bit differently, which is, not, "Do I do a Roth conversion in the existing plan, but do I wait till I retire and then decide whether to do Roth conversions?"
Scott: So technically, it would be a wash.
Pat: If you did it the way you described it.
Scott: Assuming you could do a Roth conversion from the plan while you're still working, which the plan may or may not allow.
Pat: But normally what happens is that you take the deduction while you're working, and then you do the Roth conversions between the time you retire and your required minimum distribution at age 75.
Scott: Or sometimes it makes sense to do a Roth contribution, and if you're putting in, let's say, 10 grand a year, I'm just throwing a number out, pre-tax, well, that 10,000 is gonna be taxed in retirement, so it's not gonna be worth 10 grand when you pull it out, because you got to pay the tax man. So maybe it's worth seven grand, as opposed to, if you put in 10 grand in the Roth, you've paid the tax, you've paid that extra three grand to the tax man today, and then when you pull it out of retirement, it's tax-free. So I would, I mean, clearly, dollar-for-dollar, money in a Roth's worth much more than money in a pre-tax. It doesn't mean that you shouldn't do the pre-tax but...
Pat: So tell us about your situation. How old are you? How much money do you make? How much money are in these plans? Do you plan on living in the state of Cal? Where are you from?
Jim: Kentucky.
Pat: How much money are in your plans now?
Jim: Currently in the 401(k), first off, I just turned 60 in July. Currently in the 401(k) is approximately 1.3 million. It's broken down to like about 84,000 in like a savings within that, 735 is in a 2030 target fund, and about 490,000 in the Vanguard 500 index.
Pat: Okay, and how much do you make?
Jim: A hundred thousand.
Pat: And do you have any Roth money now?
Jim: Yeah, like said, 94,000 of that 1.3 is considered Roth.
Scott: Oh, got it. Okay.
Pat: And do you have any money in IRAs outside this?
Jim: Yes, I have approximately, let's see, 21, 28, 38, about 50,000.
Scott: And are you married?
Jim: Single, no kids.
Pat: And the money outside in the regular IRAs, are they Roth or pre-tax?
Jim: The amount I just said, about 50-some is Roth. In addition to that, I have another 260 that's in short-terms, well, relatively short-term CDs, about 30 of that is two years out.
Pat: And is any of this inherited money or did you earn all this?
Jim: All that is earned. I do have another 9000 with an inherited that's sitting in a IRA.
Scott: And will you receive a pension when you retire?
Jim: A small one if I wait till 65 to claim it. I'm eligible to claim it now.
Scott: Are you retired now?
Jim: No.
Scott: When do you plan on retiring?
Jim: Somewhere between two to five years, probably.
Pat: You're an incredible saver.
Jim: Yes.
Scott: I would not contribute to the Roth today.
Pat: I would not contribute to the Roth.
Scott: And here's why. So it's all based upon where taxes are. Right? Nobody knows where taxes are gonna go in the future, but what we do know is the tax code is very progressive. And what do we mean by that? Like your first 11,000 of income, taxable income, this is after deductions, it's really about 20,000 of income you pay no tax at all. I'm sorry, your deductions you pay no tax. The first 20,000 or so, it's roughly 10% is the tax rate. From roughly 10,000 to 50,000 ballpark, you're in a 12% tax rate. Then it bumps from 12% to 22% and then from 22 to 24, right? So maybe tax rates are gonna go up in the future, but right now, we know that you can take a debt... you're getting a deduction at the 22% maybe even the 24%. And at retirement, when you go to leave, that's to Pat's point at the beginning of the call, he said oftentimes we see people doing Roth conversions during the years between the time they retire and the required minimum distributions. It gives you the best opportunity for you is those years when you're not gonna have much in the way of taxable income. You may even choose to defer Social Security for a couple years and do the conversions then, and do some Roth conversions. Maybe even live off some savings, do some Roth conversions during those years.
Pat: Because you've got $260,000 in CDs. So you can take a deduction today at 22% and then convert it later at 12% maybe the 12% will be at higher rate, 14, 15, but it's not gonna be higher. It's because your taxable income's going to be much lower.
Scott: If you're planning correctly.
Pat: The answer to your question is, no, don't use the Roth. And by the way, you're a phenomenal saver. This is Cinderella tax planning the day you retire. I mean, you look at this and you're like, "Holy smokes." I don't know if Jim did this on purpose, but it's perfect. You've got money in different places that you can set it up the day you retire and just decide, "Okay, this is how I'm gonna take income. This is how it looks. This is when I'm taking Social Security," brilliant. And so when you go to retire, you need to actually address that, and it's gonna probably take a qualified tax advisor or a financial advisor. Let me ask you one question, do you have an HSA available to you?
Jim: Yes.
Pat: And are you spending that HSA? Are you using it for health care?
Jim: Small amounts of it, but not a whole lot of it.
Pat: I wouldn't use a dime of it.
Scott: Yeah, I'd let it accumulate.
Pat: I'd let it accumulate, and I'd put it all in the S&P500. And you can probably do that through your employer. We have it here at Allworth where you can direct your HSA into an investment account. I don't spend a dime in my HSA.
Scott: I don't either.
Pat: For years, my wife fought me on it, wanting to spend it. And finally, she's like, "Well, this makes sense."
Scott: Hey, appreciate the call, Jim. And based on what you told us, continue the pretax contributions. When you retire, odds are the recommendation would be, if you were retiring, well, if you're retiring today, clearly the recommendation would be let's do a Roth conversion over a couple-year period of time, based upon the high level you have in savings would probably just use your savings for your income, push up the tax rates through that Roth conversion, get a nice, good sized chunk of your pre-tax dollars into Roth. It's perfect planning for you.
Pat: Perfect.
Scott: We're in California, speaking with David.
David: Hello. I have some questions about Roth IRA conversions.
Scott: Yes, sir.
David: I've been reading stuff online, and it seems like everybody's a little bit saying something a little bit different. I understand that...
Scott: Well, every situation is different. So there are people that will say, "Oh, you need to do Roth conversion this year," and other people will say, "Do not do a Roth conversion." So every situation is different.
David: No, it's doesn't have to do with whether or not you should do it. It has to do with the five-year rule. And I understand the five-year rule about you have to have contributed something in order for it to be...you can take distributions after five years, but then I'm finding things about each IRA conversion has a five-year clock.
Pat: Yeah, I gotta tell you, everything you said there is true. Very rarely does that actually go into the decision-making is to how to take the money out of the Roth. And the reason being is normally...
Scott: It's the last dollars you spend.
Pat: Or you're using it for tax efficiency programs over a series a year. And remember, you could still pull your principal out without any sort of penalty on it, so most of it's liquid in that first five years. So that's why...
David: Well, one website says that the Roth IRA conversion has a five-year clock, but that rule determines whether the conversion principle will avoid tax penalties.
Pat: We understand the rules. Absolutely understand the rules.
Scott: So tell us about your situation.
Pat: Tell us about your situation, then we'll give you some direction.
David: I'm 63 and I have three-quarters of my funds in a traditional and a quarter in my Roth, and I have some in a regular brokerage. But when I asked my brokerage about it, they never replied.
