HOW SHOULD PILOTS USE THEIR ACCOUNTS? 401(K)S, ROTHS, HSAS, AND BROKERAGE ACCOUNTS

Tim: [00:00:00] You’re listening to The Pilot’s Portfolio, the show dedicated to guiding professional pilots towards a future of financial success and stability. Fly along with your host, Timothy P. Pope, as he provides financial planning insights and answers to your burning questions and dives into real-life stories from fellow pilots who share their successes and cautionary tales.

The Pilot’s Portfolio takes off now. Well, folks, glad to have you along on today’s episode of Pilot’s Portfolio. We are actually talking about what is inside of your portfolio. I talk to, you know, a lot of clients, and over the years, you guys just end up with a lot of accounts. And so this episode, hopefully it’s gonna be a refresher on the basics.

Sometimes we spend time on these obscure strategies that some of you use, but not all of you, but some of you end up using. But what I’ve found is a lot of clients [00:01:00] like a refresher on the basics, so glad to have you joining for this episode here. My name is Timothy P. Pope, Certified Financial Planner, specializing in the planning needs of the professional pilot and principal here at Three Sixty Aviation Advisors, where we help successful professional pilots really integrate their financial planning with a well-rounded focus on retirement, investments, and tax.

With that, let’s jump in to today’s episode. So when we think about what is in your portfolio, I’m not talking about stocks or bonds or anything like that today. I’m just talking about the amount of accounts that you’ve accumulated, ’cause here’s what I’ve observed, right? So you started out your career, you know, however long that was ago.

You started to do all the right things. You moved from one company to another company, and finally at your destination airline, or for some of you, you started in the military. You’re at your destination airline, and then you’ve kind of accumulated accounts along the way, maybe a traditional, and then you realize you should be doing Roth, and then maybe you realize that you make [00:02:00] too much money to contribute directly to the Roth.

You opened up a brokerage account and so on. When I started looking at the number of accounts that one pilot can have, you know, it was somewhere around like nine to 12 accounts, and that doesn’t include the spouse. If you’re married, you have a spouse, they have their own accounts, and then you add on top of that the kids, right?

So what I am going to do is I’m gonna break this out. This is gonna be a couple of episodes ’cause I’m– I don’t wanna go deep for 30-plus minutes, so I wanna break it up into bite-sized pieces. But we’re going to, we’re gonna explore some of the heavy hitters, some of the most popular accounts, and then some of the other accounts that you can get into, primarily like some of the employer-sponsored things that may not be top of mind for you.

And then we’ll have one on the kids, right? If you’re helping the kids out. Let’s take a look at the accounts and kind of, kind of just go through them, right? So the first thing is you got your 401. That’s your big boy. Or if you’re military, your TSP. So that’s your big boy. That’s gonna usually be the account that ends up [00:03:00] with the most value because It has, as it comes to qualified accounts anyway, it has the highest contribution limit.

And then if you’re at a major, you’re getting a healthy non-elective contribution. Okay, so you got your 401. Inside of that, technically you’ve got three tax structures that you can use. Really, we’re only gonna be using two. Nobody will use the third one that I’m gonna talk about here in a minute. But you’ve got your pre-tax contribution, of course.

So we take our tax deduction today, we put the money in, and then down the line, whenever we take it out in retirement, we’ll have to pay taxes on, on everything that we pull out. And by the way, your NEC defaults as a pre-tax contribution. Okay? So we have that. And then you’ve got your Roth option. So if you’re early career or typically we’re telling folks, ‘Hey, if your marginal federal rate and your state rate Combined together do not exceed 30%, then, hey, we like Roth.

But that, that is not tax advice. You should look at your own circumstance and figure out what you’re comfortable or [00:04:00] what your own thoughts about the future are. Okay. Some people have a much higher rate than that, and they are very Roth-focused for specific reasons. All right? You got your pre-tax, you got your Roth.

