We always know when it is the beginning of the year, because we get so many questions about retirement accounts and everything related to them. This episode answers more of your questions about employer and solo 401(k)s, 529s, Backdoor Roths, the difference between traditional and Roth IRAs, and so much more.
Solo 401(k) and Renting Your Home Office
“My name is Andy, and I'm a urologist in the Midwest. I was calling about a solo 401(k) question. I'm in the highest tax bracket. I've been doing some side gig income this year as an expert witness and some surveys, and I've made about $15,000.
I've opened up a solo 401(k) and I was looking at contributing to that this year. However, I have been doing the expert witness work at my house and I was thinking about renting my home office to myself for 12 days a year, which would cost with comparable numbers about $9,000 that would be deducted from my net income. However, this would lower my available contribution to my solo 401(k). Should I let the tax tail wag this investment dog, so to speak, or am I thinking about this incorrectly?”
Dr. Disha Spath:
What he's talking about is the solo 401(k). He can do employer contributions to the 401(k) up to 20% of the profits that he makes from his 1099 activity. When he was talking, the thought that came up in my mind was “Why not just deduct the home office?” But the caveat to that is that the home office has to be for exclusive use of your business. You're basically using that home office for that business. I'm not sure if he would qualify if he's only doing it 12 days a year. What do you think?
Dr. Jim Dahle:
Well, it depends. Does he use that space for something else? Because when you talk about the home office deduction, the two rules are regular use and exclusive use. You have to use it regularly. The IRS doesn't define that. I don't know, is once a month regularly? I guess. Exclusive means you don't use it for anything else. That's usually the one that trips people up. I have very little space in my house, and we have a place we built for WCI. I'm not sure it's used exclusively. Portions of it, I suppose, are, but the hard one is exclusive use. Because everybody wants to use their whole house. You don't want to say, I'm only going in that room once a month. That's not a very helpful space in your house. But the big problem with the home office deduction, at least if you use the simplified version, is it's not a very big deduction. You can only take up to $5 a square foot up to 300 square feet. That's $1,500.
It's just not a big deduction. If you're renting your house to your business, that's a much larger deduction, especially given the value of most doctor's houses. If your work is reviewing charts, that might be pushing it a little bit to rent out your whole house for that business. The IRS doesn't require you to make good business decisions, but boy, that one might be pushing it a little bit. I'm not sure how comfortable I'd be with that. We do this for WCI, but we also bring over a whole bunch of people and have a meeting. Those are the days that I'm writing this off. I'll leave that up to you whether you choose to do that or not. But certainly, that's going to be a heck of a lot bigger deduction than the home office deduction would be for you.
But I don't think that's really your question. I think your question is, “Are you better off never having that taxable income or having taxable income that allows you to make 401(k) contributions?” I think the answer to that is you're better off not having taxable income. The best income you can get is money you don't have to pay any taxes on at all. When you use a retirement account, you're going to pay taxes on that money. I think you're better off not having taxable income if you can come up with a deduction that you would be buying anyway. You don't buy stuff you don't need or that you wouldn't use anyway. But you're better off with that deduction than you are with more retirement account space. I mean, I'm a big fan of retirement accounts, but I think that's the way the math is going to work out for just about any legitimate business deduction.
One other thing I think a lot of people in this sort of situation ought to consider—and it might not be worth it for a business that makes $15,000—is you can get a custom-designed solo 401(k). I'm not talking about one off the shelf at Vanguard or Fidelity or Schwab but a custom designed one. You're going to spend a few hundred dollars getting it set up. You're going to spend $100 or $200 a year maintaining it, but you can get a plan design that allows you to make after-tax contributions and in-plan Roth conversions, aka the Mega Backdoor Roth IRA. If you do that, you could put all $15,000 into a Roth account instead of just $3,000 into a tax-deferred account. I think more people ought to think about that because that's probably the right answer for lots of people. It's a little more complex to deal with. It's a little bit more cost for sure, but it's certainly a good option. Plus, soon people are going to be able to do Roth SEP-IRAs. So, you can just do a SEP-IRA and make Roth contributions there. But again, I think you're going to be limited to the $3,000 in your case if that's what you are doing.
