19. Where Should You Invest?

Question 1

What is the primary difference between a Roth 401(k) and a traditional 401(k)?

Answer 1

A Roth 401(k) is funded with post-tax money, while a traditional 401(k) is funded with pre-tax money.

Question 2

What historical event first proposed an income tax in the U.S.?

Answer 2

The War of 1812.

Question 3

What was the first income tax enacted in the U.S.?

Answer 3

The Revenue Act of 1862.

Question 4

What amendment allowed Congress to tax individual incomes?

Answer 4

The 16th Amendment.

Question 5

What was the income tax rate in the U.S. in 1913?

Answer 5

1%.

Question 6

What is a key reason for seeking professional help from a tax advisor?

Answer 6

Individual circumstances such as age, family structure, and state of residence significantly impact tax decisions.

Question 7

When deciding between a traditional and Roth 401(k), what is the most important factor to consider?

Answer 7

The effective income tax rate during working years versus retirement.

Question 8

True or False: The effective tax rate is the same as the marginal tax rate.

Answer 8

False.

Question 9

What scenario generally favors the use of a traditional 401(k)?

Answer 9

When you expect to be in a lower tax bracket during retirement.

Question 10

What is a potential advantage of converting a traditional 401(k) into a Roth IRA?

Answer 10

You can convert during a year of low income to pay lower taxes.

Question 11

Fill in the blank: The primary benefit of a traditional 401(k) is its _______.

Answer 11

optionality.

Question 12

What is the tax advantage of maxing out a Roth 401(k) for high savers?

Answer 12

It places more total dollars into a tax-sheltered account than a traditional 401(k).

Question 13

What amount did Sally and Sam each contribute to their 401(k)s in 2020?

Answer 13

$19,500.

Question 14

After 30 years, what would be the retirement spending amount for Sam, assuming a 30% tax on his traditional 401(k) withdrawal?

Answer 14

$40,950.

Question 15

What is the effective tax rate?

Answer 15

The average rate of tax across all income.

Question 16

What is a disadvantage of a Roth 401(k) compared to a traditional 401(k)?

Answer 16

Lacks flexibility in timing tax payments.

Question 17

What strategy can help maximize tax efficiency in retirement contributions?

Answer 17

Considering future income tax rates and where you will retire.

Question 18

When is it beneficial to contribute to a Roth 401(k)?

Answer 18

When you expect to be in a higher tax bracket in retirement.

Question 19

What can influence the decision on whether to choose a traditional or Roth 401(k)?

Answer 19

State income tax rates and expected changes over time.

Question 20

What is one example of a state-specific tax benefit for retirement distributions?

Answer 20

New York State residents can deduct up to $20,000 from qualified retirement plan distributions.

Question 21

What is the final amount Sam has after paying a 30% income tax on his retirement account?

Answer 21

$40,950

Question 22

Why does Sally end up with more money in retirement than Sam?

Answer 22

Sally placed more total dollars into her tax-sheltered account

Question 23

How much initial contribution does Sam need to achieve $58,500 after taxes?

Answer 23

$27,857

Question 24

What is the maximum annual contribution amount into a traditional 401(k) in 2020?

Answer 24

$19,500

Question 25

When is a Roth 401(k) likely the better choice?

Answer 25

When you expect your tax rate in retirement to exceed your tax rate while working

Question 26

What is a potential strategy for using both a Roth 401(k) and a traditional 401(k)?

Answer 26

Utilizing a Roth 401(k) early in your career and switching to a traditional 401(k) later

Question 27

What are the two layers of taxation to consider when it comes to taxes and investing?

Answer 27

* Income tax * Capital gains tax

Question 28

What is the tax benefit of using a retirement account compared to a taxable account?

Answer 28

Avoidance of capital gains tax

Question 29

How much does a No Tax account grow to after 30 years from a $10,000 investment?

Answer 29

$76,000

Question 30

What is the growth of a Taxed Once account after 30 years from a $10,000 investment?

Answer 30

$66,000

Question 31

How much does a Taxed Annually strategy reduce the investment value after 30 years?