The third option there is to do an after-tax contribution, which if you don’t convert that after-tax contribution, then the earnings on that would be taxable. So that’s why I said the third one nobody uses, right? So if you’re gonna go after tax, let’s go ahead and convert that over. It doesn’t cost you anything.

That’s what you will read or hear about referred to as a mega back-door Roth contribution. So that’s your 401. The TSP is also kind of lumped into that. A lot of times guys will ask, like, “Hey, I’ve separated from service. Should I move my TSP over to an IRA?” If you’ve got pre-tax contributions in the TSP, usually I’m gonna tell you no.

You have access to efficient investments inside the TSP, and starting earlier this year, you were able to start doing Roth conversions inside the TSP if that suits your tax strategy. So typically, we’re saying, hey, [00:05:00] for the pre-tax portion of your TSP, we’ll leave as is and use those investments, and then when you retire for the final time, that’s the time to start thinking about rolling it over.

So got your 401, your TSP, we can count that as one account type. Then you go to your IRAs or rollover IRAs. Okay, guys, this is where sometimes I see folks being– kind of stubbing their toe a bit, right? So let’s think about it. So your IRA, that’s the account type that in the past you were making contributions to and you probably were taking a tax deduction when you made those contributions.

Interesting about the IRA is as soon as you have an access to an employer-sponsored plan and you make above a certain amount, you know, it changes year by year, so you have to check what those limits are. But you have access to an employer plan, you make above a certain amount, those contributions are no longer tax-deductible.

Okay? So if you’re at a major airline, you cannot make deductible contributions to an IRA anymore. Just because, you know, your CPA says it’s a good idea or maybe you’re, you know, reading something online, just know that [00:06:00] those contributions that you’re making to an IRA are not tax-deductible. So you have that, and then sometimes folks will have a rollover IRA, so an IRA from a previous employer plan that, hey, you know what?

I moved employers. Maybe I was at a regional or like we had an example in the industry earlier this year, Spirit, right? So those guys have to move their 401at some point. And so, you know, maybe that’s just sitting around in an IRA. You have pre-tax contributions in those IRAs. That will… You’ve heard me talk about a lot on the show about a back-door Roth contribution.

If you have a pre-tax IRA sitting there or a rollover IRA sitting there, that is really going to frustrate your ability to make a clean back-door Roth contribution. So a lot of times what we’re gonna do is we’re gonna call up your current plan, Fidelity or Schwab usually if you’re at the big four, and we’re gonna say, “Hey, will your plan accept these dollars.

A lot of times they will, but not always. They won’t always accept those dollars. We’ve run into [00:07:00] that. So we ask, and if they do, then we’ll move that IRA into your current plan, and what that allows you to do is that opens up the backdoor Roth. So, I mean, if you’ve got ten years left, uh, so that would put you at, say, fifty-five, you know, that’s eighty-six hundred bucks a year that we can grab in a tax-free account.

And if you’re married, okay, so, and your spouse is over fifty, you know, that’s eighty-six hundred times two, seventeen thousand two hundred, right? So is it a ton of money? No, it’s not a ton of money. But over a ten-year period, and then you add market returns, I’ll take that over the brokerage account because I know I’m still gonna have money left over to put in the brokerage, right?

So it’s just an opportunity that I, well, I’d hate for you to miss. So you think about your IRAs, your rollover IRAs there. We help many clients push those back into the 401plan. Now, old 401s or old TSPs, here’s another one. Should we move those over? And it depends. Sometimes we’re gonna do the, what I just talked about with your rollover IRA, seeing if your current plan will accept tho-those dollars.

We’ll do that exercise. If it [00:08:00] has Roth, sometimes it makes sense to roll that to a Roth IRA. You have greater control, greater flexibility. Sometimes you’re not investing the same way, right? Like, typically in an IRA, you’re gonna have more choice than you will in a 401. So with that, sometimes we might peel off the Roth options or the Roth amounts and then send the pre-tax to a previous employer.