More information here:
Tax Deductions for a Home Office
How I Made $30,000 Taking Doctor Surveys
1099 Income and Retirement Accounts
“Hi, Jim. I’m looking for help with a question that I cannot find the answer to, and you've always given such great advice. I appreciate that over the years. Anyhow, I am an emergency medicine physician. I typically max out my 401(k) every year as well as a defined benefit plan, which is great. However, I've been doing some side hustles, and I have some 1099 income. My question is twofold. One, can someone that's just working as an individual with 1099 income set up something like a SIMPLE IRA or a SEP-IRA, or do you legitimately have to have a small business LLC, etc?
And then the second question is, is this going to be worth the headache? If I don't max out my 401(k) through my employer and instead, let's say, use a third of those funds to set up a SEP-IRA to have a separate piggy bank—to maybe invest in some alternative asset classes, like some of the real estate funds that you promote through your website—I was wondering if this would be a good thing or if it's just going to be a massive headache and more paperwork to go through and perhaps create some hurdles to doing things like the Backdoor IRA and things like that. Anyhow, I’m just looking for advice on whether or not I should do this.”
Dr. Jim Dahle:
Wow. John, great question. There is a lot swirling around in that question. This is one of those things that we need to go out in the hallway and have a chat for 10 minutes about how this all works so it's nice and straight in your mind and then I think your decisions will be a lot easier. What would you say to him, Disha, in this conversation? Because this is going to take a while, I think, to touch on all these topics that he's mentioned.
Dr. Disha Spath:
Right. The first thing that came to my mind was you definitely don't need an LLC to start a solo 401(k) or a self-directed 401(k). The solo 401(k), you're a sole proprietor, you can get an EIN from the government and just start that solo 401(k) and start contributing there. That would've been the advice from us prior to Secure Act 2.0. But now that you can do Roth SEP-IRA contributions, the reason we would've said don't do SEP-IRA would be because that would put you in the pro rata rule calculation and all that money in the SEP-IRA would count against you in the pro rata rules if you're going to do the Backdoor Roth IRA. But now you can do Roth contributions. That's going to change up our calculus a bit. Do you need an LLC for a SEP?
Dr. Jim Dahle:
No, you don't need an LLC. The other problem with this whole new Roth SEP-IRA thing is I don't know where to send anybody for one.
Dr. Disha Spath:
Right. They haven't really clarified that.
Dr. Jim Dahle:
I haven't seen Vanguard put anything out or Fidelity or Schwab. I mean, yes, Congress has authorized it, but nobody's offering one yet. It's not really an option yet, No. 1. I'm not sure it's better than a solo 401(k) for most people. You're absolutely right that lots of docs out there do not need an LLC. I don't know what your side gig is. You didn't mention whether you're just practicing medicine or what. But here's the deal. An LLC doesn't protect you from malpractice. You can't just incorporate your practice and somehow you can't be sued for malpractice personally, right? Malpractice is always personal.
For someone who's just working as a hospitalist, they have no employees. They're just getting paid on 1099; they don't need an LLC. Yeah, it looks a little more official, but who are you trying to impress? They want you whether you're an LLC or not. You don't need it for a solo 401(k). Most of the time docs doing that sort of thing can just be a sole proprietor. What you need to understand is if you're being paid on a 1099, you're in business. You are self-employed. You have a small business. The form of that small business is a sole proprietorship. Don't kid yourself that you're not in business. You are in business. You can write off all your business expenses. You can go open a solo 401(k). Yes, you have to get an EIN, but that's free and it takes 30 seconds. I helped my daughter get one of those for a business she started the other day. It's just not that hard. You don't need an LLC. When you want an LLC is when you have liability in that business. Like when you're doing rental properties, that's a toxic asset. You want that in an LLC—internal and external asset protection.
The White Coat Investor wasn't an LLC originally. It was a sole proprietorship. Then it became an LLC taxed as a sole proprietorship. Then it became an LLC taxed as a partnership. Then it became an LLC taxed as an S Corp. There are all these different entities that there are different reasons you might want, but if you want to just keep things simple, sole proprietorship works very well and it's perfectly fine and you can have your retirement account with that.
