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#4 Creating Tax Diversity and Flexibility in your Savings Accounts with Danielle Woods Thumbnail

#4 Creating Tax Diversity and Flexibility in your Savings Accounts with Danielle Woods

Episode 4 - Amanda is joined by Danielle Woods to discuss different types of savings accounts including 401ks, Roth IRAs and taxable savings/brokerage accounts. They breakdown the potential tax consequences of each type of account and emphasize the importance of saving and planning in order to meet your future goals.

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Emily Agosto (00:08):

Welcome to connecting the dollars, a personal finance podcast. I'm Emily Agosto, a CPA and financial


Amanda Vaught (00:16):

And I'm Amanda Vaught, attorney and financial advisor; both Emily and I are co-owners at Propel

Financial Advisors.

Emily Agosto (00:25):

Propel Financial Advisors is an investment management and financial planning company. We are fee-

only fiduciaries and independent registered investment advisors. I'm based in Chicago and Amanda is in

New York city, but we work with clients nationwide.

Amanda Vaught (00:40):

The purpose of our podcast is to explore personal finance topics, including budgeting, investing,

behavioral finance, current events, and other helpful information. We also hope you'll get to know us

along the way.

Emily Agosto (00:54):

Thanks for listening.

Amanda Vaught (00:59):

Welcome everyone to Connecting the Dollars. We have Amanda here today and my co-host Emily is out

today because she got to take a much needed vacation to Ecuador with her husband which is great for

Emily after a really extra long tax season. But it also gives us an opportunity to bring in one of our other

co-founders, which is Danielle Woods. Danielle say, hi, welcome. Danielle has been a financial advisor

for 23 years. She's also a lawyer and tax professional. She has just extensive experience and tons of

stories. So brings great insight into a lot of these personal finance questions. So today we want to get

into different types of accounts that we can use for savings. This is a question we get all the time from

clients and don't you think Danielle?

Danielle Woods (02:03):

Yes, I spent about 45 minutes yesterday going over it with a new potential client.

Amanda Vaught (02:08):

Yeah. And they impact people, whether they're in the savings phase, whether they're transitioning into

retirement or in retirement. Wouldn't you say? Mm-Hmm <affirmative> yes. So when we think about

these different accounts, do you mostly think of them in terms of their, their tax status? And we can get

into that, but I think for a lot of, yes, yes. And so for let's just start because a lot of people in the savings

phase of their life mostly use a 401k. So could you just briefly touch on, you know, what a 401k is and

the pros and cons of using that as a savings vehicle?

Danielle Woods (02:47):

Sure. Well as in all things that have to do with people's money, it seems the definition of a 401k has

changed over the last 10 years. It used to be a, a 401k was offered by an employer and it was a pre-tax

retirement savings account. Now you have both traditional 401ks, which are still pre-tax savings

accounts for retirement, and you have Roth 401ks, which are post-tax savings for retirement. And so it's

not as simple an answer as it used to be. To make that even more complicated, whether or not you

choose to contribute pre-tax or post-tax your employer match, should you be lucky enough to get one, is

always pre-tax. So I think I just made your question longer. <Laugh> which part of that do you wanna

start with? Yeah,

Amanda Vaught (03:42):

Well that's okay. But, you know, I think it is important to stress too. This is very individual and so no lot

of 401ks, they do have some universal qualities, but it's also very dependent on your employer because

different employers offer different types of plans. Mm-Hmm <affirmative> and so for one person and

they might have the Roth option, like you mentioned, they might have an employer match, they might

not. So we do get, you know, into some personalization here, depending on who it is and the type of

plan available, but just, just say, for example, a generic 401k, if you have a 401k and you have a pretax

contribution and that's it, should you be taking advantage of that?

