Transcript - The Money Drill: Where and How to Invest for Your Biggest Goals in Life

Transcription

1 Transcript - The Money Drill: Where and How to Invest for Your Biggest Goals in Life J.J.: Hi, this is "The Money Drill," and I'm J.J. Montanaro. With the help of some great guest, I'll help you find your way through what sometimes can be a money minefield. We make money matters understandable so you can command your own financial future. Welcome to "The Money Drill." I'm your host, J.J. Montanaro, and with me today, I have Mikel Van Cleve, an advice director here at USAA. Mikel, today we're talking to folks that are really dipping their toes in the water of investments, not maybe for the first time, but maybe for the first time seriously. We're gonna talk about a variety of different options and considerations they have as they delve into the world of investments. So, thanks for being here. Mikel: Thanks for having me on the show, J.J. I'm really excited to be here today. J.J.: I guess the first thing that people see when they're looking at investments or they encounter oftentimes is the idea of a plan at work, something in the form of a 401(k), or for our military listeners, the Thrift Savings Plan. So, those have some definite, I guess, features and benefits that people need to be aware of. Mikel: So, there are many different vehicles when it comes to the types of accounts that you can invest in. And, to your point, some are more tax-advantaged than others and serve different purposes. So, the type of account you're gonna invest in really comes down to what is the purpose of that money, what is your goal that you have in mind. And so you just mentioned there one of those options is is there an employer. And so, when we look at, you know, investing or saving money through our employer, what we're talking about there is potentially a 401(k) plan, right, which a lot of folks have that work for a private company. Could be a Thrift Savings Plan for our military folks or even a 403(b) plan for those that, you know, work for a nonprofit or maybe a public school district. And when we talk about these plans, the benefit there is a couple things. One is they can offer some tax advantages, and so depending on how that plan is structured, you may either get a tax break now or a tax break later depending on, you know, how you contribute that The Money Drill: Where and How to Invest for Your Biggest Goals in Life 1 of 6

2 money upfront. Could be on a pretax basis or an after-tax basis. But the nice thing is the money grows in there on a tax deferred basis. You don't have to worry about that from year to year. J.J.: Essentially, it sounds like you're talking about Roth versus traditional. So, why don't you jump into that a little bit and explain what we're looking at when we're talking about those two different options? Mikel: Sure. So, you've got a Roth versus traditional and a lot of cases within your employersponsored plan, or we could be talking about outside of that with an IRA. And so, with the traditional option, when you contribute there through an employer, you're putting money into that plan on a pretax basis. J.J.: So, it's lowering your taxes. Mikel: Yes, it's lowering your taxes now. J.J.: Lowering your income. Mikel: Right, lowering your income now to hopefully lower your taxes as well. The money is growing tax-deferred, and then when you get into retirement and you start taking withdrawals, at that point you would pay taxes on the money as you take it out. The Roth option on the other hand, again, if we're talking through an employee, you contribute through your payroll. The money goes in there on an after-tax basis. The earnings continue to accumulate taxdeferred, but the key here is that, when you get into retirement, everything including the earnings is now tax-free. J.J.: When you mention retirement, one of the things that people need to remember as they're looking at these sorts of options is, once you use these special plans you get tax benefits, but you also have obligations in terms of how long you need to leave the money in that specific account to avoid penalties, and taxes, and... Mikel: Right. That's a good point. So, there are some age restrictions, and so, again, just sticking with the employer plans, right, like the 401(k), that savings plan, that age is kind of dependent on when you retire. So, if you retire and leave that company at age 55 or older, then you can start making withdrawals without an additional penalty from the IRS. Now, if you leave the employer before the age of 55, now you're gonna have to wait until age 59 and a half to start taking money out without penalties. J.J.: And that's the general rule for IRAs also. Mikel: Right, and so let's differentiate there, because when we're talking about IRAs but with the traditional and the Roth IRA, a little bit different here, because we're not contributing through our payroll. So, with the traditional IRA, when you put money into that plan, you may or may not be able to deduct that money off your taxes at the end of the year, meaning reducing your taxable income. So, there are some rules around that, but the goal of the traditional IRA is to help lower your taxable income now and then have it grow tax-deferred, The Money Drill: Where and How to Invest for Your Biggest Goals in Life 2 of 6