Pat: Well, that's kind of sad you have to call radio show to get good investment advice, but you're paying someone else for that investment advice. So how much is in the IRA?
David: I've got three-quarter.
Pat: Yep. What's the dollar amount?
David: About a million in the traditional and a quarter in the Roth.
Pat: How much money is in brokerage?
David: In my regular account I have 600.
Scott: And what's your income?
David: I'm retired right now.
Pat: Yeah. But are you taking money from your IRAs? Do you have Social Security? You have pension? What are you living on?
David: I've just been using money from my investments.
Pat: From your brokerage account.
David: Correct.
Pat: Okay, and are you married?
David: No.
Pat: Okay, and so how much are you living on...?
Scott: Are you on Social Security?
David: No.
Pat: Okay, I'm so glad you called me. That brokerage, the people that are managing that brokerage account are not doing you any favors. This is exactly when you should actually be doing the Roth conversion. Forget that five-year rule.
David: No, no, I've been I've been doing Roth conversions for the last 10 years. That's how I...
Pat: How long have you been retired?
David: Probably 10 years.
Pat: Okay, okay. So what's your question for us?
David: Well, the question is, about this, every conversion has a five-year clock.
Pat: Who cares? What does it matter?
Scott: You have 250,000 in Roth.
Pat: You've already got money outside of that five-year period. What are you worried about the five-year? Whether it starts on the first conversion or it's rolling five-year conversion, it doesn't matter to you.
David: Well, I'm just worried about how complicated my taxes will be.
Scott: It's not at all. You ignore it.
Pat: You ignore it. It won't make any difference to you.
Scott: You've been doing these conversions for 10 years.
Pat: For 10 years.
Scott: When you go do a withdrawal, there is no paperwork that says, "Oh, this withdrawal came from this year, this withdrawal came from..." There's no reporting whatsoever.
Pat: You're borrowing trouble. Don't worry about it.
Scott: Even if a meteor struck your house, I wouldn't think you would need a...
Pat: There's a greater chance of a meteor striking this house than it is that you would be impacted by the five-year rule.
Scott: Yeah, don't worry about that.
David: It's just that all the websites have different information.
Pat: You called us.
David: It's totally crazy.
Pat: You called us. Don't worry about it.
David: Yeah, I called.
Scott: Look if you had no conversion, you're planning converting, and you were gonna use money in four years for something, then we would have a discussion like, if that was part of the planning...
Pat: You know, like, "Okay, is it in rolling? Is it a five-year?"
Scott: But to Pat's point, you can still pull your principal.
Pat: It doesn't matter. Go down to the SPCA, and adopt a rescue animal. You're worried about other stuff. You got to fill up your day with other things.
Scott: No worries here, David.
David: No, it was just weird, because it's the first time I've been retired, and I'm just trying to figure out what to do.
Pat: David, call us anytime, anytime. But there are things in life we should just ignore, right?
Scott: For you, in this situation, ignore.
Pat: You're just gonna ignore. Do you have teenagers?
David: I should just continue doing my Roth conversions as I've been doing.
Scott: That's right, yes.
Pat: Yes.
Scott: Sounds like you run the numbers every year and do the appropriate amount.
Pat: Yeah, perfect sense.
Scott: Yeah. Appreciate the call, David. Wish you well.
Pat: As I was saying, if you've raised teenagers, you know there's certain things that you just ignore, because in the end, it's gonna work out okay.
Scott: And you know, some questions you don't ask because you don't want them to lie.
Pat: You're just gonna lie.
Scott: Okay, well, unfortunately, I guess, being a podcast, theoretically, we could be doing this forever, like some podcasts going for hours.
Pat: But we've decided we're out of time.
Scott: Yes, we decided we're out of time. Well, part of this still pops up on the radio, so...
Pat: We keep it to an hour format. But if you've liked this, do us a favor, please rate us or share with a friend.
Scott: Anyway, hey, we wanna let all of our listeners know about our YouTube channel. I think we briefly mentioned it last week, but we've got a pretty robust YouTube channel. Who doesn't anymore?
Pat: Come on.
Scott: But on YouTube, I mean, you can watch the show. You can get the full shows there, but there's also video clips of interactions with some of our callers. So if you're kind of looking for a certain type of thing, you can view that, and then also some other video production stuff that we've done along the way on a variety of different things, whether it has to do with the election or what might happen with the markets or saving for retirement, or Social Security. We've got a lot of other videos on those various topics that you can find at our...
Pat: Informational and sometimes entertaining.
Scott: Yeah, and I don't know where you find it. You could find Money Matters on our YouTube channel.
Pat: So we go to "Allworth's Money Matters" on YouTube.
Scott: Allworth's YouTube, and you'll find it, it's pretty simple.
Pat: Yes.
Scott: It's been Scott Hanson and Pat McClain of "Allworth's Money Matters."
Man: This program has been brought to you by Allworth Financial, a registered investment advisory firm. Any ideas presented during this program are not intended to provide specific financial advice. You should consult your own financial advisor, tax consultant or estate planning attorney to conduct your own due diligence.
Scott: Welcome to Allworth's Money Matters. Scott Hanson.
Pat: Pat McClain.
Scott: Glad you're with us today. Myself, my cohost, both financial advisors, we have our podcast and radio program here to help you make wise choices with your money.
Pat: Yes.
Scott: Answer questions you bring to us.
Pat: Twenty...
Scott: Talk about the financial world.
Pat: ...nine years of doing our radio show.
Scott: Twenty-nine, 29 years.
Pat: ... podcast, yes. So now it's us, and...
Scott: Yeah, if you're new to us, welcome.
Pat: ...4 million other people that have a podcast.
Scott: That's about, right.
Pat: Yeah. We're taping the show and at least ours is named something...
Scott: October 23rd. This will be aired on the 26th, distributed on the 26th. But Trump is sitting down with, speaking of podcasts, the number one podcaster in the world, Joe Rogan, Trump is sitting down with him, and I think they're trying to get Harris to sit down with him.
Pat: Yes, not in the same room.
Scott: That would be even more interesting.
Pat: Different times.
Scott: A free-form three-hours conversation between the two would probably be the best sort of debate format we could have.
Pat: Oh, I don't think that's possible. I don't think you could put those two in a room together for three hours. Like, the way she carved him up the last debate. Oh, she knew exactly where to poke him. Oh, it reminded me of my siblings, like my younger daughter knows how to poke Lily, like she just knows how to set her up. Because that's what happened with the last debate, it felt like. Anyway, why are we talking about this?
Scott: Okay, because it's all we can get. It's like, no matter where you turn, it's politics.
Pat: Oh, yes. Listen, I'm just hoping I'm gonna get a couple more unsolicited phone calls before the elections.
Scott: On what to do with the finances.
Pat: No, no, no, unsolicited from someone trying to get me to vote their way.
Scott: What's the point?
Pat: Yes.
Scott: So not anyway. We got a great show lined up. We have several calls, that we're gonna get to. Before we do, oh, I found this quite interesting in the...oh, I feel like I'll sneeze here. I thought you'd continue on as I'm sneezing. But anyway, you're still waiting for me. Pat's staring at me. Thank you, Mr. McClain, only 29 years of doing this together. Where are we going with it? Are we gonna cut this part out?
