Is A Backdoor Roth IRA A Good Move For Higher Income Earners?

Backdoor Roth IRAThere are three primary types of retirement plans in the U.S. today: Traditional IRAs, 401(k)s, and Roth IRAs. Although there are some other plan options out there such as SIMPLE IRAs, SEP IRAs, for the most part when people are talking about their retirement funds, they are referring to one of the three main types mentioned above.

It is often debated which of the two IRA options is better: the Traditional IRA that is tax deferred, or the Roth IRA that is funded after tax. Hypothetically speaking, if your earnings and tax rates went unchanged for your entire life, both types of IRA plans would net you the same amount of money in the end – it’d just be a matter of either paying the taxes up front or deferring them until later. However, it’s unlikely you’d actually be in a situation where those two variables would stay constant for your entire lifetime, since earnings and income tax rates regularly fluctuate.

I’ve been a staunch opponent of the Roth IRA because it’s never a good idea to pay taxes up front to a government who excels at wasting money. So long as you have your money, you can figure out ways to shelter your money from the government in a myriad of legal ways.

But what if you are a super pessimist who believes taxes have to go up because the budget is so poorly managed? Furthermore, you’re inept at navigating the many legal tax savings rules. In such a scenario, even those of us in the lowly 25% and under federal income tax brackets are probably not safe.

How Investing In A Hedge Fund Saved My Retirement Portfolio

Retirement is lounging in an infinity pool by Jalon Burton

Reducing volatility from investing with hedge funds in order to relax

One of the benefits of working at an investment bank is gaining access to a variety of investment opportunities that retail investors normally wouldn’t have access to. For example, if Goldman Sachs decided to create a special opportunity fund for institutions because they saw opportunity in the Argentinian debt market, employees would have the opportunity to invest alongside some of the world’s largest money managers like Fidelity, Capital, and Franklin Templeton. Random investment opportunities came up all the time.

After two years as a financial analyst at GS in NYC, I knew my days were numbered as the NASDAQ dotcom bubble burst in March 2000. I remember optimistically telling my VP in May 2000 how I was still bullish on the markets and he sternly told me, “We’re in a bear market. Stop kidding yourself.” Three years later, more than half of my analyst class was let go.

By June 2000, it was clear the NASDAQ was not getting better. I can’t remember exactly how things played out, but I think management sent out an internal e-mail to all employees about how we should keep focusing on our clients – that now was the best time to give them a call or take them out because nobody else was. In the employee memo, management also indicated they had added some new options to our 401k retirement plan, namely several hedge funds that looked to profit from the downturn.

Given some of our smartest and most profitable clients were hedge funds, I decided to do some research and invest half of my 401k into a technology hedge fund, Andor Capital Management, founded by Daniel Benton. Andor was one of Goldman’s largest clients, and they formed some type of partnership where they would let employees invest without needing the $1 million+ minimums. The flagship Andor technology fund ended up returning 35 percent in 2000, net of fees, and my 401k actually inched up in 2000 and 2001 as a result of the hedge fund investment instead of getting slaughtered.

I kept my GS 401k until 2003, despite moving to a new firm in June 2001, due to the investment selection. But after it felt like the markets were out of the woods, and since I could no longer contribute to my GS 401k hedge fund as an ex-employee, I consolidated my 401k balance at my new firm to keep things streamlined. 

The Top One Percent Income Levels By State

A top 0.01% income earner's yacht

A top 0.01% income earner’s yacht

The Economic Policy Institute came out with a interesting report that chronicles the top one percent income levels by State. To save you the hassle of reading the whole report, let me share with you some of their charts, and my own thoughts on the subject for your review.

The EPI is a liberal, non-profit think tank based in Washington DC, which has been around since 1986. The entire goal of their report is to highlight the rising income inequality between the rich and poor over the decades. I think they’ve succeeded in making a point that the government should do more to redistribute wealth to make society more equal. We all know the wealthy have gotten really wealthy during this bull market given they hold the majority of stocks and real estate in our country. The middle class and poor have fallen behind because income growth has gone nowhere over the past 45 years.

Let’s have a look at the top one percent income levels by state and discuss five key takeaways.

Managing A Complicated Net Worth: How Messy Is Your Money?

Antique Chinese Coin Collection Part Of Net Worth

Started collecting Chinese coins in 1997

A blogging buddy of mine named J from Budgets Are Sexy publishes his net worth figures every month. Although I generally advise against sharing all of one’s financial details, if the figures are reasonable, then that’s probably fine. Otherwise, the pitchforks will be focused on those who brazenly display obnoxious amounts of wealth with no regard for others. May Stealth Wealth live on in us all.

Remember, it’s more about what you have to show for your income, not so much about how much you make. Your net worth figure should be carefully protected as it grows.

J is in his early-to-mid 30s and has a family of four with a very respectable net worth of ~$470,000. Given he has around $37,000 in cash, the next time I see him at a conference boondoggle, of course I’m going to let him buy me a steak dinner! Instead of letting his cash earn nothing in a money market account, he might as well take care of his friends right?

What I noticed about his net worth picture is how pleasantly streamlined it is. He has no more than 10 financial accounts to track. Have a look.

Net Worth Chart

After seeing J’s net worth chart, I got to thinking about how complicated my own net worth picture is. I used to track my net worth with an Excel spreadsheet every single month since 2000. It was pretty fun for a personal finance enthusiast like me, but it started getting a little cumbersome after my account total grew. By the time I aggregated my accounts online in 2012, I had 25 accounts to track. I felt relieved when I no longer had to write everything down and update figures every month. Now everything just gets updated automatically thanks to technology.

