How to Limit Downside

In this episode of Motley Fool Answers, Alison Southwick is joined by Robert Brokamp, the Fool's personal finance expert, and Sean Gates, a Fool Wealth Management financial planner, to answer listeners' financial and investment questions. They answer questions about life insurance retirement plans, the cost of raising kids, CARES Act distributions, paying off mortgage versus remaining invested, the backdoor Roth, and much more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on August 25, 2020.

Alison Southwick: This is Motley Fool Answers. I'm Alison Southwick, and I'm joined, as always, by Robert Brokamp, personal finance expert here at The Motley Fool.

Robert Brokamp: That's me. Hi, everybody.

Southwick: [laughs] That's you. It's the August mailbag. With the help of Sean Gates, we're going to answer your questions about the backdoor Roth, the life insurance retirement plans and CARES Act distributions. All that and much more on this week's episode of Motley Fool Answers.

Sean, welcome back. It's been a while, I think. How long has it been since you've been on the show?

Brokamp: January of 2020.

Southwick: There we go. Bro circled his calendar with a big heart. So, yeah, Sean.

Sean Gates: Thanks for having me.

Southwick: For those of you who don't know, Sean is a financial planner with Motley Fool Wealth Management.

Gates: A sister company of The Motley Fool.

Southwick: You can have been a little bit faster on that uptake, I feel, but yeah. So, Sean, how've you been? Everything is awful, but how've you been?

Gates: Better than I deserve. Yeah, it's very fortunate. I feel bad. I just got back from Colorado; it was nice. I left before the fire started, so perfect timing.

Southwick: Wait! Have you been there this whole time?

Gates: So, we were on a road trip for about two months, just working remotely.

Brokamp: Wow! On an RV? A VW Microbus or the Pop Up Camper?

Gates: Unfortunately, we looked at renting an RV, but I think everyone is doing that, so the prices were insanely high. And so, we --

Brokamp: I actually looked at buying one, and think I could just buy one and then sell it, and maybe even make a profit because so many people were looking for it.

Southwick: You know what you could do, a friend of the show, Greg Robleto, they have a little camper. I'll bet you could ask very nicely to borrow his and he might be willing to loan it to you. Not to put him on the spot, Greg. Actually, maybe Greg doesn't listen anymore. He doesn't have his, like, two-hour commute every day. So, anyway, that's just a tip for Robert Brokamp, by the way, not for all of our listeners.

Brokamp: Everyone, here's Greg's email address.

Southwick: Here's Greg. He's got this adorable camper. He'll loan it to you. All right, well, let's head to the mailbag, shall we?

Brokamp: Let's do it.

Southwick: Our first question comes from John. "Has there been much research done on the economic pros and cons of not having kids? I know the government wants us to have kids because there are tax benefits to doing so, and obviously, there are benefits to having someone "take care of you" when you're older; although, it's not a given that they will. But the price of having kids is pretty high too."

Brokamp: So, [laughs] if you're looking at the economic pros and cons of having kids, I have to say it's probably mostly cons. And as for who has actually run the numbers, it's the U.S. Department of Agriculture that produces a report that talks about the expenditures on children by family. The most recent report came out for children that were born in 2015, and they break it out by income. So, households that have a household income of less than $59,200 cost a little less than $10,000/year to raise a kid. And we're talking about a two-kid family, but it's still $10,000/kid. Middle income, which day qualify as $59,200 to $107,000. Those folks, it's about $13,000/year. And higher income, which is more than $107,000; it costs $20,000/year. And then they actually totaled all up to age 17, so this does not include college, total expenses for raising kids for the lower income folks, $174,000; middle income, $233,000; upper income, $372,000.

So, from a pure financial perspective, there are [laughs] a lot of drawbacks to having kids. If you instead invested all that money, you would have plenty of money to cover your long-term care expenses, so you wouldn't have to worry about that.

Just from a personal perspective, though, I would say that most of the happiest memories of my life have involved my kids and I wouldn't trade those for a bigger 401(k) or a better long-term care policy. But that's just me, and I think I actually know people who probably would make that trade.

Southwick: Well, it feels like, if you're sitting there asking yourself, should I have kids because it makes financial sense? [laughs] The answer is, no, you probably should not have kids. You're just all-around not built for this. So, go enjoy traveling the world with a suitcase of money.

Gates: This is like those questions I get where people are, like, what's the secret financial planning tip to improve my life? And it's like, there are no secrets to -- kids are just a money drain, unless you have, like, LeBron James as your kid, I don't know. [laughs]

Brokamp: That's true. So, that's the answer, have LeBron James or don't have kids.