Pat: Anyway, so this article in "The Wall Street Journal," actually, it kind of set me off a little bit.
Scott: This is this week. It set you off?
Pat: Yeah, it kind of, it made me mad a little bit. So the "New York Post" sues AI startup Perplexity, alleging massive free-writing.
Scott: And "The Wall Street Journal." "Wall Street Journal" and "New York Post."
Pat: So this reminds me of Napster. This reminds me of Napster, right? Which is this AI comes in there, they...
Scott: So Napster, we all remember, this was 20-some years ago, they offered free music.
Pat: That's right.
Scott: Free music, just download Napster, go to their website or whatever, and you get free music until...
Pat: And their point was, "Oh, we're not really actually taking it from the artist. What we're doing is we're taking it from other people's servers. So we're not really breaking the law here because we're just kind of facilitating it."
Scott: That's right. And they got slapped down. Napster no longer exists, but Apple came out with their music platform...
Pat: But they pay the artist.
Scott: They figured out how to pay the artist. Now we've got Spotify, that is an...[crosstalk 00:03:52.778]
Pat: Correct, and Amazon and the rest of them, but this sort of thing just bothers me, and it's...
Scott: But it was in the same way that Amazon, with the books, like, they just scanned the Library of Congress. I mean, they just took...
Pat: Well, those things were out of copyright though. There's a difference doing something out of copyright than in copyright, right? So Amazon, anything out of copyright is absolutely it's fair game, right? That's copyright law. But the mere fact that, you know, AI it goes and scrubs...
Scott: The internet.
Pat: The internet, and it's not really making anything up, you know, well, it makes some stuff up. There is shadow stuff in there, but it's collecting information from all kinds of things and putting them in...
Scott: Including...
Pat: Including articles that other people have...
Scott: That they sell.
Pat: Yes. And they're monetizing. It's the same thing and like, I have two kids that live in...three children that live in Southern California. You'd walk down the streets and you'd see these scooters, Lime, and I said, "Who are these people to think that all of a sudden, any street in America is a retail store for them, that they could just throw this scooter out there on the street and they don't have to pay anything for it, and..."
Scott: Well, that's why some cities have...
Pat: Banned them.
Scott: ...banned them. They got rid of them. They realized it's...
Pat: But it took a while. It took a while. So this AI...
Scott: This is Perplexity. I don't know what other companies have been doing this, but just grabbing their content.
Pat: Grabbing content.
Scott: And using it.
Pat: Right?
Scott: Without paying for it.
Pat: And so now they're getting sued. Without getting paid for it, without paying them for it. I don't even know how you'd price it, but it doesn't work in a fair market environment where we can just go and take other people's stuff and resell it as our own.
Scott: On my iPhone, I pay I think it's 9.99, maybe it's 12.99 a month now for Apple News. Do you use Apple News?
Pat: I don't use Apple News.
Scott: They curate articles from a bunch of different sources, and so I can read articles from all these other magazines and newspapers that I'd otherwise have to pay for, and they pay them a little bit for it, right?
Pat: That's right.
Scott: So I pay Apple...
Pat: And Apple gives it to them.
Scott: They get a nickel.
Pat: Yes. So this AI, and the reason I found this, sharing this with you is, watch this AI is not without risk. This AI will end up...there will be massive, massive suits, lawsuits against many of these AI companies for stealing content, as there was Napster 20 years ago.
Scott: Well, I think, look, we all need to be careful about which applications we're using. If you think you're using ChatGPT to do some research, they're also getting research from you.
Pat: That's right.
Scott: So if you're using it at work and having some trade secrets and all that stuff, and using some program, an AI program, to put together ladders or whatever, unless it's in a closed system, which there are some that companies have employed, but if you're just using the public ones, or there's a program that now people are used to it dictates all of their conversations. "So It's just free, isn't this free? And it's nice. All my meetings, I just have it running in the background. It's free dictation." Like, well, I don't think so.
Pat: It's not.
Scott: No, they're taking your data.
Pat: If you can't figure out who the customer is...
Scott: You're the customer.
Pat: You're the customer. If you can't figure out the revenue source, you are the revenue source.
Scott: Yeah, I know, this will be interesting, because it does feel like, Pat, it's like some of the early days in the internet and what was happening. And the music is a prime example.
Pat: Oh, the Napster thing, I always thought this is just terrible, right?
Scott: But even now, like Facebook, I think "The New York Times," so, "Facebook, you're gonna have to pay us, like, you can't just take repurposed articles."
Pat: Yeah, I don't care who posts it. And Facebook says, "Well, I didn't post it. Someone else posted." And you're like, "Yeah, I don't think that's the way it works, right?" I don't think there's...
Scott: And another thing, you know, you mentioned Napster, they were the early leader in streaming music.
Pat: That's correct.
Scott: They were the big early leader. They're gone. They didn't make it.
Pat: That's right. And many of the AI companies that are the early leaders here will not make it.
Scott: Will not make it. There's so much money flooding into that space. I just read an article, like, they question, like, there needs to be so many billions of dollars, trillions of dollars of productivity that comes out of it, like, some people are already kind of questioning, like, "Are we ever gonna get a return on the investment that's being put into them?" And what's even more fascinating...
Pat: Is the power.
Scott: That's exactly what I was gonna say, the amount of power.
Pat: The power plants behind it, right? We see, was it Microsoft or Google? Which one was it? Was it Google that...
Scott: Microsoft.
Pat: ...was taking Three Mile Island, lighting it back on fire.
Scott: Well, I don't think that's how they...
Pat: Whatever.
Together: Powering it back up.
Scott: All right, firing it back up, maybe not lighting it back up.
Pat: Was it Google or Microsoft?
Scott: I don't know. One of the big ones.
Pat: Yeah.
Scott: And they need the power.
Pat: They do.
Scott: Yeah, it's interesting. Even the data centers, the massive amounts, so much of our power generation goes to...
Pat: It does. Have you used it? I used it. My wife were and I were gonna go for a weekend up in the Sierra foothills, and I went to ChatGPT and I said, "Give me a three-day trip on through this area, moderately priced hotels." We didn't go.
Scott: I was gonna say, some old ghost town at some flea-ridden place.
Pat: Yeah, it's only 69 bucks for the night.
Scott: All right, let's take some calls here. We're gonna start with Martha. Martha, you're with Allworth's Money Matters.
Martha: Good morning, Pat and Scott.
Scott: Good morning, Martha.
Martha: Long-time listener to your very enjoyable financial program. I love the banter.
Pat: Thank you.
Martha: My question is, what is your opinion on direct indexing and the appropriate fee for this service?
Pat: So first of all, is the money inside of an IRA or outside of an IRA?
Martha: Both.
Pat: Who are you talking to about this direct indexing?
Martha: My wealth manager.
Scott: So I'm actually a big fan of direct indexing in the right circumstance.
Pat: Yes, I like it a lot, too, when appropriate.
