Figuring out where to invest invest after you've maxed out your 401K is a reason that many people come to financial planners.
We offer our five best suggestions on where to invest after maxing out your 401(k).
We discuss when Roth IRAs and backdoor Roths. Bridget says that there are some fun tax planning ideas that open up with what she calls Goldilocks taxable accounts. But, is fun tax planning a contradiction in terms? Well, saving money on taxes is fun, so perhaps tax planning is fun.
Other ideas include 457 or deferred compensation plans accounts and I Bonds. Of course, we love I bonds and have done multiple shows on their benefits. We love I bonds.
And we debate the use of variable life insurance. Understand why Bridget grows a (figurative) third eyeball when John says he recommends them.
Here's Bridget's firm website: https://www.sullivanmermel.com
John's firm website: https://www.trinfin.com
For advisors around the US: https://www.acplanners.org/home
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TRANSCRIPT:
Bridget: Are you able to max out your retirement savings, yet you still want to save more? In this episode, we'll reveal what we tell clients who are in that situation. We've got our top five ideas for what we tell people to do after they've maxed out their 401K or 403B savings accounts. Hi, I'm Bridget Sullivan Mermel, and I've got a fee-only financial planning practice in Chicago, Illinois.
John: And I'm John Scherer. I have a fee-only financial planning practice in Middleton, Wisconsin. And before we go any farther, Bridget, I want to remind viewers to hit that subscribe button. That helps other people find this information and helps increase our rankings on YouTube, so hit subscribe and let's get on to talking about what to do when you max out your 401K. This is a great situation to be in. It means you're doing a super job of saving, got a good income, and you’re maxing out. Now you go, “Jeez, I'd still like to save more money.” What do you tell people? Where should people go once they've maxed out the 401K?
Bridget: My number one suggestion is either a backdoor Roth, or sometimes you can just do a regular Roth contribution. Looking into those two options is my number one thing, and we work with clients on this all the time.
John: Yeah, that's right. And Roth IRAs are a place where all the future growth is going to be tax free. And sometimes people don't know that even if their income is too high, there're still ways that you can do Roth contributions. And so that's our number one place to go with things as you max out your 401K plan. If you're not already doing Roth IRA, look into that process. And you can do, what another $6,000 into that?
Bridget: $7,000 if you’re over fifty.
John: $7,000 for certain people. I'm not going to say how that goes 😊 If you're over 50 years old, you can do that. And if you're part of a married couple, that's $14,000 that you can put into a Roth IRA and that's all going to grow tax free.
Bridget: Right.
John: And so, that's the first place I look to put things. The second place we look is extra savings. Maybe you're already doing that $14,000, if you're a married couple, into Roth IRA or backdoor Roth, and you still got some more money to save. What should you do with it? At least for our business, I say just put it into a taxable account on a consistent basis.
It's not tax deductible, like your 403B or 401K, and it's not tax free in the future like you're Roth, so it's kind of in this middle ground where it's not tax deductible, but there are some other tax advantages to investing in that. It’s a good middle ground to find after maxing out those 401Ks and 403Bs, and doing the backdoor Roth, which are clearly number one in my mind. After those, just invest in a portfolio; that's the place to go with it for us.
Bridget: The way you described it, it's like a Goldilocks account. It's not tied up. The thing about these retirement accounts, like 401Ks, 403Bs, or Roth IRAs, is that you're really supposed to wait until you're retired to use them.
John: That's right.
Bridget: So if you want more flexibility, the taxable accounts are great because there are some tax advantages to them, yet they're available so you can get the money. And they can also help you in the future. You can do fun tax planning things, like donate stocks that have gone up or create a donor advised fund. There's a lot of tax planning opportunities in the future.
John: I can't believe you just said, “Fun tax planning.” What is wrong with these people in front of the camera here? Getting excited about tax planning? As funny as it sounds, those are fun things on our side.
Bridget: Yes, we look at it as great fun, because you can use them, but they're also great donation opportunities, too, and a lot of our viewers like to give money. So that's one of the things I really love talking about with our Goldilocks accounts.
John: The other thing is that we've got some clients who have a retirement account in addition to their 403B plan. As university employees here in the Madison area, they're also state employees, and certain state and federal employees qualify for a different type of retirement plan. Around here they refer to it as “Deferred Comp.”
Technically, in legal language it's a 457 plan, but what that means is that in this weird sort of angle on things, if somebody's working at the hospital (as a typical example) and maxing out their 403B, they can also do the 457 plan, that is Deferred Comp. and they can put another $20,000 or $25,000 into that. So it's one of these kind of angle things—I'm sure you have some similar stories down in the Chicago area—that, golly, it can be a really great deal to sort of double up on your retirement plans. Not a lot of people, however, know about this angle on things.
Bridget: Yeah. People that I've seen in this situation typically either work for a university or a municipality, and they have 457s, or I saw an interesting plan once that was taxable, but it had a guaranteed rate of return turn on it.
John: Interesting.
Bridget: And it was cute; I liked it! I had to investigate it because I hadn't heard about this kind of plan before. So even planners might not know about it, but if you work for a university or if you're a public sector employee, you can start diving into those employee benefits a little bit more and see if there's any kind of obscure plans that are available to you. They can be great!