The other thing that doesn't seem to be straight in your head, I think, is how to choose a retirement account for your small business. This is a lot easier if you don't have employees. The answer, as Disha mentioned, for a long time has been a solo 401(k). That's what you want. If you don't have employees, get a solo 401(k). It's especially important if you don't have a main gig whose 401(k) or 403(b) you're using to get that employee contribution. This year it's $22,500 for those under 50. But even if you still have that, a solo 401(k) has been the right answer in the past because it didn't get pro-rated when you do your Backdoor Roth IRA. Now, with this Roth SEP coming out, maybe that issue goes away because a SEP is a little easier to use than a solo 401(k). You don't have to file 5500 EZ once it gets to $250,000. It's a little bit less paperwork to set up. I don't even know if you need an EIN for a SEP. You might be able to open a SEP without an EIN. I think you can. But for the most part, solo 401(k) is the answer.
Who's using a SIMPLE IRA? A few people with employees use SIMPLE IRAs. It just makes sense for their particular practice, their particular business. But if you're a doc and you have no employees, don't use a SIMPLE IRA. It's a stupid plan. The contributions are low. You have to leave the money in there for two years before you can roll it out. You don't have those rules with a SEP-IRA. You don't have those rules with a solo 401(k). You don't have to set up a retirement account, though. It's not the only way you can save for retirement. You can always do it in a taxable account. Whether you put mutual funds in that account, whether you go invest in private real estate, whether you go buy properties down the street and rent them out, you can do all that outside of retirement accounts. There are plenty of small medical practices with employees or dental practices where they do a study and they're like, “This doesn't make sense for me to implement a retirement account. I'm just going to save in taxable.” That's perfectly fine.
I think you have to have all those issues straight, because all your questions are swirled up into one. I think you need to divide them out to really answer the questions. In your case, the answers are probably no, you don't need an LLC. You probably ought to use a solo 401(k). That's probably about it for you. I think when you get to the end of it, that's probably the conclusion you will come to, as do most docs.
Dr. Disha Spath:
Don't forget about the Backdoor Roth IRA, which you can do with any earned income.
Dr. Jim Dahle:
Yes. Remember the pro-ration though, right? No traditional IRAs, no rollover IRAs, no SEP-IRAs, at least tax deferred SEP-IRAs, no tax deferred SIMPLE IRAs, or that conversion each year will be prorated.
Improving the 401(k) for Your Practice
“Hi, Jim. My name is Leslie. I'm a pediatrician in New York City. My question is about the 401(k) retirement plan that we have at my office. I'm a partner with another doctor, and then we have another maybe 30 employees. We've only had this 401(k) plan for five years before I even discovered White Coat Investor. And it's not a good plan. It's through John Hancock, and the options have high fees. Currently, I'm paying, or I believe we're all paying, 1.5% per year in fees. I'm looking to switch us out and I just wanted advice on how to do that and where to get started.”
Dr. Jim Dahle:
Wow. Well, I'm sorry you're in this situation. This is a really common situation. People become financially literate, and they're like, “Oh crap, I've been ripped off.” In my case it was, I had a fee-based financial advisor. Not a fee-only, right? I had a whole life insurance policy. This sort of stuff happens to all of us when we figure it out finally, and we're like, “Ah, crap, I'm paying 1.5% expense ratios.” I had a bunch of actively managed mutual funds I had to get rid of. This happens to everybody. Don't beat yourself up about it. But yes, you want to change. You need a different plan in that practice for a couple of reasons. No. 1, you want your money to grow faster so you can retire someday. Maybe that's the most motivating thing for you.
But there's another reason you need to fix that plan. That reason is that you have a fiduciary duty to your employees to provide them a good retirement plan. This is not a good retirement plan. You are breaching your fiduciary duty, and they can sue you for it.
Dr. Disha Spath:
Don't scare her. She already wants to switch.
Dr. Jim Dahle:
I know. Isn't this crazy, right? She just figured this out, and now all of a sudden she's got all this liability she didn't even know she had. You have to get this changed. They're probably not going to sue you, especially if you're making changes, but they could, is my point. Here's how you do it. You've got employees, I assume, right? Because if you don't have employees, you just go get a solo 401(k). If you have employees, you need to get a study of your practice, a study of your business. The study is essentially to help you decide what kind of 401(k) to put in place or whether to put a SEP-IRA in or a SIMPLE IRA or no plan at all. Those are basically the choices that you come down to.
This is not a do-it-yourself project once you have employees. You need help. You need a team that basically puts together the plan. It includes a third-party administrator. It includes an actuary, usually. It includes a record keeper. There's a custodian for the assets because you're not going to hold onto them personally. There's often an advisor, sometimes an advisor that helps share that fiduciary duty with you. But anyway, the way you do this is you go to whitecoatinvestor.com, you go to the recommended tab, you scroll down to where it says retirement accounts and HSAs. On that page, you'll find four or five companies that do this. They come in, and they study your practice. They study your business, figure out what your goals are, what you want, and help you choose between those retirement accounts and implement one.