3 and then you pay the taxes later. But, again, there are some rules on income levels and whether or not you have a plan available through your employer as to whether you can do that. The Roth IRA, just like with the employer plan you're gonna put in after tax, it grows taxdeferred and then tax-free, but both the traditional and the Roth IRA, there's not a age 55 rule there, it's gonna be 59 and a half on those. J.J.: But the Roth IRA you can always pull your contributions out without any taxes or penalty, which, again, is different from what the rules are for a Roth 401(k). Mikel: That's right. Yeah. So, the Roth IRA, since you're putting in an after tax, you can access those contributions, no penalty, of course, not from the IRS. But depending on the type of investment you hold inside the account, you may have some issues there. J.J.: Let's shift gears and talk about those types of vehicles with a different goal, college in mind. Mikel: Yeah, so there are really two probably of the most common types of plans that you can save into for college or invest in, and that is the 529 college savings plan and in the Coverdell Education Savings Account. A couple of difference in these, I mean, both of them are for qualified education expenses, and if you use them for qualified education expenses, there are some tax advantages there. Basically, the money that you put in there, as it grows, that growth is gonna be tax-deferred, and then as long as the money is used for a qualified education expense, then you can take it out, including the earnings, tax-free. J.J.: Now, you said qualified education expenses. So what are some examples, not an exhaustive list, but what are some examples of qualified education expenses? Mikel: An example that would apply to both is higher education expenses. So, this is a college or university that typically one that qualifies for financial aid would be where is accredited, would qualify as a qualified expense, and it's things like tuition, books, and if there's fees required for enrollment, oftentimes those will be covered as well. A key difference, though, is the 529 college savings plan is only for those qualified higher education expenses, whereas a Coverdell Education Savings Account could actually be used before college for primary or secondary school. J.J.: So, we've talked about the various types of retirement and college accounts that receive favorable tax treatment. Let's shift gears and talk about some of the life events and some of the things that we may want to do with those accounts as we get ready to use them or remove employers or that sort of things. And that, to my mind, brings the idea of a rollover or a transfer. Mikel: If you left an employer, you may have a plan there that you had started contributing to, so let's just use the example of a 401(k) plan, okay? So, I have this 401(k) plan at my old employer now, so that money is sitting there. And there's questions I have to ask myself, "Okay, do I have investment options there that help me diversify like I want to? Are there fees now that I'm not an active employee that I'm being charged? Am I able to get some assistance with how to kind of invest and allocate those funds if I need it?" And then maybe The Money Drill: Where and How to Invest for Your Biggest Goals in Life 3 of 6

4 able to leave the money with your former employer, or you may have a couple of other options. One of those being rolling over the 401(k) to your new employer's plan. There can be some advantages there if they offer the investment options that, you know, are good as far as getting you diversified like you need to. Fees may be low in that plan as an active employee, and then, of course, you've kinda got everything put into one place as far as consolidating for management purposes. The other option you may have is rolling that money over into an IRA account. With the IRA, that's typically gonna open up your options more as far as what investments you can choose. You may be able to get a little more guidance and advice from someone outside of the employer benefit area by having this IRA. But you also have to consider any fees that may be involved as far as account fees, investment fees, things of that nature. J.J.: So, the big thing is that, don't lose track of it, keep the momentum going, and ideally try to avoid pulling the money out of the plan, right? Mikel: Yeah, and, you know, the losing track part is important. I wanna hit that first, so I know that my wife had an old plan out there. And when we got married, we're looking at it, and it's sitting in cash. She's got plenty of time for that money to grow, but it was just sitting there in cash, and we see that happen a lot when those plans get forgotten about. We're still really focused on that growth opportunity, because we still have quite a few years before retirement. And because it was sitting in that old plan, you've kinda forgotten about it, and it's really not positioned as well as it could be. J.J.: So, we've talked about rollovers and transfers and really keeping the momentum if we should change jobs or move to a new employer, but there's also some great things that you talk about in terms of what we can do to keep the momentum going within our life and with our employer just in terms of habits that will help us grow those future savings. Mikel: Yeah, the real key here is just staying committed, right? Because there are so many things throughout life that are gonna be competing priorities, and they're gonna compete for that money. Whether it's a plan you're contributing to through your employer, or it's an IRA you've set up on your own, or even just a regular investment account outside of those retirement plans, you wanna make sure you stay committed to that, so you can, you know, set up things like automatic allotments or I guess we can call them transfers into your investment account. You may be able to set up a payroll deduction, you know, to an account even outside of your employer. But the real key there is, you know, obviously, first of all, it's just if you haven't already getting started and if there are many things competing for your money right now, if you have to start small, start small. That's fine. That's still better than nothing, but stay committed to that goal over time. J.J.: And I love the idea of saving money that you don't have yet. So, the idea of perhaps allocating future pay raises or promotions as part of your investment plan. Mikel: Yeah, absolutely, and for those that do have an employer plan, that's one nice feature there that's often offered, maybe not always, but in a lot of cases it's out there, is you can set that up to automatically increase each year. So, they'll start ratcheting up, and if you get those The Money Drill: Where and How to Invest for Your Biggest Goals in Life 4 of 6