Scott: And so what direct indexing is, and these were created, really over the last few years because of a couple things. One is the elimination of trading fees when someone buys themselves a stock, right? It used to cost money. There was a transaction cost. Now there's essentially nothing. One could argue there's actually some cost in there, in the system, that you don't see, but essentially it's so low, it's negligible. The second thing is, with technology, now there are tools, technology, tools that can create their own indexes with very little work essentially, the machine does it all. And so with a direct index, let's say you wanna mimic the S&P 500, direct indexing technology would go out and purchase, they're not gonna purchase all 500 companies of the S&P 500.
Pat: They could, but they don't need to.
Scott: They can get highly close, maybe a 99% correlation by owning 250 or 300 of securities. And here's where they work great, and here's where they don't work so well. They work great if you have some new cash that you wanna invest. So in other words you're not triggering capital gains to come up with the cash. You have some cash to invest, a sizable amount, and you've got some capital gains that are either occurring soon or will be in the future, number one. Number two, you are highly charitably motivated, and you plan on gifting substantial amounts to charity in the future. Okay? If those are the case, what's wonderful about these, with direct indexing, you can set up a certain aggressiveness on tax-loss harvesting.
Pat: Can I stop you, Scott?
Scott: Please.
Pat: In brokerage accounts outside IRAs is where these are mostly used. Inside of an IRA...
Scott: I don't see the benefit.
Pat: I can't see it at all.
Scott: It's cheaper just to get an indexed ETF for almost nothing.
Pat: Correct, correct. That's why I pointed that out.
Scott: Yeah, so inside a retirement account makes no sense whatsoever, but on the outside, so you put some money in each fall, or actually throughout the whole year, the technology is looking for opportunities for tax-loss harvesting. And if you look at, say, the S&P500 in any particular year, even a year that it's up 20%, there's gonna be a number of stocks that are down in value. And so they will sell those stocks that are down and buy something very similar.
Pat: So let's say sell Pfizer and buy Merck, right? The way the index looks at it is like, "Oh, these things are roughly equivalent, maybe not market value, but we can adjust through that through our algorithm. And so they can generate a substantial amount...
Scott: ...of capital losses.
Pat: Even while you're making money.
Scott: Even while you're making money. Now, eventually you got to pay the piper, right? So there's no such thing as a free lunch. So let's say you put in a million dollars into a direct index and it triggered $100,000 of losses, and it grew to 1.2 million. And let's say over time, that portfolio grew to $2 million but your cost basis might be $600,000 because they've captured $400,000 of losses over the years. If you go to sell in the future, you will have to capture much more gain than you would have otherwise.
Pat: Unless you die under current tax law, it receives a full step-up in basis.
Scott: That's correct. Or you gift, you cherry pick and gift those that have performed the best, to the nonprofit or donor-advised fund.
Pat: So that's how they work. Tell us about your situation.
Martha: Well, I think what they were talking about was doing it not from my IRA, but from my other portfolio funds. And they wanted to... I do have a tax loss that I've been carrying forward. I think about 200,000 of...[inaudible 00:14:37.251]
Scott: Of tax loss already?
Martha: Yes. And they wanted to sell some stocks so I would have enough to invest 250,000 to go ahead and start this direct indexing.
Pat: And if I looked at your overall portfolio, what's the size of the overall portfolio?
Martha: About 4.7.
Pat: Okay.
Scott: So why wouldn't you have more of it in direct indexing? But if you already have $200,000 of capital loss, but I question the efficacy of this.
Martha: Well, I don't have the cash to do it, so I'd have to sell some stock.
Pat: I understand. So is most of the bond portfolio... How much is in the IRA and how much is in the brokerage account?
Martha: Oh, boy. I think the IRA has about 600,000 and the brokerage has about...
Pat: 4.1 million?
Martha: Yeah, the other accounts have about that in it, yeah.
Pat: And is IRA all bond?
Martha: No, it is not...[crosstalk 00:15:53.130]
Scott: How is it that you have $200,000 of capital losses that you're carrying forward?
Martha: Well, because I can only take 3000 a year. Is that correct?
Scott: No, no. But where did the losses come from? Why do you have $200,000 of losses? Like how?
Martha: Oh, it came from all the stocks that were tax-loss harvesting and all the stocks that had been sold throughout last year, and in previous years.
Scott: Got it
Pat: And so what they wanna do is use those as offsets and make the portfolio more tax-efficient going forward. Does that sound correct?
Martha: I believe so, yes.
Pat: Yeah, I like it.
Scott: I kind of I mean, I don't know, but ...
Pat: I like it.
Scott: I like the intent. But part of my...I'm just questioning, like, what gains are you gonna have in the future? They work well. This strategy works...tax-loss harvesting works really well. If we're gonna realize some gains in the future. If we have a rental house that we wanna sell, that can work fantastic. If there's a business transaction some of their capital gain. If there's a stock that we're over weighted in that we wanna sell.
Pat: But, Scott, this is better than not. You don't know...
Scott: I agree.
Martha: There are a couple stocks that are overweighted in that I should be selling something then off and then I'll have capital gains in that. Yeah.
Scott: Good.
Pat: Okay, I mean, that's where you want to use it.
Scott: Yes. I like this better than owning ETFs.
Pat: Oh, no, I think it's a good idea. I think it's a good idea. It works best with fresh money. But this works pretty well. I mean, it works pretty well.
Scott: Yeah, I would agree.
Pat: Especially if you've got some over, highly concentrated positions that you want to turn back on. I mean, you could build an ETF. You could build a portfolio around those highly concentrated positions as well.
Scott: Which is another thing that direct indexing can do, which I didn't bring up that. Let's say you already own...
Pat: Let's say you retire from Microsoft, and of this $5 million, you've got $2 million in Microsoft...
Scott: You're gonna have a direct indexing that owns no Microsoft.
Pat: Yeah, and maybe even underweights of many of the techs that look like Microsoft.
Scott: That's exactly, right.
Pat: Oh, I think it's....
Scott: So it gives you flexibility, though.
Pat: I like it. I like it. And what are they gonna charge you?
Martha: One-tenth of 1%.
Pat: Yeah, that's the going rate. Yeah, that's cheap.
Martha: So that's...
Scott: Plus a management fee, I'm sure. But yeah.
Pat: That's the tick. You pay a little.
Scott: It's worth the cost.
Pat: Oh, I like it.
Scott: Yeah, I agree with Pat.
Pat: You should put more in, as much as you could push every year. You just have greater flexibility, greater control.
Scott: And this didn't even exist a few years ago.
Pat: No.: It was unheard of and the reason is because of the transaction cost. And there is still transaction costs. Ask Ken Griffith of Citadel about that. Which is the...
Scott: Most people don't know who Ken Griffith of Citadel is.
Pat: Well, they can look it up, but there's a little bit on the market maker side that no one really sees. But it's relative to the benefits of direct indexing. It's great. Yeah, I think you should do it.
Martha: And have you ever heard of Aperio?
Pat: Yes, yeah.
Scott: I think that's the technology we use.
Pat: Yeah, yeah, yeah.
Scott: Look, I have a direct index. I believe it's Aperio's the technology running...