These are companies like iQ401k, that's FPL Capital Management, Wellington Retirement Solutions, Litovsky Asset Management, Emperion, CarsonAllaria Wealth Management. When we put in the WCI 401(k), this is who we went to. They helped us design it, and we had to choose one of them eventually. You'll find that upfront it seems like it costs a little bit more because these John Hancock folks are like, “Oh, there'll be no charges to set this up.” The reason there were no charges to set it up is because the fees are all under the table. They're charging you expense ratios of 1.5% instead of 0.05%. That's where they're making all their money. In the long run, it's going to cost you a whole lot more.
It is better to spend a few thousand dollars to get it set up, and maybe a few hundred or even a few thousand a year to keep it going. But you can pay for that out of the practice. You can pay for it with pre-tax money rather than have it be constantly eroding your account value. You need to go get a new 401(k). Sorry, that'll be a little bit of work. It's not too bad, though. Lots of other people have done it before you; you can do it, too.
Dr. Disha Spath:
Great job on learning this stuff and then identifying the problem and you're already fixing it. It's awesome.
Dr. Jim Dahle:
For sure. You need to fix this stuff at some point.
More information here:
Starting a 401(k)/Profit-Sharing Plan for a Small Practice
Backdoor Roth IRA
“Hi there, WCI team. My name is Sophie Herbert, and I'm 54. I have an IRA Backdoor question. On December 15, I contributed $7,000 from my Wells Fargo bank account into a traditional Fidelity IRA. Then on December 22, I converted that $7,000 (and two cents, actually) to the Roth IRA. Today, January 13, 2023, I just realized that there's an interest earned at BIC insured deposit at Wells Fargo, QPI RQ for $3.17. Not sure what to do with that. If you can give me a little insight because I know you just said in your tutorial that anything not done in the calendar year can be a little bit more complicated on the 8606 form. So, contribution and conversion should be done in the calendar year, which I’m not sure what to do with that $3.17. Any insight will be absolutely welcomed.”
Dr. Jim Dahle:
I guess we have a little bit of a lag. We still have Happy New Years running on March 2. This is the pennies in the Backdoor Roth IRA issue. This has got to be, I don't know, a third of the questions we get about Backdoor Roth IRAs. Guess what? Accounts are paying interest again. When your money makes money, there's money left behind. If you put $6,000 in a traditional IRA and it sits there for a week before you convert it to a Roth IRA, it's going to earn some interest. It used to be that was like 37 cents and you just ignored it. Now, it's like $4 and it actually causes you to be pro-rated. It's not that big a deal to get pro-rated on $4.
The easiest way to deal with, when you see that money left behind in the account, is just to convert that as well in the same calendar year. You put it in the traditional IRA on December 15, you move it to the Roth IRA on December 22. On December 28, you see, “Oh, there's $4 in there,” and you move that into the Roth IRA, too. I think that's probably the best way to deal with this sort of thing. Obviously, it's too late for this person to do that and so this person's going to be pro-rated. That's not a big deal because it's only $4.
Dr. Disha Spath:
Wait, hold on. I think what she said was she transferred from Wells Fargo to Fidelity for her IRAs and then she got some interest payment into Wells Fargo.
Dr. Jim Dahle:
Oh, well, that's no big deal, if it's not in the IRA. You made some interest in your bank account. That's great. Congratulations.
Dr. Disha Spath:
Yeah. I don't think that's going to matter to the pro-rata rule.
Dr. Jim Dahle:
It won't. I can't tell exactly what kind of account she's got the $4 in, whether that's an IRA at Wells Fargo, whether she misspoke and it's the IRA at Fidelity (which is the way we usually get this question), or whether it's just an IRA at Wells Fargo. In that case, well, you made $4 in interest, congratulations. You'll have to pay taxes on that interest, but that's it.
Dr. Disha Spath:
If that's just simple interest on your savings at Wells Fargo, that'll just be taxed at your regular tax rate. You'll get a form for it at the end of the year. That shouldn't be a big deal at all. I don't think that should come into your pro-rata calculation at all. Now, if it's at your traditional IRA and you just had a little bit of interest in between—I think you said you contributed $7,000 and then you converted $7,000 and two cents—that should not be a big deal at all. That rounds down.