Southwick: [laughs] Good luck with that. Next question comes from Stuart. "I was just listening to a book about reducing taxes in retirement, and the author was touting the benefits of ... " Bro, is this going to be pronounced LIRPs? [Life Insurance Retirement Plan]

Brokamp: LIRPs, not to be confused with LARPing. It's LIRPing.

Southwick: OK. " ... Life Insurance Retirement Plans and Roth IRAs. At one point, I had a universal life policy, but liquidated it because of the cost and did not feel I actually needed the insurance since I had a term policy and life insurance through my job. Could you discuss how one determines the trade-off between investing in a LIRP, which has the cost of insurance investment options, the best of which appear to be index funds, some complicated rules and tax-free "withdrawals" versus the possible higher returns and higher taxes of investing in stocks or other investments with after-tax money?"

Gates: Any time someone starts to talk about investing in insurance, you should have alarm bells going off. Insurance is really not a great investment, insurance is primarily there for protection, and so that's how we want to think about insurance primarily. But I know a lot of people are just trying to figure out the best way to optimize their finances. And when you reach a certain income threshold, you can find yourself running out of places to put money in a tax-efficient way. And so everyone is hoping that there are secret ways to save money tax efficiently, and people are just always incented to pay as little in taxes as possible.

The LIRP, in this case, the life insurance retirement plan, is just kind of a fancy name for a permanent VUL policy, or variable universal life policy. So, there's nothing secret about it, it's not a special type of account; it's just an insurance policy, a VUL in particular. And typically, you overfund it. So, you know, whenever you purchase an insurance contract, usually you're paying premiums on an ongoing basis and those premiums fund the face value or the death benefit that will ultimately get paid to you. With permanent policies, there's a cash value component that grows over time based on what you choose to invest, hence the variable portion of the variable universal life policy. And you can choose to prefund that balance, so that your cash value gets closer to your face value or maybe even surpasses the face value sooner rather than later.

Now, there's a couple of bad reasons to do this, but I think in this case the main reason that this is being sold is the primary one, that's typical with permanent policies is, that you can borrow against the cash value of the policy. Because it's a loan of a sort it's "tax-free" and so from that perspective it looks like an attractive option. The cash value itself also tends to grow tax-deferred.

The challenge with this type of product is, it doesn't really offer anything that you can't get with a taxable account. And I mean that almost truly aside from the death benefit portion, where you can invest in just a normal taxable brokerage account, you can invest in individual stocks and you can hold those forever. And if you do that, you won't really have any kind of tax liability, because those stocks will just continue to compound inside the account, and it's an extremely effective tax deferred growth mechanism. So, that's 1-for-1 for the VUL or this particular type of strategy.

The other is the borrowing ability. You can actually borrow against a taxable brokerage account. You do it on margin. It's actually a collateralized loan against the value of your own investments, and with where interest rates are right now, it's actually far cheaper to borrow against the value of a brokerage account than it is to borrow against insurance policies. And so, there's just really no good reason to opt-in to something like this, when you can have all of the benefits of it in a more liquid, less complicated, better investment vehicle product like a brokerage account. So, be careful when someone is trying to tout some magical retirement plan.

Southwick: A LIRP sounds like something where if a financial guru or financial planner was like, hey, you should try a LIRP, it seems like, Sean, you would be like, OK, I'm just going to disregard any other advice you have to give me, because this -- does it qualifies like a deal breaker where you're, like, no, no, I'm not going to listen to anything else you have to say? And if not, is there something that, if you heard a financial planner say, you would be like, no, nothing else you say matters now because you just said something so incredibly irresponsible.

Gates: Yeah. The cynical side of me, there's many of those. I try to be open-minded, I don't want to close off someone entirely because of what they bring to the table. There are some crazy strategies out there that can benefit people, but typically the effort that's involved or the complexity, almost always makes it not worth it in the end. And so, yeah, I mean I wouldn't write anyone off, but this is one of those where, for everyone who is reading about some sort of secret strategy, if you hear insurance and investment in the same term, be on guard is what I would say.

Southwick: All right. Next question comes from Dave. "I have read that certain tools can be used to limit downside when the market drops. An article suggested an ETF like RPAR ... " can I call it RPAR, Bro?

Brokamp: Sure, you go right ahead.

Southwick: " ... risk parity ETF or others like it, which could be a good addition to your investment portfolio. What do you think of this investment being used in a portfolio or others like it?"