Danielle Woods (04:26):

So usually our first question is, are you getting any kind of a match from your employer? And the other

word for match is free money. So I like free money. We tend to recommend it to clients. Often it looks

something like if you, as the employee contribute up to, you know, 5% of your salary, the employer will

match, you know, half of that. So if you contribute 5% of salary and your employer contributes half, then

ultimately seven and a half percent of your salary is being contributed to your retirement plan for you.

And we keep using the word pretax. What that simply means is that the money that goes into that

account, either for you or by you or both has never been taxed. And what that means is that it does not

mean that you will never pay tax on it.

Danielle Woods (05:16):

It means that you will pay tax on those contributions and those earnings potentially many, many years

from now. So whenever we talk about an employee retirement account, there are a lot of options. 401K,

I think is the most common in the one that people recognize when they hear it, it is also what I call the

Cadillac of employee retirement plans. Big companies, you know, any company of any size will offer a

401k. They are not as common for small businesses. And actually most of the employers in the United

States are considered small businesses. They can't afford a 401k. They're expensive. There are a lot of

Department of Labor and IRS requirements. And so they use something else. So the 401k again is

typically limited to bigger employers. You may or may not get a match. So back to your original

questions, should you use it if you get a match from your employer?

Danielle Woods (06:12):

Yes. I think you should use it. I think you should get your free money and let that add to your savings

going forward. Although I recently met with a small employer group and their participants and they

asked a good question. They said, if you get a match on that 401k, and you're telling me that that's free

money and I should take it, but I'm gonna end up paying taxes on all that in the future. Am I really

getting anything for it? If I do that for a Roth IRA, and maybe that's taking your question too far yet.

That's a good question that we can go into later. Mm-Hmm <affirmative>

Amanda Vaught (06:44):

Yeah, that gets back into it. It's it depends. Right,

Danielle Woods (06:48):

Right. <Laugh> right.

Amanda Vaught (06:51):

And then if we do the 401k and we do get the match, do we wanna max out our 401k?

Danielle Woods (06:57):

You know, it depends <laugh> There's that again. Usually folks who are in a very high tax bracket, I'm

talking about people who are making three, four, 500,000 a year or well into the millions. Yeah, you, you

usually wanna do that. You wanna max it out in 2021, your maximum contribution can be $19,500, if

you're under the age of 50, if you are 50 or older, then you can contribute $26,000 to your 401k. And

there's a match on top of that. So it's still a nice amount of money to put away. And if you are in the 30

plus percent tax bracket, that saves you a lot on taxes. Now in the current year <affirmative> so if you

are in a much lower bracket and you're only making, you know, you're 12% bracket or 22, or maybe

even the 24% bracket maximizing that when that's the only place that you're saving money may not be

the best thing for you.

Danielle Woods (07:55):

It also depends on what your existing portfolio already looks like. So when we have somebody come to

us, who's, you know, brand new, like a potential client I spoke to yesterday is 23 years old, right out of

college and has his first job and is asking about contributing to his 401k. He has a very good 401k, has a

very nice match. It matches a hundred percent up to 6%. So he'll get a 12% contribution if he maxes out

his bad amount, but does he wanna put all of that in there? The 19,500 in his case, it might make sense.

He has a 401k that doesn't have a restriction on what you can buy. So most 401ks have a list of assets

that you can buy. Sometimes that list is as small as four. Sometimes it's, I've seen it as big as 25 options,

but whatever it is, it's a much smaller option than the entire universe out there.

Danielle Woods (08:53):

Right. You can buy a lot of different assets. If you just had your own account and you could just buy

whatever you wanted. So back to that depends answer. It really depends on what your options are that

are available to you. If you have a, a plan like this client, I spoke to yesterday where they can buy

whatever they want in their 401k plan, that change, I answer quite a bit, you know, if you can buy

anything and you're not limited to those five things that somebody else might be limited to, then it may

make sense to max out. But the other point I would ask is, do you have any post-tax retirement savings

in my favorite account called Roth IRA? And if, you know, say we have got clients who all of their money

is 401k or, pre-tax accounts, and they have nothing in anything else. Then we may say, you know, it's

time to start looking at other options to diversify your account type.

