In the latest episode of our Q&A series, Paula Christine sits down with Aaron, who's going to get married soon. She answers his questions about:
Personal Injury Protection (PIP) on car insurance
How to rollover a 401K from a previous employer, where it should go, and what are the tax implications
In addition to 401K, HSA, and Roth accounts, where else can I invest my money, and in what priority?
Should I get a prenup?
Should we keep put our finances together and keep them separate?
What about taxes - file joint or separately?
At the end of the episode, Paula mentions the budget worksheet, which can be found on her website here: https://paulachristine.com/resources/
For more information or help with your finances, you can visit Paula's website at https://paulachristine.com/
Or send her an email: Paula@PaulaChristine.com.
Paula: Welcome to Beyond the Paycheck. I'm Paula Christine. Living paycheck to paycheck and struggling to get ahead really sucks, but you can take control of your money and live the life that you dream about, with knowledge and commitment. I'll provide you with the knowledge. It's up to you to make the commitment.
So we have found great success in having our listeners call in with questions. So today Aaron is joining us. He has some questions about his situation that he would like me to answer, so welcome Aaron.
Aaron: Paula, thanks for having me.
Paula: So what is your first question?
Aaron: So I guess my first question related to car insurance, in terms of, I guess picking the correct level of PIP.
I guess I've always just been given advice to do the unlimited, but that adds a significant portion to the premium.
Paula: So PIP is,personal injury protection, and I know Michigan just had a law just went in, I think a couple years ago, and I'm not sure all states have PIP insurance. I have the unlimited because I wanna make sure that I have coverage.
The easy answer to that would be check with your health insurance policy to see if it covers auto. And then you have to have a deductible that is $6,000 or less. And then you have to make the decision, you know, if something happens, because it's not just about your auto insurance. PIP covers a lot more than just the injury.
It could be getting you to physical therapy or having someone come in and take care of you. So if you can't afford it, if it makes it too pricey, then go down to the next level.
Aaron: Okay.
Paula: Next question.
Aaron: Related to a 401k. I recently just switched jobs and I had a 401k with my previous employer.
Not a ton of money. But it's been there. It's consistently losing. And I passed the grace period to roll it over into my current employer's 401k. So I was just wondering, did you have any. Suggestions on what I should do with that? Should I just cash it out and take the penalty?
Paula: Oh, no.
Aaron: Or try to roll it into a Roth?
Paula: Well, first of all, don't cash it out and take the penalty. You can roll it to a Roth, that's called a Roth conversion. First you'd have to roll it to a traditional IRA, and then you can convert it to a Roth IRA. So there's great benefits in doing that because then the money grows tax free, and then when you withdraw it many years down the road, it'll be withdrawn, tax free too.
But you have to pay the taxes on that. And you said it's a small amount, and I don't want you to tell me what it is, but even that small amount gets added to your income. So you're gonna wanna take a look at what your current income is. Look at the tax brackets, because what would happen, let's say that you're, you're single, right, Aaron?
Aaron: Uh, no.
Paula: You're married?
Aaron: Uh, significant other.
Paula: Okay. Well then you're single.
Aaron: Legally. Okay. Yeah. No, I'm single.
Paula: For tax purposes. You are single. So Aaron, one of the things that you have to be concerned about is you have to pay the taxes on the money that you convert over to the Roth. Now, you said it wasn't a large balance, so it may not be that big of an issue, but remember that money gets added into your income, so we wanna make sure that when you're making that decision, it's not gonna put you into a higher tax bracket.
So I'm just gonna pull some numbers. I don't know have any idea what you make, but let's say you made $89,000 a year. The next tax bracket was $89,075. So the next tax bracket would be $89,076. So let's just say you made that, that's your just addressed in gross income. So let's say you were rolling over $25,000.
That $25,000 would be taxed at 24%, and you don't wanna take that money from the money that you're converting. You wanna take that money from savings. So that 25% of $25,000. I can't do the math that best in my head. But you would wanna make sure you have that to pay those taxes outta your savings account and not on the money that you're converting. That make sense?
Aaron: Yeah. So keep whatever was invested. Invested.
Paula: Correct. So that could be a great option for you. So you can either leave it at that 401k, you can move it to a traditional IRA, or you can move it to a traditional and then convert it to a Roth. But I don't think that really is your question as much as, because you said that you keep losing money now if you keep losing money.
Is that just because of the market and the way that it's declining right now?