But something funny happens when you just leverage technology to track your net worth. You stop being as analytical with your finances as you used to because you just rely on technology to do everything for you. In other words, you start getting a little lazy. Laziness is a net worth killer because it prevents you from taking action when opportunities arise, e.g. refinancing a mortgage.

My net worth has grown since 2012, like I’m sure most of your net worths have. What I’m curious to know is how many financial accounts I have now, because I haven’t checked in over a year! Perhaps you’ll share your count as well.

Always Work On Improving Cash Flow For Financial Independence

Cash Flow For Financial Independence

Cash Flow by Jo Z-Sunny

The other day I asked a very wealthy entrepreneur about his main financial concern. He’s probably worth anywhere between $50 million to $75 million dollars. Given he has so much money, I thought his answer would be more philosphical, like “making sure my kids appreciate the value of money,” or “how to create a lasting legacy.”

Instead, the entrepreneur responded, “My biggest concern is making sure I have enough cash flow to maintain my lifestyle.”

I initially thought the answer was odd because why bother measuring cash flow given he can simply draw down principal to fund his lifestyle forever. $500,000 here, $1 million here, who cares? He’s still left with tens of millions of dollars left over! But maintaining a lifestyle that is meaningful to you is what having money is all about.

Many people with tremendously high net worth figures don’t have nearly as much LIQUID net worth as one would assume. People mistakenly think that just because someone has a $10 million net worth, that they can withdraw 10 million $1 dollar bills and make it rain. Instead, high net worth individuals likely have much of their net worth tied up in equity stakes that could disappear if a downturn like 2008-2009 ever happened again.

Just look at the guy who founded CNET, the technology online review site. He was worth $2 billion dollars, but after a divorce and leveraging up in 2007, he filed for bankruptcy. Every super wealthy person I know is well aware of how ephemeral wealth is. This is why buying real assets, like property or fine art is so attractive to many equity millionaires.

It’s Impossible To Stay Retired Once You Retire Early

Retired couple by Sebastian Flickr Creative CommonsIn the spring of 2012, I hung up my sword after working in finance since 1999. There was actually a hiccup the very last day of work, a Friday. When I was e-mailing some personal files from my work account to my personal account (pictures, tax docs, etc), I inadvertently e-mailed a five year old client file that was caught by compliance. I was warned this was a violation of company policy and that I would be hearing from them about any repercussions the next week. I apologized for the mistake and waited nervously about the fate of my severance check.

To allay my worries, I actually went to a free Hastings School Of Law community service event where law students and professors helped those with legal questions. They just so happened to host the event on what I thought was the first free weekend of the rest of my life. It was great to see the school give back to literally hundreds of people regarding questions about divorce, employment, accidents, theft, trusts, and more.

My question to a professor and to a law student was simply, “Can my firm take away the agreed upon severance contract due to a five year old company file that I inadvertently sent to myself?” Financial companies are notoriously strict about ex-employees transferring sensitive client documents that can be advantageously used against their old employer if they join a competitor. I told my company that I was retiring from the finance business altogether, but how could they know I was really telling the truth? In our business, few people voluntarily walk away from such paychecks.

After getting comforting council saying that I should be fine, I promised that day to NEVER go back to work in finance if I could still get my severance and deferred compensation. My new manager was in from New York City that day and was already busting my balls for the incident. I went a step further and promised to never go back to working for anybody. Hundreds of thousands of dollars were at stake and I was worried.

HR called me the following Tuesday and told me everything was fine in the end. They agreed the client file was irrelevant given it was five years old, and accepted my e-mail apology for the mistake. Once I got my severance check several weeks later I felt like I had sheepishly won the lottery. Instead of spending it all, I sat on it like I would any financial windfall. By the summer of 2012, the market had taken a little dive and I finally invested the entire amount in the stock market so as to make it disappear. I wanted to stay hungry and pretend I received nothing. 

How To Save More Than $100,000 A Year Pre-Tax: Open A SEP-IRA Or Solo 401k

SEP-IRA by American Advisors GroupOne big goal on Financial Samurai is to highlight to readers what is financially possible. Once you know what is possible, you minimize your limiting beliefs and tend to strive much farther. Through close to eight hours of research and production, this post will explain how you can add more than $100,000 every year pre-tax to your retirement account if you have the right employer and proper strategic money making mindset.

The 401k maximum contribution for 2015 is $18,000. The increases will likely continue by $500 increments every year or two to keep up with inflation. Contributing $18,000 pre-tax a year for 30+ years will most likely make you a millionaire by the time you retire. Unfortunately, $3 million is the new $1 million, and in 30 years, $7 million will likely be the new $1 million if we assume a 3% annual inflation rate!

The 401k is not enough for most people to retire on. Sure, we potentially have Social Security to help us when we reach, at the earliest, 62 years of age. But I wouldn’t count on the government to properly manage our money until then. Beyond maxing out a 401k every year, I encourage everyone to also invest at least 20% of their after-tax, after-401k money into a diversified investment portfolio.

As a contractor over the past year, I’ve discovered something that will really supercharge one’s pre-tax retirement savings. The discovery still seems too good to be true, so for any of you tax gurus out there, please speak up and correct me if I’m wrong. We are going to crowd source this post into one of the best maximum pre-tax retirement posts around. The research I’ve done is based off the IRS website, my own experience, and speaking to Fidelity’s small business retirement department where I have a rollover IRA, SEP-IRA, and Solo 401k.