John: And the big one for us, too, is university employees who have the 403B plan as a school employee and then they also have a 457 plan as a state employee—at least in Wisconsin with a lot of the state universities. And as people hear us describe this, they might think, “Where does this come in? I'm working for a university. Am I going to save $50,000 a year or something like that?”
And we've got clients where one spouse is working and they're running a business and they make a good income—enough to save that sum—or we've got clients where there was a stay-at-home mother, and the dad was working and supporting the family. And when the kids are out of the house, the mom says, “Hey, I'm going to go back and work at the UW Hospital as a nurse. We don't really need my income at all, but what the heck!”
You go, “Okay, well, jeez, I’m going to make $50,000, $60,000, $70,000 working my schedule, and we don't need the money. What should we do with it? I guess it makes sense to put a lot of money into this tax deferred 457 plan.” Earning this income all goes to building retirement funds. In the right circumstance, that can be a huge deal to defer income into the future when maybe you're in a lower tax bracket.
Bridget: Yeah.
John: That's a whole other topic, but there're these opportunities that are there, so I think it's a great thing for those university and public employees to at least consider.
Bridget: Yeah. And I have a public employee as a client and we just did this for one year, because he also had a rental property, and if he contributed a lot, he could get his income low enough so that he could deduct some of the losses on the rental property. Then everything went down. And so, it was a great opportunity. He couldn't maintain it, but he did one year, and it was awesome.
John: That's a great description. You have these changes in income. You got some things to do. And it's a reminder to me that this isn't the sort of thing that if you max out your 401K, then everybody should do exactly same thing. No, you need to think about this stuff. And this thing impacts that thing, and that thing impacts the other in your rental property and then your spouse's business, and then my employment.
It's not a straightforward thing. It just takes planning. It takes some thought and some detail in it. These are great ideas, but your mileage may vary. You need to look at your situation and make a plan for what your situation is and think about how that moves forward. And just remember that one moving part here changes that moving part, changes the other moving part. Everything is connected. These decisions can't be made in a vacuum.
Bridget: Right. So the fourth idea is I bonds. We love I bonds. And we've done several videos about I bonds, and we'll be doing more. With I bonds each person can contribute $10,000, and it's tied up for a year, but they're have very high interest rates right now because they're tied to inflation, and inflation happens to be high. With I bonds that gets you another $10,000 a year without doing any fancy things. There're other ways you can contribute more to I bonds too, but you can easily do $10,000 a year.
John: That's right. So yeah, I bonds are a great short-term investment and what getting nine plus percent these days?
Bridget: Yeah.
John: That’s ridiculous! I'll throw one other thing out there that we talk about with people. It happens in a narrow sliver of things but surprisingly life insurance that has cash value can be another option. And I know Bridget is looking at me like I just grew a third eyeball over here. In general, we recommend term insurance. Get lots of insurance. Buy term insurance; don't buy cash value, because it's usually a better deal for the agents selling it than for the customer buying it.
But in a certain circumstance you say, “Listen, I'm maxing out my 401K plan. I don't have access to a 457 plan. We're doing backdoor Roths. We're already doing some other investing for college, and I've got young kids and I need the insurance.” It's at least a place where it makes sense. That's one of the narrow slivers, in my mind, where it's an option. I don't know that it’s the first option or the best, but it's something that can be on the table.
And when you already need the life insurance it makes sense. If the kids are out of the house, no way. If you got young kids, like I do, however, it's an option. For somebody who is a little bit older, and their earning have gone up, and that rate of return inside there is pretty good, when you take a look at it with all those other factors and say, “Hey, I need to buy insurance anyway,” that investment component can be a decent deal. So it's at least on the table for people in that situation.
Bridget: It's interesting. It's a great idea, but the thing is that people need to understand that it's the fifth idea after you're already saving a whole lot of money. I had a client once who wasn't contributing to a 401K, didn't have anything else, and their insurance agent recommended this as a great retirement planning tool.
John: Right.
Bridget: Okay, so this is where this is where the third eyeball comes in.
John: But in fairness, it was a great retirement plan for the agent.
Bridget: Yeah, that's exactly right.
John: And I see this. You should ask, “How much can you put in your life insurance as a 23-year-old for retirement?” No, that is not the deal. I'm glad that you brought that up. It's after you've done all those other things and still think, “Hey, I'm in a really high tax bracket, and I need the insurance.” How many people are in that high tax bracket and still need the insurance? Not everybody. They've saved all these other ways. So, yeah, it can be in there, but it is definitely the fifth option, something that could fit only in particular situations.
Bridget: Yeah. My suspicion, unfortunately, is that the vast majority of the policies sold are not to this little sliver of people. It's to the great majority of the other people. So that's again, back to the third eyeball.
John: Right.
Bridget: That's a great place to wrap up. I'm Bridget Sullivan Mermel, and I have a fee-only financial planning practice in Chicago.
John: And I'm John Scherer. I have a fee-only financial planning practice in Middleton, Wisconsin. And before we go, I just one more reminder. Hit that subscribe button. Help other people find this information. And if you like what you hear on Friends Talk Financial Planning, both Bridget and I are members of the Alliance of Comprehensive Planners, a nationwide group of fee-only, tax focused planners who think similarly to us. Visit acplanners.org to find an adviser in your area. And with that, until next time.
At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.