Ep # 62: Where Should I Save? Here's The Pecking Order.

Benjamin Haas |
  • Cash reserve first - 1:38
  • Tax treatments - 4:15
  • Employer plan options - 5:52
  • Diversification - 7:46
  • Investing outside of a savings account - 10:12
  • Deferred compensation - 12:54
  • Health Savings Accounts - 14:54
  • Stock options - 16:59



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Full Transcript:

Benjamin Haas  00:03

Hi everyone and welcome to A/B Conversations where we will help you CFP your way out of it. A podcast where you get into the minds of a couple Certified Financial Planners on how we think and feel about everyday financial planning questions and what should really matter most to you. A healthier financial life starts...now! Hey, Adam. Season's Greetings, as they say.


Adam Werner  00:29

Yes, Happy holidays. 


Benjamin Haas  00:31

We are in the thick of it. 


Adam Werner  00:34

Yeah, hard to believe. 


Benjamin Haas  00:36

Cold outside. It's a beautiful day in the neighborhood. I know people can't see but I'm wearing my Mr. Rogers sweater with how cold it is. 


Adam Werner  00:46

I did specifically pick out one of my heavier sweaters knowing it was going to be a little cold today. So I hope when people listen to this, it's not 65 degrees and rainy. 


Benjamin Haas  00:58

Heavier sweaters for maybe a little bit of a heavier topic. We often get questions on random ways to save or is this the best way to go about it and like many things in our world, the answer is it depends. But we thought today, let's just talk about that process to being able to answer a question. We've packaged it in a way of like, is there a pecking order that we can go through that says, if this and this and this and this, then do that. So hopefully, that's teeing it up enough for you to maybe kick start this for us. But let's talk about the pecking order of savings for people. 


Adam Werner  01:38

Yeah, so you'll tell me if this is not the direction you wanted to go but I'll start like, right off the bat. It is the number one piece of any fundamental planning process for us is cash reserve. Get that into place. That is like the fundamental building block that as long as we feel comfortable from a cash reserve standpoint, or an emergency fund or whatever you want to call it, then you can go down that remaining checklist and let's look at other arenas but it is make sure you have enough cash and I think you said it -that varies depending on the situation. We often say between three to six months' worth of expenses in a cash position accessible for opportunities or emergencies, that you're not having to go to any sort of investment account or any sort of retirement account that comes with other dominoes. We often hear, do I really need to be holding this amount of cash at the bank knowing it's not really earning anything? And it's not the fun thing to say but the answer is yes. Its purpose is to be the safety net, not necessarily grow exponentially.


Benjamin Haas  03:03

Yeah, and I think that's fair to say, no matter what the phase of life is. I think there probably could be higher if we're going to talk about the pecking order of savings. Maybe the older generation that we serve that's maybe gotten to retirement or is really close to it is thinking, well, I can tune this out. No, this applies due to the three-bucket theory. We've talked about that in different podcasts. There is a reason to hold cash, there's a difference to us, cash reserve versus investing but make sure that cash reserve is full before we invest. I think the second part of the process then if I could go there, once that cash reserve has been discussed or has been full, it really comes down to accessibility and taxes. I think that's where some of the questions come from. Should I save here versus here versus here? So we talked about three different tax buckets. Maybe we should go through that too. 


Adam Werner  03:53

Okay. Yeah, we call it the Tax Control triangle. 


Benjamin Haas  03:57

Yeah, from way back in our infancy of us working together. Back when drawing upside down in front of a client was like mind blowing.  I hope some people listening remember that? You know, that's the way it was before all these computers. 


Adam Werner  04:15

Yeah, and before you had the whiteboard, and you know, TV screens, and yeah, I don't know that I could do that anymore. But yes, there's those three different tax treatments, different savings accounts. So there's the taxable. Go ahead.


Benjamin Haas  04:33

I was just going to say let's not get too granular but yeah, taxable. 


Adam Werner  04:38



Benjamin Haas  04:39

Tax free, just beat you to it. 


Adam Werner  04:43

So let me summarize what Ben just said: taxable, tax deferred, and tax free - there. We're both covered. I think really the thought after the cash reserve that people usually come with, if you are in that phase of life where you're saving for retirement. The question is going to be: Do you have some sort of employer plan? And maybe more importantly than just setting money aside. If the company that you work for is giving you some sort of incentives to save there regardless of the tax control triangle, that sounds to me like free money? If I put in 4%, they'll match it. Do it. Take advantage of that match. Yeah, that's usually a no brainer. Obviously, there's, like anything we're going to talk about. There may be extenuating circumstances, someone's situation may be completely different but more often than not, yeah, if, it is free money and you literally are going to contribute anyway, at least contribute up to the match before then figuring out where else maybe more efficient or more advantageous for your specific situation.