Amanda Vaught (09:45):

Right? Yeah. That's what I wanted to get to next was how about using other savings accounts that are

not through your employer and how can those benefit you? And you just brought that up there, the

Roth. So can we just touch on the Roth here really quick, just for people who don't know, give a little

background on what the Roth is and then get into how it can benefit you.

Danielle Woods (10:07):

Yeah. So whenever we're talking about any kind of an account, we have a legal structure and a tax

structure, and I'll talk about tax structure first because there's different definitions for the legal structure

of the Roth, depending on what kind of a Roth you have. All Roths are considered post-tax retirement

savings. That means that whatever you contribute to it has already been taxed. And therefore that

amount that you contributed, plus the earnings on it over the years, whether that be five years or 20

years or 40 years, depending on how old you are, when you make that contribution, those contributions

on earnings will never be taxed again. Any withdrawal from that Roth IRA in the future for retirement

purposes, after the age of 59 and a half, will be invisible on your tax return, which, you know, if you're in

your thirties right now, that doesn't matter to you, but if you're in your or sixties, it matters a lot. And so

it's one of those mm-hmm, <affirmative> diversifier for any portfolio that we recommend

Amanda Vaught (11:04):

That cause that can affect your, your taxes, but also your Medicare premiums,

Danielle Woods (11:10):

Medicare premiums, healthcare dot gov premiums, social security, taxation. Yeah. Anything that you put

on your tax return, anything you have to declare is income is gonna have an impact on a, a variety of

other issues on your tax return. And that's becoming more and more the case and, and more and more

items are are getting linked to that. For instance, in the last year, whether or not you got a stimulus

payment, for instance, had everything to do with how much money you showed that you earned that

year. So the name of the game is putting as little on your tax return as possible. And sometimes that

means paying some tax now to save tax later.

Amanda Vaught (11:49):

Mm-Hmm <affirmative> yeah. So your, your lifetime tax bill is lower. Yeah.

Danielle Woods (11:54):

That's a good way to, that's a good way to think of it. So back to the legal structure, when I talked about,

I said, legal structure, there's individual Roth, IRAs, meaning anybody can just go open a Roth IRA and

have their own. It is limited to whether or not you can contribute to it is based on your income. There's

that, that income <laugh> issue you again on your tax return. If you are a married couple, for instance,

and you filed jointly and you earn less than about 200,000 per year, you can both contribute directly to

your Roth IRA, regardless of whether or not you have a 401k or some employer plan at work. Now, if

you're lucky enough to have a 401k Roth option at work, which is usually only offered by much larger

companies, for the reasons I already went over, your income, doesn't matter.

Danielle Woods (12:39):

And that's, what's so great about those 401k Roths. It doesn't matter how much you make. So, so say

Amanda has an employer, 401k Roth option. And me, I only have an individual Roth option say make

250,000 a year. And Amanda makes 250,000 a year. Amanda can contribute $19,500 to her 401k Roth.

Her income doesn't matter. And it's not limited to $6,000 a year like mine would be. So even if I did

make less than 200,000 a year, a married person, I could only contribute 6,000 Amanda with a Roth

401k, regardless of how much she makes can contribute 19,500 and get her match. The match will

always go into the post or the pretax savings portion. So even if you have a Roth 401k at work and you

contribute whatever you contribute, your employer match is always going to end up in a different type

of tax account. Mm-Hmm

Amanda Vaught (13:36):

<Affirmative> yeah, yeah. That's great. And I think a lot of people, they will look at maybe their 401k

balance and they think, oh, maybe I'm, I'm doing okay. Maybe I have $500,000 saved. Which would be a

nice 401k. I don't think many people have that much saved, but if you do and you say, oh, okay, maybe

I'm okay, but you have to think, okay, the tax man is waiting to get a chunk of that. And you don't really

have 500,000 saved. You have 350K or, or whatever your tax bracket is. That's gonna cut down into that

account. And when you look at your balance in your Roth, that's, you're free and clear. The tax man

already came and he's paid. And

Danielle Woods (14:18):

Right, right. So that's exactly right. So if you have half a million dollars in your Roth and half a million

dollars in an IRA, you actually have more money available to you and your Roth than you do in the IRA,

because you're gonna be losing, you know, 20% give or take to income taxes.