Dr. Jim Dahle:
It used to be nobody made any interest because the money market funds and the IRAs didn't pay anything. They really didn't have to worry about it. Now, it actually pays something. you get a few bucks. But here's the deal. Being pro-rated is not illegal. It's not that bad. A little tiny pro-ration, right? You put $7,000 into an IRA, you convert it to a Roth IRA and you leave $4 behind. Yes, you're going to get pro-rated, but the consequences are nothing. If you had a $400,000 SEP-IRA and then you put $7,000 into a traditional IRA and then move that $7,000 to a Roth IRA. You thought you were putting after-tax money into that Roth IRA. You weren't. It was almost all pre-tax money and you're going to pay taxes on that Roth conversion because you got pro-rated. That's a much different story than if you're leaving behind $4 in your traditional IRA. It's important to understand how the math works on the pro-ration. You can see that as you work your way through Form 8606. But it's not that big a deal if it's just a few bucks.
More information here:
Funding the Backdoor Roth IRA
“Good evening, Dr. Dahle. My question relates to funding a Backdoor Roth IRA. My wife and I are two business professionals with high incomes. Every year, we max out both our 401(k)s and our Backdoor Roth IRAs. We would like to save 20% of our salaries so we first fill the 401(k)s, then the IRAs, and lastly, a taxable brokerage for any overage. In years past, to fund the Backdoor Roth IRA, we built up $13,000 throughout the year in the savings account. On January 1, would do the Backdoor Roth IRA.
Rather than have that money sit in a savings account for the entire year, would I be better off to invest that money in the taxable brokerage account throughout the year and then sell $13,000 every January to fund the Backdoor Roth IRAs? If so, does it make sense that I should be selling the assets with long-term capital gains? What are the implications if I sell a loss as I would've had to do this January?”
Dr. Disha Spath:
We don't invest the money we're going to be putting into a Roth IRA at the beginning of the year just because it's too much headache. Anytime you put money into a brokerage account, you take the risk of loss. I don't want to lose that money. I want to invest it. I believe strongly in investing with a time horizon in mind. I don't usually put money in a brokerage account that I need in a year or less than a year.
Dr. Jim Dahle:
Yeah. Here's the deal. You're doing a Backdoor Roth IRA. If you have to do your Roth IRA through the back door, it means you're making at least what? A couple hundred thousand dollars. You're saving 20%. You're saving at least $40,000 or $50,000 a year. What's a monthly savings amount for somebody that's saving that sort of money? Maybe it's more, I don't know, that's like the minimum amount you're making because you're telling me you have to do a Backdoor Roth IRA. The point is, every month you're probably saving at least $6,000 or $7,000. Maybe your monthly savings for January goes into her Backdoor Roth IRA. Maybe your monthly savings for February goes into his Backdoor Roth IRA. Maybe your monthly savings for March through August go into the 401(k)s, and your monthly savings for September through December go into the taxable account.
That's kind of how our savings look. It's not as easily automated. But by the time you're having to do your Roth IRA contributions through the back door, you're kind of past the automation point. You've already got complicated finances. I wouldn't necessarily be putting $500 a month toward the IRAs. You make $200,000 plus; you can put it all in at once. You make enough money to do that. I would encourage you to not be saving up for these Roth IRA contributions over the course of the year, but to use the money that you are ready to invest then to make the Roth IRA contribution. I think that'll work out better for you.
If you choose to do this, if you choose to put $500 a month away and put it in the taxable account, then yes, it's good to have long-term capital gains, meaning something you've had for at least a year. Obviously, you're going to pay a lower tax rate on that, but you're also more likely to have more significant gains. Those are kind of offsetting factors. I don't think most people do what you're talking about doing, though. I think most people do what Disha and I do. Either have it in cash, you're saving it up in maybe November and December in cash and just let it sit in cash. You put it in the Roth IRA or this is just the money that you invest for January that's going into the Roth IRAs. I hope that makes sense.