Answer 31

$57,000

Question 32

What is the annual return loss when frequently trading in a taxable account?

Answer 32

0.55%

Question 33

What is the total annual return loss due to capital gains taxes when comparing a nontaxable account to a taxable account?

Answer 33

Over 1% a year

Question 34

Why is the Taxed Annually strategy detrimental to investment returns?

Answer 34

It prevents gains from compounding

Question 35

What is the annual benefit of a 401(k) over a taxable account with a 2% annual dividend?

Answer 35

0.73% per year

Question 36

What could eliminate the long-term tax benefit of a 401(k)?

Answer 36

401(k) plan fees that exceed 0.73%

Question 37

What is the average all-in cost for a typical 401(k) plan in the U.S. as of 2019?

Answer 37

0.45%

Question 38

What happens if your 401(k) plan fees exceed 1%?

Answer 38

The long-term benefit of contributing beyond the match would be negative

Question 39

What should you consider before maxing out your 401(k)?

Answer 39

The illiquidity of capital until age 59.5

Question 40

What is a behavioral reason for maxing out your 401(k)?

Answer 40

Automation and illiquidity can help manage money better

Question 41

What does asset location refer to?

Answer 41

How you distribute your assets across different account types

Question 42

What is the conventional wisdom regarding where to place bonds and stocks?

Answer 42

* Bonds in nontaxable accounts * Stocks in taxable accounts

Question 43

What should you do to maximize after-tax wealth regarding asset location?

Answer 43

Put your highest-growth assets in tax-sheltered accounts

Question 44

What is a recommended strategy for tax-sheltered accounts?

Answer 44

Put your highest-growth assets in tax-sheltered accounts and your lowest-growth assets in taxable accounts. ## Footnote This strategy is based on maximizing after-tax wealth.

Question 45

Why might shielding bonds from taxes not be the best choice?

Answer 45

When bond yields are lower than dividend yields on equities, it may not maximize after-tax wealth. ## Footnote This is particularly true if tax rates on ordinary income exceed those on capital gains.

Question 46

What is the effect of a 15% long-term capital gains tax on a $700 gain?

Answer 46

$105 in taxes owed. ## Footnote Calculation: $700 gain × 15% = $105.

Question 47

What is the effect of a 30% tax rate on $200 interest income?

Answer 47

$60 in taxes owed. ## Footnote Calculation: $200 interest × 30% = $60.

Question 48

What should be considered before making an asset location decision?

Answer 48

The expected growth rate of your assets and the tax rates on income/capital gains. ## Footnote This consideration is crucial for minimizing taxes paid.

Question 49

What is a potential benefit of placing high-growth assets in a nontaxable account?

Answer 49

You may be less tempted to sell them during a market crash due to harder access. ## Footnote This could help in maintaining long-term investment strategies.

Question 50

Why is having low-growth assets in taxable accounts beneficial during market crashes?

Answer 50

They are more easily accessible and likely to maintain their value. ## Footnote This provides extra liquidity when needed most.

Question 51

What is a challenge of separating high-growth and low-growth assets across accounts?

Answer 51

It can make rebalancing across accounts more difficult. ## Footnote For example, if stocks in a 401(k) drop, you can't add money from a brokerage account to rebalance.

Question 52

What is the author's preferred method of asset allocation across accounts?

Answer 52

Having the same allocation across all accounts (brokerage, IRAs, 401(k)). ## Footnote This approach simplifies management of investments.

Question 53

What is the trade-off of having similar allocations across account types?

Answer 53

It may not be the most tax-efficient solution but allows for easier management of investments. ## Footnote The author prioritizes manageability over tax efficiency.

Question 54

What might be the best strategy for someone needing more return?

Answer 54

Sheltering higher-growth assets in nontaxable accounts. ## Footnote This strategy aims to maximize returns while managing tax implications.

Question 55

What is the author's stance on wealth management?

Answer 55

Wealth will never make you feel rich regardless of how it is stored. ## Footnote This suggests that emotional aspects of wealth should also be considered.