Pat: Yes. That's great. We run on Aperio, as well as, I think one or two other platforms.
Scott: I believe so, yeah.
Pat: Yeah, it's gonna be commoditized.
Scott: It is commoditized.
Pat: Not as much as it was going to be.
Scott: Yeah, that's probably fair. The cost will only come down.
Pat: The cost will come down.
Scott: That's right. And your advisor will be looking out in your best interest, I would assume, they should be. I imagine they are looking at your best interest. And if there's another technology provider other than Aperio, that can do it for less expensive, they will swap out technology, but you won't even know the difference, because it's yeah, kind of...
Pat: Yeah, it kind of all runs in the background. So I like it. I like it.
Scott: I agree. Sounds good.
Pat: Sounds like you have a good advisor too. Appreciate the call.
Martha: I appreciate your advice. Thank you so much.
Scott: Yeah. Thanks, Martha. And obviously Martha was just calling for a second opinion on this, right? She's got advisors she's been working with.
Pat: And so if you wanna a second opinion...
Scott: It sounds like the advisors have been doing a good job and are continuing to do a good job.
Pat: Yeah, I tell you, one of the hardest things is actually taking tax loss to a client, many clients. It's hard for them to understand, because you're saying to them, "We made some bad choices here."
Scott: We lost money. Yeah.
Pat: And they're like, "Well, wait, but the account is up, the overall account is up." And you're like, "Yes, it is, but we're gonna harvest these losses. Even if we don't use them this year, we're going to put them in our loss bank for...
Scott: Which works well. If you have a portfolio with other things that have gains in them today that you know at some point in time, you're gonna be reducing some exposure there, or selling some off. So you don't necessarily need to have selling a rental house or having a business transaction.
Pat: Yeah, and it's okay to take losses. Look, even in my own portfolio, last month, I went through and harvested losses, and I harvested losses. I don't even know when I'm gonna use the losses against the gains. Maybe I'm not gonna use them this year, maybe I'm not gonna use them next year, but I will use them at some point in time. Under the current tax code, as I always qualify.
Scott: That's correct.
Pat: Under the term current tax code, always qualify.
Scott: That's right. We're in Tennessee talking to Amanda.
Amanda: Hey, guys, how are you?
Scott: Wonderful.
Amanda: Awesome. So we are very blue class, working collar folks. I grew up and my grandparents always had a little bit of rental property, so I've been very much drilled into like, you're never gonna go wrong with real estate, within reason. I mean, there's bubble crashes and all that kind of stuff. I get that.
Scott: If you don't have much debt, you're never gonna go wrong.
Amanda: Right. And that's kind of what we're working on. So I got four properties that I wanna run down. The one house in Wellington, which is in Palm Beach County Florida, was my grandparents house. I bought it. I remodeled it. I'm using it as Airbnb. It's not doing fantastic this year. It's worth about 713,000. I owe about 206.
Pat: What's the interest rate?
Amanda: Five-ish.
Scott: What'd you pay for it?
Amanda: Two eighty.
Scott: And do you use it for your vacation home, or is it just a rental?
Amanda: It's a rental, but it's somewhere that I anticipate living in the future. It's my "retirement home." My husband and I are both 51, new-ish marriages to each other.
Pat: Okay, and how long ago did you buy this?
Amanda: '18-ish.
Scott: Okay, right after the financial crisis is my guess.
Amanda: Well, it was...I don't know.
Scott: Well, that's irrelevant.
Pat: Why is the interest rate 5% if you bought it in 2018?
Amanda: Because I'm a face painter and I don't make a lot of money, and my DTI was high, and I did it by myself. So that's why.
Scott: Okay, so that's one property. Run down the other ones.
Amanda: Okay, so that's the house that we wanna live in. So the house that I'm currently living in was the house of my prior husband and I just outside Nashville, Tennessee. So basically, my idea was to sell that house...
Scott: What's that worth?
Amanda: Hold on a minute, 450 to 500. And I owe 205 on it.
Scott: What's the rate on that one?
Amanda: Couldn't tell you. It's probably not fantastic. I don't even know how I've gone to properties that I've gotten with the money that I make. It's a sheer act of God. I don't even know. I'm not gonna look at it, I feel like it gives [inaudible 00:24:09.382]
Pat: Okay, and in the Nashville property, you're living in it?
Amanda: Correct.
Pat: Okay, all right. So next property?
Amanda: We plan on, if we sell that one, which is what I'm planning to do, like dollars to donuts, I will pay off the Wellington house completely, and then we can live in the Wellington house in Palm Beach County, debt-free at 51.
Scott: Yep. Okay, I like that. Yeah, I like that a lot.
Pat: We're pretty much on the same page.
Scott: And then my guess is your vocation could be transported to just about anywhere.
Pat: I'm guessing there's little kids everywhere?
Scott: Maybe less in Florida.
Amanda: Yeah, and Palm Beach County is great for throwing parties. I mean, there's a lot of little kids in Florida and a lot of parents with money.
Pat: All right, which is actually probably the most important thing, not the number of kids.
Scott: Parents can afford to hire. "Let's have a face painter over the party too. Why not?" We'll have Barney show up in the face painting.
Pat: You've been to those parties where they have the face painter that is the...
Scott: Oh, I know we've had the hula dance lessons at my house.
Pat: Actually, Scott, I went to a...off subject, but still, one of the funniest things I think I've ever heard from you, when your daughter was probably three or four, we were at your house, and there was this purple dinosaur named Barney.
Scott: It was a fake Barney, I think, yes.
Pat: But reeked of cigarette smoke.
Scott: That's right.
Pat: The whole room reeked of cigarettes.
Scott: The costume stunk.
Pat: And you looked at me and said, "The real reason the dinosaurs went extinct."
Scott: Yeah, yeah, yeah. That was it.
Pat: Okay, to the third property.
Amanda: Okay, the third property will go with his home in northwest of Nashville. That was his prior marital home that we now have as an Airbnb, and it's doing really good. Also, there's a mother-in-law that houses the mother-in-law.
Pat: On that same property.
Amanda: On that same property.
Pat: What's the value of that property?
Amanda: Between 500 and 600.
Pat: And what do you owe on it?
Amanda: Two-hundred-and-six.
Pat: Okay. And is there another property?
Scott: Does the mother-in-law pay a rent?
Amanda: Hell, no. No. Sorry, no, she does not. No, I mean, no, no, she doesn't.
Pat: Oh, that's nice. We're not gonna cut that out either.
Scott: We're not gonna cut that comment out.
Pat: And you said there's one more property as well?
Amanda: And there's one more property. It's in North Florida, in Palm Coast, which is, you know, it was very retirement-y. Everybody is kind of dying off, and then new folks are coming in, so that's looking pretty good. So it's probably valued around 450 and we owe 256 on it.
Pat: And it's a rental?
Amanda: It's also an Airbnb, yeah.
Pat: Okay, I like the idea of selling the number two property outside of Nashville and using the proceeds, there's no capital gains...[inaudible 00:27:05.090]
Scott: Is the Airbnb rent from that, is it covering the mortgage cost?