More information here:
17 Backdoor Roth IRA Mistakes to Avoid
Roth vs. Traditional
“Hi Jim, this is Tim in Salt Lake City. I had a thought about the age-old question of investing in Roth vs. traditional tax-deferred accounts. We normally think that tax-deferred accounts make sense if you will be paying a lower marginal tax rate in retirement than you are in your working years. And I imagine that's usually the case, but I was wondering if there's another reason why people might generally prefer to use tax-deferred accounts. If your income drops before retirement age—maybe due to disability or decision to work less—then it seems good insurance to have a good tax-deferred account. Now you'll be able to draw on that money potentially before retirement age through all the various means that you can do so at a lower marginal tax rate.
I wonder if some people get hooked on the idea of tax-free withdrawals from Roth, but then don't end up benefiting that much from them because they end up needing their retirement funds early when they're at a lower marginal rate. So, do traditional retirement accounts serve as a sort of insurance against a drop in income earlier in life?”
Dr. Jim Dahle:
Your comment feels like less a question and more a pontification, which is probably right. What do you think about that as one of the reasons to use tax-deferred accounts, Disha?
Dr. Disha Spath:
I think that's the right way of thinking. The Mad Fientist has a post on Roth conversion letters because that's kind of the strategy he used to retire early. I think he retired in his 30s. He does the FIRE lifestyle so his living expenses are low. He converts his pre-tax to Roth once a year to take advantage of those pre-tax dollars at a lower income. Certainly, that's a strategy that a lot of early retirees use to get more Roth money into their accounts when they retire early. I'm not sure. If you actually wanted to withdraw the money from pre-tax, you would still have to pay penalties. But it's a good way to get more Roth money, anyway, to do those conversions.
Dr. Jim Dahle:
Roth is the sexy one, right? Everyone loves Roth. It's tax-free. Who doesn't want tax-free income in retirement? Certainly, if you got to inherit $100,000 in a traditional IRA or $100,000 in a Roth IRA, you'd rather inherit the $100,000 in the Roth IRA, no doubt about it. But it is true that there are times and places where tax-deferred is the right answer. For a very high earner—let's say somebody that's in one of the upper brackets, 35%, 37% bracket or whatever—that has no retirement savings, tax-deferred is almost surely the right answer for you because you don't have that much in retirement. There's not going to be that much coming out of these retirement accounts filling up lower brackets. It makes a lot of sense for everybody to start the retirement savings with tax-deferred accounts when you're in those upper brackets, because you're almost surely going to get that money out at a lower tax rate than what you're saving when you put the money in.
If something bad happens to you, you get disabled, you don't work as long as you think you're going to work, your income drops, whatever, then yeah, you're really happy you did tax-deferred instead of prepaying those taxes at 35% or 37%. As you go throughout your career, you become wealthier and wealthier. All of a sudden you realize, “Wow, I have a ton of money and everything I take out of retirement accounts now in retirement is going to be in the top bracket.” You're kind of to the point where you've got a supersaver problem, and those people ought to be doing Roth all the time. But for the most part, early on and during your peak earnings years, the answer is going to be tax-deferred accounts for most people. There's a reason it's the rule of thumb. Are there all kinds of exceptions we can all come up with? Yes, there are exceptions. If you're an exception, do Roth. But this is like the anti-exception, right? This is someone who is a high earner for five or six or seven years and then is done. Yeah, man, tax-deferred is the way to go for you, for sure.
More information here:
Should You Make Roth or Traditional 401(k) Contributions?
Roth and 529s
“Hi, Dr. Dahle. I have Roth and 529 questions for you. I'm a military doc in my early 40s, PCSing this summer, at which time my wife will be leaving her clinical pharmacist job. This year, we are in the low end of the 24% tax bracket, and we will dip into the 22% tax bracket for the next three years while my wife isn't working. When I retire and get a real job in four years, we will be in the 32% or 35% bracket. Before we PCS, we will max out her non-matched 401(k), which will have about $75,000 at that time. We plan on rolling all of her 401(k) into Vanguard within the 60-day limit to ultimately end up in her Roth IRA to grow tax-free for at least 16-20 years. Could you let us know whether or not this needs to be done all at once into her Roth, or can we use a rollover IRA to spread out the back door taxes over 2023 and 2024?
Finally, we have a single 529 in my wife's name that we plan on using for our two children as well as one semester of tuition for our six nieces and nephews by changing the beneficiary every 1-2 years. Knowing we have one post-9/11 GI Bill for our two kids and that all these beneficiaries are at least four years apart in age, is this approach wrong? And instead, should we open additional 529s allocated to each child? Thank you so much.”