5 pay raises and stuff, even if you had a flat percentage, if you get pay increases, that's a little bit more going in each year, but you may be able to say, "Hey, every year I want this to go up another percent." If it's not something through your employer, you can still do that same thing, where you just begin to increase it every year. Just tell yourself, "I'm gonna increase this." One really neat feature that USAA has recently come out with is a tool called Savings Booster, and with Savings Booster, you can take a percentage of your pay and set it aside. You can even take your tax refund and boost part of that, and that way you've got money automatically being pulled when it comes in, any additional dollar, so that things like that can be pulled in and set aside into savings or investing. J.J.: Now, what do you think, what's your advice when it comes to a big tax return, or some sort of inheritance, or just something that's out of the ordinary that comes into our financial front door, and now we've gotta decide what to do? Mikel: Well, I was gonna say, first of all, is you get excited and celebrate, right? Because all of a sudden this money has come in, right? This extra windfall, so you definitely wanna take a moment to appreciate that and enjoy it, and it's okay to have some fun. I think where we get ourselves in trouble sometimes or maybe where you could almost say even wasteful is when we spend all that on having fun. And so, you know, when we do get those windfalls, tax refunds, bonuses, and inheritance, unexpected money, whatever the case is, there are some key things we can do with that, and so I would say, you know, just to list a couple of those. One is, if you don't have money set aside in savings already, liquid money available for emergencies or unexpected things that come up, then I would do that first. That way when unexpected things do happen, it doesn't derail the other fun that you do wanna have. The other thing is, if you've got a lot of high-interest debt out there, you've got credit cards, maybe unsecured loans, things like that that have high rates, any type of windfall you get, that's a great opportunity to start paying that down, but there's also an opportunity there to invest. And so, as a general rule of thumb, I would say take anywhere from, you know, at least 10%, 15%, maybe even 20% of that windfall that you've received and start investing it. But, again, it really comes down to what you've already done and need to do. I mean, if you've already got an emergency fund in place, if you've managed your debt well, you may be able to invest even more than that. J.J.: Let's close out talking a little bit about management of these types of accounts. And so oftentimes people will hear the idea of rebalancing and reallocating. What exactly does that mean, and how should people be approaching that? Mikel: You know, rebalancing, that's an interesting topic. Let's try to break that down, what that word really means, right? So, when you think of...i'm gonna try to use just an easy example here. So, let's say we have these two different investments inside of this one account. Let's say it's our employer plan, for example, our 401(k) or whatever. And they're both at 50%, and I've got 50% in one and 50% in the other. I'm not saying that's how everyone should invest, but let's just say for these purposes that's what we have. We've got this mix. Well, the one investment is a little more, I guess you could say, aggressive than the other, and because of that, let's say the market's doing well, well, that aggressive investment has now become 75% and the other one is only 25%. Well, am I really The Money Drill: Where and How to Invest for Your Biggest Goals in Life 5 of 6

6 comfortable taking on that level of risk? Because things aren't always gonna just go up, up, up, up, up. At some point things may start to go down, and I have to ask myself, "Am I comfortable now with 75% over here?" J.J.: Your portfolio got more risky just by virtue of what happened... Mikel: By virtue of growth, yeah, with what happened in the market. And so when I rebalance that, I may put that back to Now, I'm back to that comfort level of risk I said I wanted initially, and in doing so, I have effectively sold off the one investment that was higher and bought the other investment which is lower, which in just basic investing you wanna buy low and sell high. J.J.: See, you almost didn't get that out right. Mikel: I almost said it backwards, so it would have messed everything up. J.J.: Now, how often should folks do that in terms of rebalancing? Mikel: It really kinda depends on what's been going on, but it's a good idea to at least once a year review that and see if you need to do the rebalancing, or for some folks, it's easier just to set it up automatic. And sometimes that is an option that's available depending on the type of account and the investing you're doing. If it's an option, you may look to set that up to just automatically rebalance once a year. J.J.: All right, Mikel, any final thoughts on these sorts of plans that are tax-advantaged that really people can use to take them to the next level when it comes to their finances? Mikel: Yeah, I think the key, again, just comes down to what is your purpose in that investment, what are you investing for, what is your goal. And then once you know what that goal is and you know how much time that you have, that's when you can look at what are my different options, right? So, what are the different investment vehicles that I should be looking at, and I will say if you've got a plan available through an employer and they are offering some type of matching contribution, you definitely wanna at least consider that and look to that as one of your first places to invest. J.J.: That's the type of money that's really hard to leave on the table. All right, Mikel, thanks so much for being with us here today, appreciate your insights on the tax-advantaged accounts that are out there and really some of the things that people need to be aware of, whether it's rollovers, whether it's how they can grow those contributions in the future, and ultimately some of the nuances of rebalancing. So, great as always to have you with us here on "The Money Drill." Mikel: Hey, thanks, J.J. I appreciate it, and I enjoyed being here. J.J.: For more information on this and a whole lot of other topics, visit usaastories.com. Thanks for listening. This is "The Money Drill" with J.J. Montanaro. For more great advice, check out usaatories.com. The Money Drill: Where and How to Invest for Your Biggest Goals in Life 6 of 6