Brokamp: I would say, really, there are two ways to limit downside in your portfolio. One is to not take any risk with a portion of your portfolio, and you keep it in cash, highly rated bonds, something like that. That's one way to do it. The other way is to invest in assets that have a similar attractive long-term returns, riskier assets, but they have dissimilar short-term returns. In other words, they are not highly correlated, so that ideally, once one thing is down, something else is up and that mitigates risk over the long-term. It could be U.S. stocks versus international stocks, small caps versus large caps, different industries, things like that.

This risk parity ETF is something more like that second type. It does go up-and-down in value, but theoretically it goes up-and-down in a way that is somewhat different from the market. As for risk parity itself, it's pretty complicated. I'm going to give a very bare bones description. It basically says that everything in the portfolio should contribute equally to the risk of the portfolio. So, just to give an example that frankly came from Wikipedia, if you look at its entry on risk parity. If you have a typical portfolio that's 60% stocks, 40% bonds, 90% of that risk is going to come from the stocks. So, what you do is you use leverage to buy bonds, which increases the risk, also increases the potential return. Now, when you have a risk parity portfolio, you invest in things beyond stocks and bonds, you're investing in all kinds of different assets. So, that's risk parity in a nutshell, probably the most famous practitioner of it is Ray Dalio of Bridgewater. Perhaps the biggest most successful hedge fund in history, so there's something to risk parity. But as for this specific ETF, I think one of the things that's good about what we went through earlier this year is, you can see how it performed and did it hold up. And when you look at it, you remember the stock market, the S&P 500, went down 34% from Feb. 9th to March 23rd. This ETF did go down, but it only went down about 20%. So, that's better than the S&P 500. For the year so far, it's up 13%; better than 6.5% for the S&P 500.

So, you could say, yes, this is a diversifying asset. It's good to have in your portfolio. It didn't hold up completely, but it didn't go down as much. The thing about this ETF is, it's only been around for about eight or nine months, it's not even been around a year, so I can't really endorse it. But I certainly like the idea behind the philosophy, and it's an ETF that I'd probably keep an eye on.

Gates: This was something that came about right around after the financial crisis, when I was in the old world as an independent advisor. A lot of the mutual fund wholesalers were trying to pitch us on risk parity funds, and the problem with risk parity funds, that's the problem with most low volatility asset classes, or lower volatility asset classes is, you typically aren't invested in it in the moment that you need it and then you buy it as a reaction to what has just occurred and then it dramatically underperforms in bull markets or positive markets. So, I think everything Bro stated is absolutely true. But you just want to be aware going into it that this is probably going to provide lower total returns on an absolute basis and the price that you're paying is that safety component. So, just be aware.

Southwick: Our next question comes from Meryl. "I got a late start saving for retirement. So, at 52, I currently only have about $170,000 in two retirement accounts. Aside from that, I have about $12,000 in a trading account that I started three years ago this September. I'm a Motley Fool Stock Advisor member and have acquired 11 stocks so far. I'm up 95% to-date, a decidedly better return than the investments in my retirement accounts, which are up 56% in the same timeframe. The CARES Act is making a one-time exemption in 2020 for 401(k) withdrawals up to $100,000 with no penalty. I think I qualify because I've been temporarily furloughed due to COVID-19. I'm seriously thinking of taking the maximum out and reinvesting it in stocks that I personally love, or in real estate or maybe both. Is there any downside to what I'm considering? I do realize I have to pay the taxes on that withdrawal, but even that can be spread over the next three years' tax returns."

Gates: This is a great question. The CARES Act is new and all of these features are still being analyzed, so it's good that you're paying attention to it. And I would say, I've personally struggled with this as well; it's an attractive option. The one downside that I don't think you or others who are considering this strategy are fully appreciating is, even though, yes, you can spread the income over three years, you still have income, right? And the goal of having something in a retirement plan like a 401(k) is tax deferral. So, anytime you bring that in, that is additional income in addition to your employment income. And so, you run the potential of bumping yourself up into another tax bracket or paying a less attractive tax bill than you otherwise might have in the distribution phase of your retirement, when you would typically take it out.

The other thing that I would note here is that it sounds like one of the reasons that this is particularly attractive to you is because you're viewing it as a way to get access to superior investment returns vis-a-vis your personally managed portfolio following Fool stocks. You want to just make sure that that is the only way that you can get exposure to that type of investment. A lot of the time, 401(k)s and retirement plans nowadays offer a brokerage account option, a self-directed brokerage account option, where you can invest in individual stocks. So, you could recreate exactly what you're doing inside of your personal account in your 401(k). Now again, this isn't available to everyone, there are certain limitations, but I would say that might be your first step if that's the main incentive that's attracting you to this idea. But definitely sit down with a tax advisor, see what this year's tax rates would look like or tax liability would look like versus some future calendar year tax rates and this idea could make some sense.