Benjamin Haas  05:52

Then let's get a little more granular there. Sometimes the follow up question to that is great, I'm going to save into my plan, I have two options and this is going back to the Tax Control triangle, then, do I move it to tax deferred? Or do I put it into the by title Roth 401k, where there's actually money going in that's not being deducted from your taxes now but can grow tax free? 


Adam Werner  06:16

That one really is situational depending on the tax bracket that somebody is in and the tax bracket they expect to be in retirement? Who knows where tax laws change? Unfortunately, that's the area where there is no black and white answer and at some point, that answer may shift over time, as you know, life changes, income changes, tax laws change, but really, in a snapshot in time. Yeah, there's still many, many levels of gray. 


Benjamin Haas  06:48

Yeah, maybe that comes down to live in that gray area for a minute. There are very high limits relative to those employer plans that don't exist when you do it outside of an employer plan and what we would call just an individual retirement account. There are different rules for saving into a Roth IRA versus a Roth 401k. Your ability to even use individual retirement accounts when you have an employer plan eligible come into question. So again, thinking pecking order, we're going to look at that employer plan first. We're going to look at deductibility versus not and that sometimes is going to lend us into what should we really be saying. But if I could give something that feels like concrete advice, we do love the Roth portion of savings, whether that's in the 401k or the IRA because look, tax free compounded growth is as wonderful as it sounds. 


Adam Werner  07:46

Yeah, and historically, we are at a historically low taxation rates even though it may not always feel that way but historically speaking, our rates on income taxes are still historically low. Just like anything else from an investing standpoint, we wouldn't recommend anybody to put all of their eggs in one basket. So we often think, diversification from investment, we also think diversification from taxation when it comes to your savings. So having a little bit that may be tax deferred and some that may be tax free. We often use the term flexibility. People probably are sick of hearing that but it is it is true. By having savings in those three buckets - the tax triangle - you have some that's taxable, you have some that's tax deferred, you have some that tax that is tax free. Whenever retirement comes in the future, it gives that flexibility to pick and choose where you're pulling from. So yeah, it may be a little from Column A and a little from Column B. It may not be hey, do all the Roth or hey, do all the pretax. It may be a variation of the two. 


Benjamin Haas  08:56

Yeah, so part of our process needs to be, we're not pretending to be accountants here, right. We're not pretending to do tax returns for clients. We do want to be thoughtful about what your modified adjusted gross income might look to see if savings a certain way is going to provide significantly more savings if you're close to thresholds. But again, to kind of give something that feels a little more concrete. We do like that Roth portion of things. You saving into a Roth IRA is going to be dictated by your earnings. So knowing taxes is really an important part of this process but I'll maybe set you up. We've been talking about these employer plans and saving for retirement. I don't want that to overshadow how much we also like people outside of retirement saving in that taxable bucket. Tax me sound like a negative thing. But let's go through then, what are the advantages to having a savings account on steroids, which is really the way we want to think about it. Yeah, that's suitable like a bank account but it is investable. 


Adam Werner  10:12

Yeah. I think this part of it, investing outside of a retirement account, to your use your words, having essentially like a savings account on steroids, I think is often the most overlooked part of someone's savings life, especially if they have any thoughts of retiring before age 59 and a half, where you can get access to those retirement accounts without penalty. It's very often overlooked and it is, you use the word taxable, that's what it's considered but essentially, you pay taxes as you go rather than like 401k or an IRA where you're getting the tax deduction upfront until you actually take money out, that's when taxes are due. This taxable bucket, at any given year, whatever dividends, whatever interest it earned, you're going to pay some tax on that from an income tax standpoint. and the other difference being you pay tax on what it earns, essentially, what it's grown to. You put $10,000 into a stock, it grows to 15,000, you sell it that difference that $5000 is what you end up paying tax on. It's not that you're double taxed on the $10,000 that you put back in.


Benjamin Haas  11:33

What you're gaining there and I think this is why we would say as financial planners, this is the value, you're trading some of that more immediate taxation for flexibility. Flexibility over time, accessibility. I think you hit the nail on the head. When we think about people that want to consider phasing out of work, we'll use that word instead of retirement. Phasing out. Not only is this accessible at a younger age but we can really help people look destitute early in retirement from a taxability standpoint, Which is going to help with early health care, it may help with tax credits with health care, it may help, you know, overall taxability on Social Security income. There's just so many dominoes to that that would put this type of savings in a taxable bucket high on our list. 


Adam Werner  12:25

Yeah, definitely. 


Benjamin Haas  12:28

I think the other side of the younger retirement savings, maybe more situational, I'm thinking also not just those three tax buckets but as situation where people can actually have deferred compensation. Again, that may be more situational but let's hit on that one, too. 


Adam Werner  12:54

For anybody that has it, I'm sure they're aware but it's another way to essentially kick that tax can down the road where you can dictate and I think that's the way it works is essentially, before the calendar year starts. This usually happens during open enrollment with benefits, you essentially have to make that determination. What do I want to save into this deferred compensation plan in advance and essentially what you're doing is it acts much like a retirement account. But unlike your 401k and unlike the IRA, when you retire, and there's so many different variables that factor into this but essentially, you're able to save this money without paying the taxes on it today, knowing that at some point in the future, when you retire, it's going to come out and you're going to pay taxes then. 