Dr. Jim Dahle:
What the heck, man? You just fit an entire financial plan into a minute and a half. Which piece of that do you want to take, Disha? Because there are about six pieces I think we need to talk about.
Dr. Disha Spath:
There are some rules here that I'm not familiar with. He said the required six-month window for the rollover. Does he have to roll everything over into an IRA?
Dr. Jim Dahle:
The 60-day window. Here's the deal. Never do a rollover. Technically a rollover is when you take possession of the money and then you've only got 60 days to get it into the other account. Whether the other account is a rollover IRA or a Roth IRA or some other 401(k), whatever it is, you only have 60 days. If you botch it, it's like you just took the money out of the retirement account and you had to pay the taxes due plus penalties, if you're under 59 and a half. That is not the good way to do these transfers. What you want to do is just contact the institution that it's going to and have them pull the money over directly. You're doing a direct transfer and not actually taking possession of the money. They might take longer than 60 days, hopefully not. It usually happens in about three weeks, but then you never take possession of it.
You don't have to worry about the 60-day time limit. You don't have to worry about the fact that you can only do one a year. You won't get burned having to pay penalties. Always do direct transfers. The only reason anybody would ever purposefully do a rollover would be if they're trying to use that money in between. I've seen some crazy people try to close a real estate transaction using that money during that 60-day period. You can imagine what happens when your closing gets delayed or the mortgage doesn't come through or there's a holdup with the inspection or whatever. Now you're caught holding the bag, paying penalties. Don't do that. Sixty days is not a long enough time period, but that's what he's talking about.
Dr. Disha Spath:
Oh, OK. I didn't know if it was like a military-specific rule or not.
Dr. Jim Dahle:
No, that one applies to everybody.
Dr. Disha Spath:
That's good to know actually, because I've rolled over a couple of retirement accounts now and the direct transfer was never an option that I was told about.
Dr. Jim Dahle:
That's weird. They always wanted to send you a check?
Dr. Disha Spath:
Yes. Then it was a complete headache because then I get a check and then the next institution would want a different form and blah, blah, blah. The form didn't have the right information, which Secure 2.0 now fixes, that form has to be standardized, but doesn't go into effect until 2025, I think. But yeah, that's great information. Thank you for sharing that.
Dr. Jim Dahle:
Yes, for sure. I don't know where to start with all those questions. I guess we could talk about the 529s to start. Do you put it all in one 529? I don't do that. I've got a gazillion 529s. I've got 34 nieces and nephews, and I have a 529 for every one of them as well as one for each of my kids. I don't have one for my spouse and I don't have one for me. The nice thing about putting it all into lower generations originally is there's not later this weird gift tax stuff you might have to worry about if you have an estate tax problem and when you move it to that generation. I just started with the next generation. I think that's a good place to start your 529s.
In Utah, we get a tax credit of 5% basically for whatever we put in a 529. But there's a limit. You only get it on the first $4,000 that goes into an account. It would be stupid for me to put it all into one account. Then, I'd only get a tax credit on the first $4,000 that went into that account. If I spread it about among 38 accounts, then I get it for the first $4,000 that goes into each of those accounts. I'm a big fan of not putting it all in one 529. I don't know why you'd want to do that. I guess it's only one account to manage, so that's nice. But it's not like these are hard-to-manage accounts. They're set-it-and-forget-it. I don't know that I would do that. Do you have 529s for your kids, Disha?
Dr. Disha Spath:
Yes, I do.
Dr. Jim Dahle:
Do you have one or do you have multiple?
Dr. Disha Spath:
No, I have one for each.
Dr. Jim Dahle:
One for each. Yeah. I think that's the way most people do it.
Dr. Disha Spath:
It's pretty easy. He said he had an account for his wife. I'm not sure if that already has money in it that they're trying to figure out.
Dr. Jim Dahle:
Yeah, it sounds like he's got this account for his wife and then the plan is to later change the beneficiaries and split it into multiple accounts. I don't know, maybe it came from her parents. 529s haven't been around that long. Maybe that's what it is. If that's what it is, then you're kind of stuck dividing it up at some point. Whether you do it this year or next year or whenever. I guess it doesn't matter. But if you're starting these accounts, just start them for the next generation. I get these people who are like, I don't know, they're just really worried about this or something and they start 529s before the kids are born. They're like, “We might have kids someday, let's start a 529. I'll put it in my name and I'll front-load it. I'll put five years' worth of contributions into it and then later we'll change the beneficiaries.”