Brokamp: As Sean pointed out, they're still working out the details on a lot of this, and we've discussed this on the show previously where some people were asking, well, is this is a way just to get money out of my 401(k), because any of that money you take out, you have three years to put it back in. And the question is, can I take it out of my 401(k) but then just put it in a traditional IRA, which essentially makes it a rollover and you don't owe any taxes? I originally thought, I don't think you could, then we had Dan Caplinger on the show, former attorney, former financial advisor, the way he read it, he thinks he can. I don't know if there has been a definitive statement about it yet, but I would look into that, because that is a way to do what you're trying to do, at least if you're trying to buy individual stocks and avoid those taxes. Get out of the 401(k), put an IRA.

You also mentioned real estate. That's trickier, because most typical IRA providers, like Vanguard and Fidelity and all that, don't let you buy real estate, but there are some that do, some special custodians. So, just making you aware of all those options.

Southwick: Next question comes from Jim. Do you have an opinion about rebalancing a portfolio, such as, Moneymakers?" And here's where I get to show my complete ignorance of the products and services we offer at The Motley Fool. I think Moneymakers is a service we offer at The Motley Fool?

Brokamp: It is. As opposed to money losers, which is one of our less popular services. Just kidding, we do not have money losers. [laughs]

Southwick: [laughs] Ah, it probably would. You know what, knowing our community, there probably would be some people, who would be like, no, I still love it, I still love this service, I love money losers. I love you guys, right?

Brokamp: Yeah. Anyway. So, OK. So, let's talk about rebalancing in general. So, the whole point of rebalancing is that your portfolio doesn't become too concentrated in one asset or too underweight in something else. So, a simple example, let's say you decide that you should have a portfolio that's 75% stocks, 25% bonds. Well, if after several years the stock market goes up, you could get to a point where you're now 85% stocks, 15% bonds, and you're a few years older and you should theoretically be becoming more conservative, not more aggressive. So, you would rebalance. And you can also do that with different types of assets, like, U.S. versus international, large versus small. You know, if you decided 10 years ago that you should have a quarter of your stocks in international, well, you're probably down to about 20% or 15% international, because the U.S. has done so well, so you might consider rebalancing that. A lot of times people talk about doing it annually, which is probably more than necessary unless there's some sharp moves in the market. I think doing it once every few years is good enough.

That said, as for Moneymakers, I did try to look up and see what is their philosophy on rebalancing. So, I pulled this quote from one of their articles, "We don't typically advocate rebalancing your portfolio, selling shares of your best-performing positions, and adding to your laggards. We believe that winners tend to keep winning over time and we like to let them run, but if a certain position has become too big for your comfort, you may want to sell at least some shares." And that's typical of most Motley Fool services. We do generally believe in adding to your winners, you know, pruning your weeds, not pruning your flowers or whatever [laughs] way they express that, which I'm totally onboard with. But you do get to a point where it could be one or two or three companies or one or two or three types of companies dominating your portfolio.

And as a real-life example, in our Supernova service, we had a portfolio called Phoenix that was designed for retirees. And every quarter they would sell some shares off, sort of, roughly following the 4% rule. Well, in most quarters they were selling off Netflix, because Netflix was doing so well. If they didn't do that, Netflix would come to represent 40% to 50% of the portfolio.

So, while theoretically I'm on board with adding to your winners when you're talking about individual stocks, there is a point where you might want to cut some of those back before you become too concentrated in one company.

Gates: Yeah. And I would say, the typical advisor, it depends on the firm, it ranges, but a financial planner is going to usually give the advice of keeping no single stock position to between 5% and 10%. Motley Fool, I think, is different in, like, even though the planners at Motley Fool Wealth Management, I think some of us are comfortable seeing a position get as high as 25%, and then we get a little bit nervous, but I've run into portfolios of Fool subscribers and they have a $2 million portfolio and five stocks. And part of the reason that that happened was because they got the five right, and diversification would have robbed them of that $2 million, but in part, they got a little bit lucky. But you know, diversification is a way to protect yourself; single stock investing can power a lot of growth.

Brokamp: Yeah. You know, Warren Buffett and Jeff Bezos would not be the wealthiest people in the world if they followed those directions. On the other hand, there are a lot of people who worked at Enron and WorldCom and Lehman Brothers, who have nothing because they didn't follow those directions.