Amanda: Yeah. So Palm Coast, and my husband's house with a mother-in-law on it, they are doing really well. They are just little [inaudible 00:27:19.514] outside. Although, and this is where my thing is, like, well, if we pay it off, then we could have retirement money and we can have something to back up. But my husband says it's gonna be so long before we pay it off, because, you know, our working balance in the banks are about 10,000 and we don't take any money out of it. We don't actually use the money from it because in case of whatever, the air-conditioning goes out...
Scott: I mean, are you guys prepared to move to Florida now?
Amanda: I am.
Scott: Well, from a financial standpoint, it clearly makes the most sense.
Pat: Yeah, but how about your husband?
Amanda: So we're looking between six months and a year. The problem is here's a hook. The mother-in-law wants to come with us, and she would have to come with us if we sold Ashland City. So she wants her own little house built on my property in Wellington, Palm Beach County.
Pat: Okay. And how do you feel about that?
Amanda: I'd rather her out than in, like, have her own space than under the same roof.
Pat: I'd love to, actually, I'd love to rent an Airbnb with a built-in mother-in-law. I don't have one. And you're like, on the listing, you go to an Airbnb and it says, "This comes with a mother-in-law."
Amanda: It comes with the actual mother-in-law, not just the building.
Pat: Are you thinking, "We could use it for bachelor parties?"
Amanda: Yes.
Pat: So are you thinking of getting married? I can see a whole marketing campaign around this. Are you thinking of getting married? This is a test. She comes into the house every morning after these bachelors.
Scott: I had the best mother-in-law in the world, so I had a different than most.
Pat: Let me just go on this riff, Scott. So she comes in the morning. Okay, I've got this whole marketing, call me afterwards. I'll put together this bachelor.
Scott: So all right. So look, if your mother-in-law stayed in the house that she's in, that's like an ideal situation, because, from a financial standpoint?
Amanda: Right, absolutely. And then we still have the money coming in from the main house, and that's a property that we could keep, and she'd have her own space, and if she wanted to come down, she can come down for...
Scott: Is there room on your property in Wellington to build a mother-in-law unit?
Amanda: I can build up to 795 square feet extra.
Pat: Okay, I think you should do that.
Amanda: Okay, so here's the other thing. My husband wants to sell Palm Coast, which we don't have that much equity in. He thinks we should use that to push in our move into Palm Beach County, and he likes the idea of the S&P500. I don't like stocks at all. My parents lost their self on it. So we have a very like...[crosstalk 00:30:14.165]
Scott: Whose house is that?
Pat: Yeah. So one of the things that I'm concerned about is what Scott just said, who owns these properties, and what kind of estate planning did you do?
Amanda: I haven't done a darn thing.
Scott: How long have you been married?
Amanda: We had a civil union last year. We're getting married-married in a couple weeks.
Pat: How long have you known him?
Amanda: Six years.
Pat: Kids from previous marriages?
Amanda: Me, two. Him, one.
Scott: Okay, I think the most important thing is having this structured, because you're each coming in with assets, right, and different viewpoints on how to manage money going forward.
Amanda: That's also a thing.
Scott: And having something structured now, like, what happens if one of you dies?
Pat: What happens if...
Amanda: Right. Well...
Pat: Or what happens if the marriage doesn't work?
Amanda: I mean, that's something once bitten, twice shy kind of thing with me paying off my house, selling my house, and paying off my house, then there's no...
Scott: That's right.
Pat: That's right.
Amanda: There's no mingled money.
Pat: Well, look, there's going to be mingled money. You're talking about actually taking certain assets from one and the other and combining the two.
Scott: Which may be the right thing, but everyone needs to come in with eyes wide open, number one. Number two, to think about the kids, right?
Pat: So you need to have a trust that is structured. So you need an estate planning attorney. And by the way, your opinion of the market is wrong, it's just flat-out wrong.
Amanda: Listen, I know nothing. I'm doing my own prejudices.
Scott: And your own experiences. You've learned from your own experiences.
Pat: That's right. And whatever your parents told you about the market, they may not have... Everyone pretends like stock is all the same thing. It's not all the same thing, right? It's not.
Scott: I mean, the S&P500 is only the 500 largest companies in the United States.
Pat: And by the way, if that fell by 100%, your real estate would be worth nothing. Just gonna throw that out there.
Scott: If every company became worthless.
Pat: Yeah, your real estate becomes worthless, every economy, everything becomes, then we'd be talking about moving to Northern Idaho and buying guns and...
Scott: Getting a bunker.
Pat: ...and a bunker. So you need an estate planning attorney first. And I think you're pushing this timeline, was a little aggressive. You're not even...
Amanda: Well, the problem is that the Palm Beach County... Okay, the other two properties that we share, we share one property 50/50 partners, that's in the North Florida. His house is 100% his.
Pat: Okay, that's why you need an estate planning attorney.
Scott: Well, you need to talk this through. If we sell the house in Nashville and go to the Wellington that you owned before, how do we structure it? And what happens if one or two things, one, one of us dies, how's it structured then?
Amanda: We have two houses in Nashville, one's down there...
Pat: I understand. Yeah, we get all that. We get all that. The bigger issue is you're trying to commingle assets that don't have equal value, without any clear understanding about how things will be divided if someone dies and/or the marriage doesn't work out, right? The weird thing about marriages is they're so easy to get into. It's like a timeshare. You get there, it's all super exciting, you know, a couple drinks.
Scott: You're only seeing the good parts.
Pat: You're only seeing the good parts. And then, bam, and you're like, you're calling up a commercial where someone's trying to get rid of it. They're very, very difficult to get out of, especially if you have commingled assets without a clear exit path on the way out. So if you were sitting in my office, better yet, you'd be my younger sister, I'd say, "Are you out of your mind, Amanda? What are we talking about here? You're talking about selling this house..."
Scott: You would. You'd be all over your sister. Man, if you were a client, would be the same thing.
Pat: Correct. If you were my sister, I'd call you today. I'd call you tomorrow. I'd call you the next day, until you went to a qualified estate planning attorney to figure out what the exit looks like if it doesn't turn out.
Scott: Or if you die. Otherwise, kids get disinherited.
Pat: And then I would tell you, slow down on the horse-trading. Just slow it down. You haven't even been married...you're civilly married, I get that. But look, it's too fast, it's too soon. You need to go through the estate planning process first, settle it down for six months, nine months, a year. There's no hurry, and then revisit the issue.
Amanda: Well, the problem is that Palm Beach County is getting more expensive [inaudible 00:35:17.894]. So I need to do something...
Pat: No you don't.
Scott: There's no rush today.
Pat: You think you have to do something.
Scott: Whatever short-term economic cost you're talking about the next six months is negligible compared to the economic cost, you guys get married and suddenly you get hit and get killed in a car accident, and your assets go to your new husband, and your kids get disinherited.
Pat: How's that look?
Amanda: I 100% see where you're coming from. I need to pay the house in West Palm. But listen, listen, listen...
Pat: No, not going to. I'm just telling you, Amanda, you're my sister.
Amanda: That house is losing money.