Sometimes we just might send all of it to the current employer. It just depends on if the plan is gonna accept it. So your 401, IRAs, rollover IRAs, old 401s, a lot of times I see these in folks’ portfolio. Let’s move on. Now, we’ve got the Roth IRA as well, and this one is everybody’s favorite one to talk about.

It’s tax-free earnings on your contributions. It’s a great deal, right? So that’s why the government kind of caps it. They cap it two times. They give you a small contribution amount in the IRA, and then they say, “Hey, if you make over a certain amount, your modified adjusted gross income for the year, then you’re not able to contribute at all,” right?

We will certainly use the loophole, the backdoor Roth loophole there, as long as it’s available and open to us. And so and that is [00:09:00] really, it becomes valuable, and that’s why we don’t want to stub our toe with an IRA, IRA that prevents us from doing it. So you’ve got your Roth IRA there. It’s another common account type that folks are using, and if you’ve heard me talk about it, it’s like a decision tree.

So, like, where should we invest our next dollar? Obviously, you guys are getting the NEC in your 401. The IRAs and rollover IRAs are not gonna be… They’re not gonna make sense for you. So then we think about, “Should we do a Roth or should we do a brokerage?” This is gonna be nuanced. This is not blanket advice for everybody, ’cause I was talking to somebody that was very committed to retiring before the age of fifty the other day, and so guess what?

Their qualified plans might take a backseat to their non-qualified plans. But that being the case, usually we’re gonna wanna go ahead and max out that Roth, that backdoor Roth as much as we can and then flow the other assets to Whatever makes the most sense. So you got your Roth there. All right, let’s talk about your HSA.

Your HSA, this is a health account, and matter of fact, structured from a tax [00:10:00] structure perspective, I like the HSA even more than the Roth just because you get a tax deduction when you go into it. Roth, I get no tax deduction. HSA, I get a tax deduction when I go into it. I invest the money, and as long as I use it for qualified healthcare expenses, either now or in the future, it becomes tax-free.

So that’s a wonderful advantage. It really is. Just be mindful, if you are on TRICARE, you are not eligible for the HSA. So for those that are retired military, TRICARE For Life, you are not eligible for the HSA. Or with the current situation going on, I know some of you doing reserve work, you’ve been activated.

If you’re taking active orders for that time, you– well, you will not be eligible to be on the HSA at that time. And if you’ve run into that, give us a call, we can help you just do the math and figure out how many months you were eligible for HSA and then kind of pro-rate that for the amount that you’re able to put in it for that year.

And so there’s the HSA. A lot of folks have that. And then your brokerage account So your brokerage [00:11:00] account is going to be what I call y-your ultimate flexibility, your ultimate freedom. I think, like, your brokerage account is like your unsung hero. It does not wear a cape, but boy, does it give you a tremendous amount of flexibility.

That being said, we pay for this flexibility because it’s not a tax-advantaged account, okay? So your Roth or your even your, your IRAs or your 401Ks, your TSPs, hey, those are tax-deferred. We can avoid taxation as long as that money stays inside the account. It’s not gonna show up on our 1040 every year. But with your brokerage account, we gotta be careful how we build it, because since it’s not tax advantage, if you put investments in there that spin off income, you think about REITs, you think about high dividend stocks that spin off income, you could have this portfolio that’s spinning off five, six-figure income, and you’ve not done anything.

You haven’t sold anything. It’s just sitting there, but yet that money is still showing up on your 1040, and then you’re having to pay the NIT, so the net investment income tax on it. And [00:12:00] so the idea here is, with the brokerage account, let’s enjoy that flexibility. We can put as much in as we want. We can take as much out as we want.

We can use it at any time with no questions asked, no penalties. We just wanna be careful how we build it. And so when I think about brokerage accounts, we certainly wanna build them in the most tax advantaged way as we can. And particularly for the guys who are listening to this podcast, you are successful pilots.