Southwick: All right. Next question comes from Jeff. "I have approximately $104,000 in stocks and my mortgage is sitting at around $132,000. I'm considering cashing it out and throwing it all toward that mortgage. My thoughts are for me, as a 39-year-old dad of a four- and two-year-old, the sooner I pay off the last remaining debt and get financial independence, the better. Once the mortgage is fully paid off, I fully intend to max out all my retirement accounts. So, it's a question of potential returns in 10 or 20 years versus the possibility of being debt-free now and living more securely while building what I would term real wealth."

Gates: I think this is an eternal question. If anyone's heard of Dave Ramsey, he probably gets this question every other day. He has a different view on things; I think baby step No. 6 is to pay off your mortgage early. Part of the reason that that person holding themselves out as a financial expert recommends that is because they've done studies of silent millionaires, if you will, and their data suggests that people on average who identify as millionaires got that way with very little debt. The majority of their net worth is a function of the value of their home that they have successfully paid off. And so that's just statistically some of the logic that they use.

I think there's a lot of disagreement in the financial planning community about this. One thing, and I don't think there's a right or wrong answer, because some of this is a values question. You know, being debt-free can be a solace. It can be stress-reducing in life. It can give you a firmer financial footing to make better investment decisions on other assets. And we have to figure out in a conversation where those values lie. But one thing that I think often gets missed in this conversation, which I think is particularly salient, as you're describing yourself as a 39-year-old. If you pay off your mortgage early, let's say it takes you two, three years, you know, traditionally it might take even longer than that, but whatever time period that we're accounting for in you paying off your mortgage, that is time that you have lost for your investment portfolio. And as a young person, time is your most valuable asset. Having your portfolio grow, and presumably a more risky portfolio, because you're young, is going to create a lot of wealth. And if you pay off your mortgage early, you now have, sort of, a dead asset which could be the most gratifying thing in the world. But now when you're 45 and you have a paid off house and you're starting to invest in the stock market, you might not be as aggressive, because you're 45 and you're not 39 anymore, you might have a different view on investing. And that's going to crimp your overall return. So, just be aware of your own timeline for investing and choosing which dollars work for you over what specific time period.

Brokamp: I would just say, at current interest rates, I mean it's such a low hurdle rate. I'm refinancing my mortgage now to 2.87%.

Southwick: What?

Brokamp: Yeah. [laughs] I can create a portfolio of dividend paying stocks that almost yield that much. And that dividend will grow over the years. I've said before on the show, I was someone who was paying down my mortgage more, but now I have stopped doing that and I'm going to just start putting that money into investing, because it's just hard to pay off debt with such low interest rates when you have long-term, long-term, I don't know what's going to happen over the next few years, but I certainly expect between now and the day I retire, to earn more than 2.875% of my money.

Southwick: Yeah, that's what I was going to say. Paying off your mortgage early, it seems like old advice, it seems like advice that used to make a ton of sense when interest rates would be, what, more than 10% to buy a house. So, with interest rates being where they are, it just doesn't make mathematical sense anymore. But it's still advice that's hanging around.

Gates: Yeah. And I would say just one thing particular to Jeff's question. He's not even asking the typical question, which is, where should he throw his money? Like, if you have additional cash flow, this is that dichotomy that's always questionable; I think harder to make the case nowadays for sure. But Jeff is suggesting selling an investment portfolio to pay off his mortgage. And that, I just could not recommend at your age with interest rates where they are. Do not take a capital gains tax hit unnecessarily to pay off a very low interest mortgage.

Brokamp: Yeah, totally agree.

Southwick: Next question comes from Twitter ShipOfFoolsGD. "I invest in a Roth IRA, but if my growth stocks really take off won't I be prohibited from retiring early or be penalized? I believe I can withdraw the principal, but not the appreciation."

Brokamp: Yes. So, ShipOfFools is right. When you contribute to a Roth IRA, you can take the contributions out tax and penalty-free anytime you want, it's the earnings that you might be taxed and penalized on. For the distributions from a Roth IRA to be tax-free, the account has to have been open for five years and you have to be age 59.5. However, there are some exceptions, and for his situation, the thing I would look at is something that's known as Substantially Equal Periodic Payments, also known as 72(t). There's a particular calculation in which you figure out the amount you can take out each year and you have to take out that amount at least over five years or until you're aged 59.5, which is later. I should say, that will avoid the 10% penalty, it won't avoid the taxes actually because you're not 59.5, but that's one way to avoid the penalty. There are calculators on the internet that will help you calculate the 72(t) to figure it out. There are actually a few methods of doing it, so that's how I would do it to avoid the 10% penalty, but again, you may have to pay the taxes.

Southwick: Next question comes from Tyler. "Can you help explain dollar-cost averaging versus buying the dips? I understand that DCA is about equal with buying the dips, which is hard to do. I find myself wanting to have cash in my account when I see the market take a huge dive, so I can buy stocks in ETFs when they are low, is that a mistake? Should I just invest it little by little?"