Benjamin Haas  13:50

Yeah, I think with, certainly the way that the economy has been with the way that employment has changed, I almost liken this to somebody creating a severance for themselves. Where you may have been given this kind of parachute outside of work that says, hey, if you retire now instead of later, we'll give you X amount of pay for X amount of months and it creates a beautiful little segue into retirement. That's the way this deferred comp feels to me that there's going to be some sort of contract that says, you know, either over a period of time or in lump sum, once you retire, now, you didn't pay the taxes while you were earning, you're going to pay it at that time and maybe spreading that out, ultimately saves you a couple bucks in retirement. 


Adam Werner  14:38

It's a different way to fill whatever gap that may be at retirement. 


Benjamin Haas  14:44

Yeah. So again, thinking process, it's not going to be available for everyone that may be depending on who you work for, what's available to you, but it's certainly one of those considerations.


Adam Werner  14:54

Yeah. So I'll throw out another one that may not apply to everybody but a Health Savings Account, I know we've talked about this in other podcasts but the HSA, the health savings account is almost a unicorn when it comes to taxation by the IRS in that you can contribute. As long as you're eligible, you can contribute money to an HSA to get the tax deduction, right. So you're putting in money, essentially tax free, it grows tax deferred, much like other retirement accounts and then as long as you use it for qualified medical expenses at some point in the future, or even you can do it in real time, even while you're earning, it also comes out tax free. So it is triple tax free which there are not many things like that out there. Like everything else, there are limitations on what you can contribute is capped but it is, if you're able to check a lot of these other boxes on where you're saving, it is often one of the best options when it comes to saving with tax advantages on all fronts. 


Benjamin Haas  16:06

And again, I think you hit the nail on the head. It's not universal that everyone can depending on what they have available to them through some sort of employment. But if we were to then kind of funnel all the way down to certainly more specific situations and we get these questions too, look, if you're self-employed, there's many different types of retirement plans that would be available to you. I don't think this podcast is the place to go through those details. But certainly, there's a process there to also determine based on number of employees, maximum money that aside, how you're compensated. There's definitely a process to go through to determine where should that fall in the pecking order for somebody that has a business? 


Adam Werner  16:53

Any anything else on the pecking order? Are there other topics? Other areas?


Benjamin Haas  16:59

Sometimes people have stock options available to them? Hmm. I think we put that somewhere in here, too. Maybe not? Run of the line. Right. One of the things that we've talked about but we certainly get those questions stock offered, maybe at a discount. Should I do it? 


Adam Werner  17:15

The ESOP plan and employee stock ownership plan where, yeah, theoretically, you have access to buy stock at a discount and then you can turn around and essentially sell that for a very quick profit. It is taxable but it's an added benefit in within many large companies. 


Benjamin Haas  17:33

Yeah, I'd put that in that camp. It's more of an employer provided benefit and not necessarily to be a form of compensation, I guess. As opposed to am I actively trying to save money over here for my future plan? I guess the only the only other thing I would add, if we've kind of checked all of these boxes, and you filled, you know, to the best of your ability, all these different things. We'll certainly get questions, then there are different ways to save and invest, whether that's, we did a podcast on property, investing in businesses, there certainly are private business deals that are out there, private investments. I think that's a higher level of conversation deeper conversation that we have with certain people but yeah, to a certain extent, at some point, if you're not spending money, there's other ways to invest. 


Adam Werner  18:25

Yes, that is true. So maybe wrapping it all up. The pecking order of savings, like most things in financial planning, it is dependent on the situation and the difference between saving into the Roth IRA or saving into a taxable investment account. The answer is not always straightforward. If you have questions, you want to go through your situation, let's do it. That's why we're here. Let's go through that planning process and find out what's the best method of saving or find that pecking order for you specifically and let's just do that efficiently. 


Benjamin Haas  19:07

So that was the word I was going to use. We want to do it efficiently. We want to help people understand too that no matter what we do in planning, we're going to have to make certain assumptions, especially around tax codes and things, compensation later in life. So understand that it is to do the most efficient thing that we can. Offer ourselves some flexibility, right? You said it well, we do want to diversify where we're saving for accessibility and taxes in the future. But yeah, there's definitely a process here so let's go through it with you. Alright, stay warm out there, my friend. 


Adam Werner  19:42

And everybody at home. Thank you. Bye


Benjamin Haas  19:53

Hey everyone, Adam and I really appreciate you tuning in. Please note that the opinions we voiced in the show are for general information only, and are not intended to provide specific recommendations for any individual. To determine which strategies or investments may be most appropriate for you. Consult with your attorney, your accountant and financial advisor or tax advisor prior to making any decisions or investing. Thanks for listening!

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