Pat: I am not going to listen to this. You're giving me excuses about a real estate property, and what you think is going to happen in the real estate property, by the way, which you don't know whether it's gonna go up in value or downward value. You don't know.
Amanda: Well, what I do know is...
Pat: What I do know is I have sat in rooms with people that are in the process of divorce and I help them decide what came into the marriage, what left the marriage.
Scott: Look, you don't always decide. You mean the attorneys, or there's a mediator, or I've sat down with people have been widowed, and I've talked with kids who've been disinherited, not because mom or dad didn't love them and didn't want their assets to go to them. It's because it was a future marriage.
Amanda: And that is something that we're totally planning on doing is the estate planning.
Scott: Yeah. So I would do that first. So we can't talk about the other stuff.
Pat: We can't talk about until that time.
Scott: Not to be rude, Amanda.
Pat: When that is done, call us.
Amanda: Thanks.
Scott: All right, there you go. I just feel like she didn't like our answer. Sorry.
Pat: You called. It was an opinion, and it was a biased opinion.
Scott: Based upon our experiences, whatever short-term rental.
Pat: Come on.
Scott: Rentals, not renting is good enough for it to share something.
Pat: It's going, it's doing, we know it did. Remember, your investment, already dead. It's not doing...
Scott: And we have no idea what comes tomorrow.
Pat: No, none.
Scott: All kinds of things can happen.
Pat: Like what happened during COVID, Scott, what we do know is at some point in time, death will happen. We do know that.
Scott: Yeah, we know that, 100%.
Pat: And without the proper estate planning in that...
Scott: We know that and we've seen what happens. We'll talk now with Jim.
Jim: Hello. This is Jim.
Scott: Hi, Jim, glad you joined us. How can we be of help?
Jim: Question in reference to, I have a 401(k) plan that I've been contributing to, and I've been considering putting some money into a Roth 401(k). And what's the pros and cons on whether I do the current contribution as a Roth or if I leave it go in as traditional and then just do a Roth conversion from my 401(k) into a Roth 401(k) within the same plan?
Pat: Well, great question, maybe we should ask it a little bit differently, which is, not, "Do I do a Roth conversion in the existing plan, but do I wait till I retire and then decide whether to do Roth conversions?"
Scott: So technically, it would be a wash.
Pat: If you did it the way you described it.
Scott: Assuming you could do a Roth conversion from the plan while you're still working, which the plan may or may not allow.
Pat: But normally what happens is that you take the deduction while you're working, and then you do the Roth conversions between the time you retire and your required minimum distribution at age 75.
Scott: Or sometimes it makes sense to do a Roth contribution, and if you're putting in, let's say, 10 grand a year, I'm just throwing a number out, pre-tax, well, that 10,000 is gonna be taxed in retirement, so it's not gonna be worth 10 grand when you pull it out, because you got to pay the tax man. So maybe it's worth seven grand, as opposed to, if you put in 10 grand in the Roth, you've paid the tax, you've paid that extra three grand to the tax man today, and then when you pull it out of retirement, it's tax-free. So I would, I mean, clearly, dollar-for-dollar, money in a Roth's worth much more than money in a pre-tax. It doesn't mean that you shouldn't do the pre-tax but...
Pat: So tell us about your situation. How old are you? How much money do you make? How much money are in these plans? Do you plan on living in the state of Cal? Where are you from?
Jim: Kentucky.
Pat: How much money are in your plans now?
Jim: Currently in the 401(k), first off, I just turned 60 in July. Currently in the 401(k) is approximately 1.3 million. It's broken down to like about 84,000 in like a savings within that, 735 is in a 2030 target fund, and about 490,000 in the Vanguard 500 index.
Pat: Okay, and how much do you make?
Jim: A hundred thousand.
Pat: And do you have any Roth money now?
Jim: Yeah, like said, 94,000 of that 1.3 is considered Roth.
Scott: Oh, got it. Okay.
Pat: And do you have any money in IRAs outside this?
Jim: Yes, I have approximately, let's see, 21, 28, 38, about 50,000.
Scott: And are you married?
Jim: Single, no kids.
Pat: And the money outside in the regular IRAs, are they Roth or pre-tax?
Jim: The amount I just said, about 50-some is Roth. In addition to that, I have another 260 that's in short-terms, well, relatively short-term CDs, about 30 of that is two years out.
Pat: And is any of this inherited money or did you earn all this?
Jim: All that is earned. I do have another 9000 with an inherited that's sitting in a IRA.
Scott: And will you receive a pension when you retire?
Jim: A small one if I wait till 65 to claim it. I'm eligible to claim it now.
Scott: Are you retired now?
Jim: No.
Scott: When do you plan on retiring?
Jim: Somewhere between two to five years, probably.
Pat: You're an incredible saver.
Jim: Yes.
Scott: I would not contribute to the Roth today.
Pat: I would not contribute to the Roth.
Scott: And here's why. So it's all based upon where taxes are. Right? Nobody knows where taxes are gonna go in the future, but what we do know is the tax code is very progressive. And what do we mean by that? Like your first 11,000 of income, taxable income, this is after deductions, it's really about 20,000 of income you pay no tax at all. I'm sorry, your deductions you pay no tax. The first 20,000 or so, it's roughly 10% is the tax rate. From roughly 10,000 to 50,000 ballpark, you're in a 12% tax rate. Then it bumps from 12% to 22% and then from 22 to 24, right? So maybe tax rates are gonna go up in the future, but right now, we know that you can take a debt... you're getting a deduction at the 22% maybe even the 24%. And at retirement, when you go to leave, that's to Pat's point at the beginning of the call, he said oftentimes we see people doing Roth conversions during the years between the time they retire and the required minimum distributions. It gives you the best opportunity for you is those years when you're not gonna have much in the way of taxable income. You may even choose to defer Social Security for a couple years and do the conversions then, and do some Roth conversions. Maybe even live off some savings, do some Roth conversions during those years.
Pat: Because you've got $260,000 in CDs. So you can take a deduction today at 22% and then convert it later at 12% maybe the 12% will be at higher rate, 14, 15, but it's not gonna be higher. It's because your taxable income's going to be much lower.
Scott: If you're planning correctly.
Pat: The answer to your question is, no, don't use the Roth. And by the way, you're a phenomenal saver. This is Cinderella tax planning the day you retire. I mean, you look at this and you're like, "Holy smokes." I don't know if Jim did this on purpose, but it's perfect. You've got money in different places that you can set it up the day you retire and just decide, "Okay, this is how I'm gonna take income. This is how it looks. This is when I'm taking Social Security," brilliant. And so when you go to retire, you need to actually address that, and it's gonna probably take a qualified tax advisor or a financial advisor. Let me ask you one question, do you have an HSA available to you?
Jim: Yes.
Pat: And are you spending that HSA? Are you using it for health care?
Jim: Small amounts of it, but not a whole lot of it.
Pat: I wouldn't use a dime of it.
Scott: Yeah, I'd let it accumulate.
Pat: I'd let it accumulate, and I'd put it all in the S&P500. And you can probably do that through your employer. We have it here at Allworth where you can direct your HSA into an investment account. I don't spend a dime in my HSA.