Aaron: I think so. I'm just looking at the statistics for it. I guess overall I'm down like 30% since I opened it, and I know it's not that long. It's only been a couple years.
Paula: Yeah, I guess 30%. That is kind of a shocking number for anybody to see their portfolio go down 30%, but if we look over historical times, it will come back.
But maybe the investment isn't the right investment for you. Maybe it was too aggressive. And maybe we need to look at something a little bit more moderate next time. Does that make sense?
Aaron: Yeah.
Paula: Okay. Do you have any other questions on that?
Aaron: No. I think pretty much cleared that up.
Paula: Okay. So Aaron, go on to your next question.
Aaron: I guess, sticking with investment accounts, currently I have a 401k and an HSA and a Roth. Is there any reason, or I guess another type of account that I can invest in that's doesn't have an age restriction on it?
Paula: Yeah, that would be a brokerage account or it doesn't necessarily have to be a brokerage account, but what we would call that would be non-qualified money.
That's invested money that you've already paid taxes on, so after tax dollars. So you have exactly what I would tell a client that, you know, you have the Roth IRA. You have your 401k, so you have tax free withdrawals, you have taxable withdrawals, and now you wanna have a third option, which is, Well, I call it the brokerage or the non-qualified because that money is available to you anytime you want.
You just have to sell it in there. You might have capital gains or capital losses at that time, but you have access to that money when you go into retirement too. Now we have three different buckets of money to pick from. We've got the Roth money again, tax free. The taxable bucket in the 401k. And then we would have the brokerage account and that would be taxed at capital gains.
And depending on where your income level falls for capital gain purposes, it could be zero tax on those capital gains. So it gives me retirement options to pull from different buckets of money to potentially have a very low tax bracket for you during retire. And again, it's also completely liquid.
You can stop at any time. You don't have to keep investing in it. You can just stop and hold off for a couple of years. And really, depending on what you're doing, the only time that you're gonna have to pay potentially tax on that is if you pick something that pays a dividend, and that would be ordinary income, or if you sell something for a capital gain.
So, yes, go ahead. That would be your third bucket of money. I would suggest that you start thinking about opening a brokerage account.
Aaron: Now, would you only suggest that after the other ones, I guess, are maxed out or decently contributed towards?
Paula: Let's say you had $21,000 to invest each year for retirement or just in general?
My first thing would be you max out your 401k to the level of where your employer's matching, and then you would back out your Roth IRA if you're eligible to do that. And then if you have additional savings money to go away, then I would say that you would consider either going back to your 401K or going into the investment account.
So that's kind of the rule of thumb that I would look at, but it also has income limitations to the Roth and different things. But for most of us, I would do the 401k to the match, max out the Roth, and then consider either going to the 401k or the brokerage.
Aaron: All right. So, I guess I see marriage coming in my near future and I've heard varying suggestions on whether or not to get a prenup.
So I guess in your opinion, do you think they could be worth it, and if so, what would they include?
Paula: So I had to do a lot of research on free nuts. I was really surprised to find out that only like five to 10% of the people get a prenup. I think they have a great purpose because they can protect the asset that you're coming into the marriage with.
So your premarital assets, and premarital debts that could protect you. You know, you can have the document say that if you were ever to divorce that you're gonna waive the right, or she's gonna waive the right to alimony. You know, who's financially responsible, provisions for children from previous relationships.
There's a bunch of different things that you can include in there, but I'm gonna share a little story with you. I was buying a card to go to my nephew's wedding and I was in a card store and I ended up next to this woman. We were both buying cards for weddings, and I had just gotten divorced and I said, Oh, you're going to a wedding too?
And she goes, Yeah. She goes, I wonder how long this one will last. And I said, "That's pretty cynical to say that." I said, I'm going to a wedding too. And I said, I hope it lasts a long time. She goes, Well, I'm a divorce attorney. And I said, Well, what do you do? How do you protect yourself? And if you're getting married, what's the first thing that you do?
And she said to take a picture or a snapshot of all your assets and debts the day of your wedding, so that if something does happen, you can go back and say, Well, you know what? I already had, you know, $200,000 in my 401k. Now it's worth $400.000, but that $200,000 I had before we were married. Here's the document to prove that.
And then when you go to get the divorce, They'll say that was a premarital asset and therefore it would be eliminated from your divorce proceedings cuz it was a premarital asset. So that would make be a little easier way to do it is like, the day that you're getting married, is just take that snapshot of all of your assets and she needs to do the same thing.