I love this question, because I feel like half the time The Motley Fool talks out of both sides of their mouth on this one. [laughs] Where it's like, dips, buy on dips, but have some cash on the side. It's like, what do you want me to do? Am I wrong?

Gates: No, no. That's how I talk --

Southwick: That's totally what we say. We'll say dips, buy on dips. And then we'd be like, but have some cash on the side so you can take advantage of those market drops. It's like, [laughs] you are literally saying the opposite things.

Gates: I'm so glad you framed it that way, Alison, because I was going to say, this question is one of the hardest questions to answer as a financial advisor. You almost want to have your cake and eat it, too, which is why you sound like you're talking out of both sides of your mouth. Because the behavior of the average person is to want -- like, logically, why wouldn't I want to buy on dips? And that makes perfect sense, it's just really hard to do.

And even embedded in this question, I think slightly erroneously was, he was suggesting that dollar-cost averaging and buying the dips work out to be about the same. If you look over, like, the last 40 years, a systematic dollar-cost averaging system would dramatically outperform perfect market timing, and just do that with the amount that you save. And it's like an order of magnitude. I think they did a study where you had about $600,000 with $96,000 worth of cumulative savings. And in the result where you just systematically DCA, you end up with $400,000 more than both a perfect timer and a worst market timer in the world. And there are several studies like this. But DCA almost always works out better, because you're removing the emotion and the seduction of trying to time the market.

The one thing that I like to tell people, and this gets back to talking out of both sides of my mouth, because I still do it, too, buy the dips. [laughs]

Southwick: Me too. I do it, too. I do both; we do both. [laughs]

Gates: Right. And so, there is a way to do both, kind of. And so, what I tell people, because again, it's hard to fight the seduction of the logical part of your brain trying to suggest buy low is, if you have either excess cash flow or cash, set up a systematic dollar-cost averaging on some time based frequency, quarterly, every other month, with whatever amount of cash you have. And then implement an acceleration technique, where, if there is a 20% or 25% market decline, some sort of systematic numerical trigger point, you can accelerate that dollar-cost averaging plan, so you lump in the cash on the dips, but if you don't get that, right, if we don't get the dip for five, seven years, your cash isn't just sitting there waiting for the dip that never comes, it's being dollar-cost averaged into the market. So, this is the way that I try to preach people to move investor behavior, which is one of the hardest things to move.

Southwick: All right. Next question comes from Vic. "I've been working in the investment banking sector for the past seven years, and I always wanted to transition over to personal finance. Growing up I realized how disadvantaged many households are due to the lack of knowledge and education, and I'm afraid this pandemic will make things worse if people are making ill-advised money decisions. I've always been helping my friends and family with their finances since college, now I want to start getting serious and help as many people as I can while following my passion. My question is, how do I start making the move over? Is it possible to keep my job currently while I start transitioning over? Also, what key elements contributed to your success as a financial advisor?"

Brokamp: So, I'll be very interested to hear what Sean has to say to this, but the reason I chose this question was it reminded me a good bit about my story. So, I was a teacher, not making much money, I decided I need to learn how to be better with my finances, kind of, fell in love with it, got a job with American Express, called up my high school English teacher's husband, who worked with Prudential Securities, and he said, don't work for them, come to Florida and be part of my group. So, one lesson from that was, it was easier for me to join an established group rather than me try to go out on my own as a Financial planner, so that was good.

The other thing is, he sort of made me, we didn't use the term back then, but what we would now call a paraplanner, which is a whole other career path that could lead into being a full-fledged Financial planner. So, that's something I would look into as well.

Now that said, I said to my boss something along the lines of what you said, that I said I'd like to help a lot of people, I see a lot of disadvantaged people, a lot of young people making bad decisions, I'd like to help them. And he frankly said, that sounds great, but you can't build a business on helping those people. And to a degree, he is right. You have to serve at least the middle market, if not the higher market, starting out. But once you get established, you can find ways to help people who may not be able to afford your services, because it does cost a good $150- to $300/hour for a financial planner, and financial planners often need to really charge that to cover the cost of the business.

To answer another part of your question, can you start now? I would start taking CFP classes and see if you like it. You have to take the classes, then you have to take the exam and then you have to get a certain number of years of experience. But I think if you start with the classes now, you'll find out if it is something you really want to pursue. And then I would also check with organizations like the Garrett Planning Network, which really does try to help sort of the middle market. NAPFA, National Association of Personal Financial Advisors, and maybe your local chapter of the Financial Planning Association. They often have resources for people coming into the business. You can see if there are established firms that are looking to hire someone who would like to break into the business.