Amanda Vaught (14:36):

Right. Right. And then I just wanna touch on also using a brokerage account, which is another type of

account, which doesn't have the tax advantages that we see with retirement accounts like 401ks or

Roths. Are you recommending to people to use brokerage accounts for their retirement savings?

Danielle Woods (14:54):

Yeah. So those are taxable accounts. You can think of those, just like a checking account or a savings

account, except you invest in it. You buy stocks, bonds, whatever you wanna buy in it. It can look exactly

like your Roth IRA if you want it to. But the taxes are different. So it does have some tax benefits in that

you have a lot of control over what gets taxed. So in a, an IRA for instance, or a 401k, if you take money

out, all of that is subject to regular earned income tax rates. It doesn't matter what you sold or how long

it's been in there. There's no issue whatsoever on date. In your taxable savings account, when you

purchased a security versus when you sold it has everything to do with how it gets taxed. And the only

thing that gets taxed at earned income tax rates is non-qualified dividends and interest.

Danielle Woods (15:44):

So if you have a variety of bonds and stocks how the income from those securities are delivered to you is

gonna make an impact on how it's taxed in the year in which you received it. But whether or not you pay

taxes on say a stock you've held for 10 years and it's gone up 50% in value. You're only going to pay tax

on that earnings. So say you bought, you know, a stock for a thousand dollars and you held onto it for 10

years and now it's worth $2,000 and you wanna sell all of it to, to help pay some bills that you have or

whatever. You're only gonna pay taxes on $1,000, because those are the earnings. Under current tax law

that would be subject to long term capital gains rates, which right now at best are 20%. And that only

impacts the high, much higher earners.

Danielle Woods (16:32):

So at if you're like the rest of us, <laugh>, you'll be taxed 15% on that thousand dollars. So if you take

$2,000 out of an IRA and you're in the 24% bracket, for instance, you're gonna pay what $480 in taxes

on that. If you take out $2,000 from your Roth IRA, you'll pay nothing. And if you take out $2,000 from

your taxable account on a security that you sold, where you have a thousand dollars in earnings, you're

only gonna pay $150 in tax. So they're all different. And they all have, or will be taxed at some point. But

having the three types of accounts gives you that flexibility to choose when and how to take out what

you need. And ultimately, again, it's how that distribution is going to look on your tax return. And if you

use all of those tools that are available to you, those very confusing, <laugh> constantly changing rules

that apply to those types of accounts. You can really, you can really make out a lot better than you think

you will at first glance. And, and that's something, that advisors like us and our firm specialize in, and

because this is a constantly moving target, it's confusing and it is always changing. And it's one of those

ways that we add value to our clients.

Amanda Vaught (17:46):

Yeah. Yeah. And wouldn't you say that people we work with once they retire or they're retirees, they

really appreciate having that flexibility from where to withdraw the funds, don't you think?

Danielle Woods (17:58):

Yeah. I mean, my, one of my favorite stories was a couple years ago, I had a client and she called up and

she says, I need $10,000 and I don't wanna pay taxes on it because my premiums are set on healthcare

dot gov. And if I make more money than I told healthcare.gov, I was going to make, they're gonna make

me pay more premiums. I just had a friend who had to pay $12,000 or something in back premiums for

credits that he no longer got because of some unexpected income that came in. And so, because she

had an IRA, a Roth IRA and a taxable account, we had the flexibility to take that $10,000 from where we

needed to, without making an impact on her tax return as, as, as much as possible.