She needs to be protecting herself too, but oh, by the way, congratulations.
Aaron: Oh, thank you. I guess keeping with the marriage topic, would you have any suggestions for whether or not to keep separate finances or if we should join like a single account?
Paula: That's a tough question. I've been in the financial service industry now for, I don't know, 22, 23 years, and I've seen it both ways and I've seen it work out fantastic.
You know, everybody's on the same page. And then I've seen it cause a lot of fights both ways, separate and joint. Here's how I look at separate, So I'm gonna make up some numbers here. Let's say you made a hundred grand and she made 50 grand. So does that mean you're gonna pick up two thirds of the expenses and her only a third?
And then what happens when you see that, you know, they're covering their expenses that they're supposed to, but yet they have all this extra money to go out and do things, do their hobbies and stuff, and the other person doesn't. I mean, it's really hard to split when it's not quite totally equal. And then what happens when you come out to retirement?
If you're the person earning more, was able to save more for retirement, then the person who was earning less, then how does that work? Do you keep separate expenses when you're on social security and living off your investment? I think if you're gonna step into a marriage, you have to have this conversation before you get married and talk about doing things together as a team.
Meet on a weekly basis and say, Okay, this is the money that we have coming in. We need this to go to our living expenses and we have this extra money for savings. Even if you still keep your money separate, you can still have that conversation. And just communicate. Cuz if not, it's gonna cause problems.
So sit down once a week and just figure out what's gonna work for the two of you. And it doesn't really matter what I think or what anybody thinks, it's just whatever's gonna work for the two of you. . So I had that separate expenses in my last marriage and I didn't like it personally, but once it was set up, well we ended in a divorce anyway, but there was no way of setting it up to be jointly and we didn't have those conversations.
I would now, so that I'd have a better idea what he's doing with his money than what I'm doing with my money. You should be a team, right? And you need to be working together for a common goal, and that's for, you know, whatever it is, buying a house or your retirement or just living. Does that answer your question? In kind of in a roundabout, not answering your question.
Aaron: Yeah, no. Something to think about.
Paula: Yeah. But have that conversation? I mean, I just worked with a couple. We started working together about a month ago. And that was one of the things that they were talking about because he's bringing in kids from a previous marriage and they were having another child and they were getting married.
All this stuff happening at once. And we had the conversation about joint and separate. But when I had gave them the project to create a budget, then they had to talk about what they wanted to do together and well, who is saving this and who's doing that? And a meeting with them in a week or so to figure out what they ended up deciding to do.
But you gotta just look at it from both ways and see what makes sense. And how everybody's gonna be comfortable because you don't want anybody resenting one or the other for, Oh, well you make more money than you. You should be contributing. It can just ends up in a battle and we don't wanna have battles when we're married.
Aaron: Right.
Paula: Any other questions you got?
Aaron: I guess I have one kind of related to that. Okay. When filing taxes, doing a joint or separate?
Paula: Typically it's done jointly when you're married.
Aaron: So like hypothetically, even if we had separate finances we could still file jointly?
Paula: That is a great question for the CPA, you can actually have them run it separately versus jointly. So in my own personal experience, because we did keep our finances separately, when we did finally do that last tax return before the divorce, I had him look at it both ways just to see how it worked out. And it ended up, I found that I was paying the majority of the taxes. And so it kind of gave me an idea, but if you both have the correct withholdings and you're not getting huge refunds now, then I don't see any reason why you wouldn't file jointly.
But that's a really good, whoever does your taxes, or if you do 'em yourself on TurboTax, just run it both ways and see what the outcome is. , But I think there's, and I'm not a CPA, but I think there's reasons why you don't want to file them separately. I'm not sure if it's better tax wise.
Aaron: Right.
Paula: So do you have any other questions Aaron?
Aaron: Nope, that was it.
Paula: That was uh, actually some great questions. I appreciate you calling in and letting me answer your questions for you.
Aaron: No, I appreciate the help.
Paula: Since we were talking about budgeting, there is a budget worksheet that you can download on the PaulaChristine.com website where you can start preparing and creating your budget and having those conversations with your soon to be wife.
So Aaron, again, I wanna thank you for being here with us today. If anybody wants to reach out to me again, you can check out the website at paulachristine.com or email me at paula@paulachristine.com. Thank you.