Sean, do you have any ideas?

Gates: I think you covered a lot of it. There was a part of your question in here that was, can you do both jobs simultaneously, keep your investment banking career and start as a financial planner? It's possible, but one of the things that you need to know as a financial advisor is that there's a heavy amount of compliance and regulation. And so, for me even, like I have an Airbnb side business, I have to report that I have that, it's called the outside business activity, and we're getting really in the weeds here. But a lot of those businesses you can't do, and investment banking may be one of them where there is a tinge of advice or could create an illusion of a conflict of interest. So, when you go to report that on your outside business activity, that particular business is probably going to be problematic and they would likely make you shut it down. I'm not saying it's impossible, but I think it's going to cause problems.

And yeah, I think, Bro, you mentioning or putting a realistic color on the conversation is helpful. It's a hard business to start for sure. I think now that there's a lot of interesting marketing tools that you can do, but you still likely need some sort of internal network, you know, some more money people in your own life that would be willing to work with you to get your foot in the door, so that you have some runway to start to market to new clients, because it's a challenging business to start in for sure.

Southwick: All right. And our last question comes from Mike. "I am not able to make Roth IRA contributions due to my income level, so I was quite excited to learn about the backdoor Roth, which involves contributing to a nondeductible traditional IRA and then converting to a Roth. But then I dug deeper into the IRS pro rata rules and realized Roth conversions are taxed based on all IRA accounts combined. It sounds like the only way around this is to move the pre-tax funds into a non-IRA account, such as a 401(k). I have a large sum in my traditional IRA, which consists of rollovers from several 401(k)s. In this IRA account I have been following several Motley Fool services and have been experiencing some great returns. Would it make sense to continue contributing the annual limit of post-tax dollars into a separate IRA for the next 15 years? Then, a few years out from retirement, roll my IRA with pre-tax dollars into my employer's 401(k) to leave me with an IRA that is purely post-tax, then the next year convert the remaining IRA with post-tax dollars into a Roth IRA. And finally, the year after that, roll my 401(k) back into a traditional IRA to take advantage of more diversity in investment options. What are the potential issues with this approach?" Woo!

Brokamp: There's a lot going on in there, man.

Gates: You've got the detail. So, what I love is, he basically described a strategy that we help people with not too infrequently. This is actually, sort of, they call it the creamer and the coffee rule or the IRS aggregation rules. It's all kind of synonymous with the same thing, which is, once you mix nondeductible or after-tax contributions into pre-tax or traditional IRA dollars, they're sort of blended together and they aggregate together in terms of calculating the income tax portion that you're going to be responsible for. And it can cause some problems.

The strategy that you've described in this question is one that we do. So, if over time you're accumulating nondeductible contributions to an IRA and you have, let's say, $300,000 worth of after-tax dollars inside of a larger $800,000 pre-tax IRA value, you can roll the $500,000 into the 401(k) leaving just the after-tax portion behind. And then either roll or Roth convert those dollars into your Roth account.

I would say that there are a couple of different ways to think about it. So, one of the nice things about the larger backdoor Roth IRA or the super backdoor Roth IRA, where instead of using an IRA with nondeductible contributions, you use a 401(k) with after-tax contributions or nondeductible contributions. It's already separated out from the IRAs, right. The aggregation rules don't apply to a 401(k), so you can immediately Roth convert or Roth rollover the after-tax contributions in a 401(k) without worrying about mixing up the income tax ramifications. So, take a look and see if that's available inside your 401(k).

The other thing is, I would maybe pivot your strategy, it may be wiser to rollover your IRA value, the pre-tax portion, these old 401(k)s that you've accumulated over time, into your 401(k) now, leaving just the after-tax contributions, because then, all you have is a $6,000 or $7,000 ongoing after-tax IRA and you can Roth convert that on an ongoing basis, getting the after-tax dollars into a Roth account and growing tax-free, so that you don't have to worry about it on the end. Because doing it in reverse is kind of a challenge and you do run into some of the delay hiccups that you've described in this question.

Southwick: I actually lied, I said that the last question was the last question, but this is actually the last question. All right, here we go, it comes from David. "I'm 73 and still work for at least one and perhaps several more years. My wife is retired and I anticipate that when I do retire, we will be fortunate to be able to live comfortably and on a combination of required minimum distributions, dividends and fixed income investments. My primary objective for the money will be to pass as much as possible on to my children while giving a portion to charities. In addition, to a large taxable income investment portfolio, largely 80% in equities, we have well over $3 million between my wife's and mine's 401(k)s. My question is for when I do retire and have to take RMDs, should I take more out of the 401(k) and invest it in stocks? I realize, from a tax point-of-view, I'll be paying more now. My thinking is that when my children inherit what is left of the 401(k), they will get an account that they must take distributions from, while what they inherit in stocks will come to them with a stepped-up basis, meaning they can get the tax benefit. Since I can afford the taxes, does this kind of strategy make sense to you or am I missing something?"