Amanda Vaught (18:38):

Yeah, that's great. And I think, you know, it helps with the tax bill. It helps with healthcare dot gov

premiums, like you said, and it also, I think helps with just overall stress, you know, just like definitely


Danielle Woods (18:51):

I don't have to worry about.

Amanda Vaught (18:53):


Danielle Woods (18:53):

Know, I think there's a big difference between folks who are still working and who have money being,

you know, somewhat magically deposited into their accounts every month, compared to a retiree who

suddenly realizes, oh my gosh, that flow of money that I had gotten so used to over the years, it's, it's

gone, it's stopped. So you have a finite amount of money to work with and you can't make more, you

know, unless you choose to go back to work. So that's a very different situation. I don't know if you're

planning to talk about estate planning for those accounts either.

Amanda Vaught (19:25):

Mm-Hmm <affirmative> I think that might be a topic for another episode. All right. So we know go too

far over time, but I just think, it seems like based on what we talked about today, the name of the game

is really getting tax diversity in your retirement savings or your savings in general. Mm-Hmm

<affirmative> would you say

Danielle Woods (19:43):

Yes, definitely.

Amanda Vaught (19:45):

Okay. And then any other final thoughts you'd like to share on using these different types of account?

Danielle Woods (19:52):

No. I think just I guess just be careful actually talk to somebody who's whether it's us or someone else

talk to someone who actually knows you and asks the right questions about what else you have going

on, what you're expecting to happen. It's a very big picture kind of discussion. It's not something you

should just say, oh, you don't have a Roth. Well, you need one. I mean, I say that I like Roths and I like

everyone to have 'em, but yeah, there are, there are situations where I was like, you know, it just

doesn't make sense for you. Right, right. And that should always be, that should always be taken into

consideration mm-hmm <affirmative>

Amanda Vaught (20:26):

Yeah. I think that's important to stress too. That's what you get with a, with a fiduciary, somebody who

is looking out for your best interest, not just trying to sell you a life insurance product or some other

thing that you may or may not mm-hmm <affirmative> need so

Danielle Woods (20:42):

Well saving. I guess that's what I would tell people, keep saving <laugh> somewhere, anywhere. Yes.

Amanda Vaught (20:48):

We'll have to do another episode on, you know, how much to save. Cuz that's another common

question I get all the time. How much would I be putting in this? Yeah. How much should I be putting

over here?

Danielle Woods (20:59):

I had a client. Yeah. I had a client tell me, I, I heard once that you had to have this much money to retire

and I'm not anywhere near that. And I was like, well, that's not how it works. You know, we did a, you

know, a financial plan and, and looked at their individual income and, and export needs and you know,

what their situation was with their kids and their debt. And yeah. And I, I found that there was no reason

they couldn't retire and they're very happy. They've been both been retired for over five years and, and

haven't really touched their savings yet. They've been fine.

Amanda Vaught (21:28):

Oh, well good for them. Mm-Hmm <affirmative> isn't that? Yeah. Retirement doesn't look the same for

everybody. No different people have different lifestyles, different goals, different ways they want to

spend their life and, and you know, we can use these different types of savings vehicles to help you

achieve those goals and live your life. How you'd like to.

Danielle Woods (21:48):

I think exactly.

Amanda Vaught (21:50):

That's where we would like everybody to get if they can. Yep. Okay. Well, thanks for joining us today,

Danielle. We can't wait to have you on again, Emily, you should be back for our next episode and we'll

talk to you then.

Danielle Woods (22:07):

Okay. Thank, thank you

Emily Agosto (22:10):

For all links and resources mentioned today. Head over to www.connectingthedollars.com. Thank you

for listening.

Amanda Vaught (22:17):

This podcast is for informational and entertainment purposes only and should not be relied upon as a

basis for investment decisions. This podcast does not engage in rendering legal, financial, or other

professional services.