You currently, you’re doing very well, and if you are not where you wanna be, you will be there soon. So you wanna build it with the future in mind. So I wanted to go over these account types because, like I said before, a lot of times you’re going through your career, you’ve met a level of success, you’ve been doing all the things that folks tell you to do.

“Hey, you save here, save there, open this account.” And you kind of pop up and you’re like, “Wow, my stuff is scattered everywhere.” It’s probably over two, three different custodians or more. You know, your Vanguard, your Schwab, your Fidelitys, your TSP, Robinhood, and so on. You know, it’s kind of scattered everywhere, and you’re wondering [00:13:00] like, “Is my money working as hard as it could be?”

Typically, the questions that I get is like, “What should I be doing with all of these accounts?” Or, “Which account should I be focusing on?” Folks usually don’t ask How should these accounts be working together? Maybe because that’s just not something that you’re aware of that you should be asking, but you should be.

And so what we’ll do is, hey, we optimize the accounts to make them work harder for you, and the only thing we do is we just use the differences of the account types themselves. And I’ll tell you, here’s what we do. I just finished talking about the brokerage accounts. We want those to be tax efficient.

Usually want them to have mostly stock and less bond. Sometimes, depending on when you’re gonna use it and what the account’s for, we will have some bond allocation in there, but it’s not like you’re not gonna see an order you want usually a brokerage account that is super bond heavy. It’s just tax inefficient.

And where your income rates usually are, then we might be looking at munis if we need to. Okay, so that’s one. Your Roths usually, as long as you have [00:14:00] the risk tolerance for it and your financial circumstance has the risk capacity, we’re gonna usually wanna load your Roths up with as much growth-oriented stock as possible, or growth-oriented investment as possible, right, with your Roth.

And then as you get closer and closer to retirement, where we add the bond are usually going to be in the pre-tax portion. Okay? So you guys have been getting NEC for years. Some of you have contributed to Roth, and then you’ve pivoted once your tax rates jumped up to pre-tax, and we’re gonna allow the pre-tax portion to hold the bonds.

That right there, look it up. When you think about, like, personal finance and so on, when you think about… It’s called asset location. And when you think about asset location, those decisions on how you build your portfolio and how you allow the account types themselves to work for you, the academics have put a value on that, and I forget how many percent per year kind of thing, just by using the structure of the account types themselves.

So that’s gonna do it for this episode. [00:15:00] The next episode, we’re gonna jump into other things like deferred comp, market-based cash balance, uh, ESPPs, and so on. We’ll jump into that, and then probably we’ll need to have a third episode talking about, hey, you know, you wanna help out the kids, which account types are appropriate for you, if that’s the stage that you’re in in your life.

So thanks for listening to this episode. As always, guys, big shout-out to Beacon Relocation. If you’re in the Charlotte area, definitely give them a call, and if you’re nationwide, give them a call. They’ve got fifteen hundred Realtors all over the country standing by ready to help you save money on your next real estate transaction.

So with that, thanks for joining, and we’ll see you on the next episode. Thank you for joining this episode of Pilot’s Portfolio. If you found this information helpful, spread the word and share it with a pilot buddy. Or if you have questions and there’s something that you would like to hear discussed on the show, send us an email.

You can find the address in the show notes. For those of you who are ready to learn how [00:16:00] we help professional pilots with their financial planning needs, schedule an appointment. Until next time, keep the shiny side up, and we’ll see you on the next episode Pilot’s Portfolio is hosted by Timothy P. Pope.

Timothy P. Pope is principal owner of Three Sixty Aviation Advisors. Three Sixty Aviation Advisors is a registered investment advisory firm regulated by the state of North Carolina in accordance and compliance to the securities laws and regulations. Three Sixty Aviation Advisors does not render or offer to render personalized investment or tax advice through Pilot’s Portfolio.

The information provided is for informational purposes only and may not be suitable for all investors and does not constitute financial, tax, investment, or legal advice. All investments involve a degree of risk, including the risk of loss.