Scott: I don't either.
Pat: For years, my wife fought me on it, wanting to spend it. And finally, she's like, "Well, this makes sense."
Scott: Hey, appreciate the call, Jim. And based on what you told us, continue the pretax contributions. When you retire, odds are the recommendation would be, if you were retiring, well, if you're retiring today, clearly the recommendation would be let's do a Roth conversion over a couple-year period of time, based upon the high level you have in savings would probably just use your savings for your income, push up the tax rates through that Roth conversion, get a nice, good sized chunk of your pre-tax dollars into Roth. It's perfect planning for you.
Pat: Perfect.
Scott: We're in California, speaking with David.
David: Hello. I have some questions about Roth IRA conversions.
Scott: Yes, sir.
David: I've been reading stuff online, and it seems like everybody's a little bit saying something a little bit different. I understand that...
Scott: Well, every situation is different. So there are people that will say, "Oh, you need to do Roth conversion this year," and other people will say, "Do not do a Roth conversion." So every situation is different.
David: No, it's doesn't have to do with whether or not you should do it. It has to do with the five-year rule. And I understand the five-year rule about you have to have contributed something in order for it to be...you can take distributions after five years, but then I'm finding things about each IRA conversion has a five-year clock.
Pat: Yeah, I gotta tell you, everything you said there is true. Very rarely does that actually go into the decision-making is to how to take the money out of the Roth. And the reason being is normally...
Scott: It's the last dollars you spend.
Pat: Or you're using it for tax efficiency programs over a series a year. And remember, you could still pull your principal out without any sort of penalty on it, so most of it's liquid in that first five years. So that's why...
David: Well, one website says that the Roth IRA conversion has a five-year clock, but that rule determines whether the conversion principle will avoid tax penalties.
Pat: We understand the rules. Absolutely understand the rules.
Scott: So tell us about your situation.
Pat: Tell us about your situation, then we'll give you some direction.
David: I'm 63 and I have three-quarters of my funds in a traditional and a quarter in my Roth, and I have some in a regular brokerage. But when I asked my brokerage about it, they never replied.
Pat: Well, that's kind of sad you have to call radio show to get good investment advice, but you're paying someone else for that investment advice. So how much is in the IRA?
David: I've got three-quarter.
Pat: Yep. What's the dollar amount?
David: About a million in the traditional and a quarter in the Roth.
Pat: How much money is in brokerage?
David: In my regular account I have 600.
Scott: And what's your income?
David: I'm retired right now.
Pat: Yeah. But are you taking money from your IRAs? Do you have Social Security? You have pension? What are you living on?
David: I've just been using money from my investments.
Pat: From your brokerage account.
David: Correct.
Pat: Okay, and are you married?
David: No.
Pat: Okay, and so how much are you living on...?
Scott: Are you on Social Security?
David: No.
Pat: Okay, I'm so glad you called me. That brokerage, the people that are managing that brokerage account are not doing you any favors. This is exactly when you should actually be doing the Roth conversion. Forget that five-year rule.
David: No, no, I've been I've been doing Roth conversions for the last 10 years. That's how I...
Pat: How long have you been retired?
David: Probably 10 years.
Pat: Okay, okay. So what's your question for us?
David: Well, the question is, about this, every conversion has a five-year clock.
Pat: Who cares? What does it matter?
Scott: You have 250,000 in Roth.
Pat: You've already got money outside of that five-year period. What are you worried about the five-year? Whether it starts on the first conversion or it's rolling five-year conversion, it doesn't matter to you.
David: Well, I'm just worried about how complicated my taxes will be.
Scott: It's not at all. You ignore it.
Pat: You ignore it. It won't make any difference to you.
Scott: You've been doing these conversions for 10 years.
Pat: For 10 years.
Scott: When you go do a withdrawal, there is no paperwork that says, "Oh, this withdrawal came from this year, this withdrawal came from..." There's no reporting whatsoever.
Pat: You're borrowing trouble. Don't worry about it.
Scott: Even if a meteor struck your house, I wouldn't think you would need a...
Pat: There's a greater chance of a meteor striking this house than it is that you would be impacted by the five-year rule.
Scott: Yeah, don't worry about that.
David: It's just that all the websites have different information.
Pat: You called us.
David: It's totally crazy.
Pat: You called us. Don't worry about it.
David: Yeah, I called.
Scott: Look if you had no conversion, you're planning converting, and you were gonna use money in four years for something, then we would have a discussion like, if that was part of the planning...
Pat: You know, like, "Okay, is it in rolling? Is it a five-year?"
Scott: But to Pat's point, you can still pull your principal.
Pat: It doesn't matter. Go down to the SPCA, and adopt a rescue animal. You're worried about other stuff. You got to fill up your day with other things.
Scott: No worries here, David.
David: No, it was just weird, because it's the first time I've been retired, and I'm just trying to figure out what to do.
Pat: David, call us anytime, anytime. But there are things in life we should just ignore, right?
Scott: For you, in this situation, ignore.
Pat: You're just gonna ignore. Do you have teenagers?
David: I should just continue doing my Roth conversions as I've been doing.
Scott: That's right, yes.
Pat: Yes.
Scott: Sounds like you run the numbers every year and do the appropriate amount.
Pat: Yeah, perfect sense.
Scott: Yeah. Appreciate the call, David. Wish you well.
Pat: As I was saying, if you've raised teenagers, you know there's certain things that you just ignore, because in the end, it's gonna work out okay.
Scott: And you know, some questions you don't ask because you don't want them to lie.
Pat: You're just gonna lie.
Scott: Okay, well, unfortunately, I guess, being a podcast, theoretically, we could be doing this forever, like some podcasts going for hours.
Pat: But we've decided we're out of time.
Scott: Yes, we decided we're out of time. Well, part of this still pops up on the radio, so...
Pat: We keep it to an hour format. But if you've liked this, do us a favor, please rate us or share with a friend.
Scott: Anyway, hey, we wanna let all of our listeners know about our YouTube channel. I think we briefly mentioned it last week, but we've got a pretty robust YouTube channel. Who doesn't anymore?
Pat: Come on.
Scott: But on YouTube, I mean, you can watch the show. You can get the full shows there, but there's also video clips of interactions with some of our callers. So if you're kind of looking for a certain type of thing, you can view that, and then also some other video production stuff that we've done along the way on a variety of different things, whether it has to do with the election or what might happen with the markets or saving for retirement, or Social Security. We've got a lot of other videos on those various topics that you can find at our...
Pat: Informational and sometimes entertaining.
Scott: Yeah, and I don't know where you find it. You could find Money Matters on our YouTube channel.
Pat: So we go to "Allworth's Money Matters" on YouTube.
Scott: Allworth's YouTube, and you'll find it, it's pretty simple.
Pat: Yes.
Scott: It's been Scott Hanson and Pat McClain of "Allworth's Money Matters."
Man: This program has been brought to you by Allworth Financial, a registered investment advisory firm. Any ideas presented during this program are not intended to provide specific financial advice. You should consult your own financial advisor, tax consultant or estate planning attorney to conduct your own due diligence.
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