Brokamp: I would say that it is worth considering, I can't tell you specifically which to do, I would maybe see a tax accountant or a state planning expert to really look at your complete situation, but just to make it clear, it's interesting, and it might be worth considering. Just so everyone knows, if someone were to inherit a 401(k), when that money comes out, assuming it's a traditional 401(k), you'll pay taxes on it as ordinary income, plus you don't have much flexibility, because in the situation if you were a kid inheriting your parent's 401(k), due to new rules, new laws, you generally have to liquidate it within 10 years, you can't just leave it alone.

Those rules have gotten more complicated, so that's another day. If you inherit any sort of a retirement account, definitely see an accountant to make sure you're following the rules on that. As opposed to if you inherited stocks, just in a brokerage account that your parents bought decades ago, when you inherit it, you get a stepped-up cost basis, so that's the value of the stock as the date of death, and then you can hold on to that stock and do whatever you want for as long as you like. And when you do sell it, you might be just paying long-term capital gains. So, it's an interesting idea.

As David points out, if he's going to take more out of this 401(k) and put in individual stocks, he is going to pay taxes on that, so he's going to pay more in taxes. So, that is also money, that tax money is also money his kids won't inherit. So, I think if an expert were to look at your situation, they'd look at your current tax bracket, compare it to your kid's tax bracket and decide who really would be benefiting most by paying more taxes today. Like, whether you should take taxes or whether you should leave it to your kids? But I think it's worth considering.

Gates: I think the only thing that I would add to this is that this strategy is almost always suboptimal to just Roth converting, maybe because the Roth IRAs don't have the same distribution rules that are newer, exactly like Bro described. And it's tax-free growth. So, rather than taking it out of your pre-tax 401(k) and having a brokerage account with stocks, while, yes, they get a step-up in basis, for ever more, they will be susceptible to long-term capital gains rates on the taxes -- or short-term, depending on when they sell them. And so, that's an ongoing tax that they wouldn't have if they inherited a Roth.

So, per Bro's comment, see a professional to get some tax planning for your situation at a familial wealth level. And that's usually hard to do with CPAs, maybe a financial advisor-CPA team would be helpful. But I would definitely encourage you to consider Roth conversions first, before you consider this particular strategy.

Brokamp: Yeah. And I think that's great advice. And just so everyone knows, Roth conversions do not count as required minimum distributions, so you have to take your RMDs first and then do the conversions, but there are no RMDs this year due to the pandemic, so you could even do some converting this year if you wanted to.

Southwick: All right. Well, that's it for that part of the mailbag, now it's time for my part of the mailbag. Because you know what, it turns out that some of our listeners are still getting to travel and sending in postcards. How long has it been since I've asked for a postcard?

Brokamp: It's been a long time. And how long has it been since we've been in the office to see postcards? [laughs]

Southwick: [laughs] March? Was it March when we were last in the office, I guess? So, thank you everyone who's continuing to send postcards, because it turns out there is a lady who goes into the office every few weeks and goes through the mail. And so, she took pictures and sent us our postcards.

So, I would like to say thanks to Bill and Bonnie who were sipping scotch while surveying the Salish Sea. Stocks! Doesn't that sound nice? Then we also, 50billionCent, sent a card from Seaside, Oregon. And we also have Monica, who sent a card from Minsk in Belarus. Monica, I hope you're safe. I know there's a lot of unrest going on in Belarus, so sending good juju your way.

Brokamp: I think that's our first postcard from Belarus, right?

Southwick: You know what, I left our running list of where we've gotten postcards from at work, so sure.

Brokamp: Let's just say, yes. Absolutely.

Southwick: Yes. Absolutely. And then P.T. also sent cards from Mammoth Cave National Park in Kentucky, as well as the Cumberland Gap National Historical Park. So, thanks everyone for sending in cards, it helps remind us that there are real people out there still, and maybe someday we'll all see each other again face-to-face, right? All right.

Well, that's the show. It is edited bandana-ly by Rick Engdahl. He's got some sort of bandana in his hair today. Our email is [email protected].

Sean, thanks again for joining us. For Robert Brokamp, I'm Alison Southwick. Stay Foolish, everybody!