Come on. You have 18 years to save up for college. It's not that expensive. If you have the money now to front-load a 529, you're not going to have any trouble saving up for college for these guys. Even if they go to Harvard and even if they go to dental school afterward, you're going to have enough money. You can wait until they're born and a few more weeks until you can get a Social Security number for them and open them with them as the beneficiary from the beginning. If you want to front-load them then for five years, that's OK with me. But just starting them before they're born, I think, is just nonsense. Go save in your taxable account. The money will be there. I mean, congratulations, if you're that wealthy that this is even an option for you. Because when my kids were born there was no way I could put money in a 529 for them. About 90% of the money that went into their 529s has gone in within the last three or four years. We just didn't have the money. I think that's the way most people are.
Dr. Disha Spath:
We were too busy paying for my school still three years later.
Dr. Jim Dahle:
Right, and we had student loans. What else was he asking about? He was asking about Roth conversions. Here's the deal. You're in the military. We talked earlier about tax-deferred vs. Roth. The general rule of thumb is in your peak earnings years, you want to use tax-deferred. Other years, you want to use Roth. It doesn't sound like you're in your peak earnings years yet. It sounds like you're going to get out of the military and make more money later. That means everything you're doing now should be Roth. That's the general rule for most military members. It was such a lame thing when I was in. We had the TSP. The TSP is great. At that time, it was the cheapest 401(k) in the country. Even Vanguard and Fidelity didn't have these super low-cost expense ratios. I think the expense ratio at one year in the TSP was like 0.025% or something. It truly was the cheapest one in the country, but they didn't have a Roth option the whole time I was in.
That didn't come until after I got out, which was a real tragedy because military members often will have a pension that fills up those lower brackets, No. 1. No. 2, they're not taxed that high. A good chunk of your pay is allowances. There's basic allowance for housing, basic allowance for subsistence, that's not taxed. When you get deployed, a big chunk of your income isn't taxed. Most of them, if they're smart, have chosen a state that doesn't have a state income tax, so they're not taxed. Of course, you want to use the tax-free account. Military members almost always should be 100% Roth all the time. If they have some tax-deferred money, they probably ought to convert it, which you are doing. So, kudos to you. That's the right move. You do want to do a Roth conversion.
How long do you want to spread it out over? That's up to you. If it's a big conversion, just spread it out over two or three or four years, that's fine to do. Keep in mind if it's sitting in a rollover IRA, it's going to cause a pro-ration of a Backdoor Roth IRA if you do one of those each year. Maybe you just wait and don't do the conversion step of the Backdoor Roth IRA for three or four years, which is fine. But keep in mind that if it sits in a rollover IRA for a few years, it will cause pro-ration of any conversions that you do. It doesn't matter in the end. As long as you convert it all, it's all the same.
Dr. Disha Spath:
Can he transfer portions of it to the IRA and then convert it?
Dr. Jim Dahle:
It's all about the 401(k), right? If the 401(k) lets you do these partial withdrawals, if you're like, “OK, I want to convert $80,000 this year, let's pull $80,000 out of that old 401(k) into the Roth IRA and that's it, that's what we're going to do.” Great. The next year, you take another $80,000 out or whatever. Yeah, you can do that as long as the 401(k) allows it. They may say if you're going to take $80,000 out, you've got to take it all out. 401(k)s can have weird rules a lot of times.
But there are lots of opportunities in the military for some cool tax arbitrage stuff. When I got out, I had a bunch of tax-exempt money, after-tax money basically sitting in my TSP, and I pulled it all out along with all the tax-deferred money and then I put the tax-deferred money back in. Because you're not allowed to put tax-exempt money into the TSP. I still have a TSP in there, but I was able to get the tax-exempt money out and convert that to a Roth IRA. Lots of cool opportunities while you're in the military. Thanks for serving. There's a reason you're in the lower tax brackets; we don't pay you that well to be in the military. Thanks for being willing to do that for us and defend our freedoms.
Dr. Disha Spath:
Yes. Thank you so much.
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Milestone to Millionaire
#107 — Cardiologist Becomes a Millionaire
This cardiologist became a millionaire just 3 1/2 years out of residency. He shares with us his tips for how he achieved this milestone—live on less than you make, get rid of debt, and invest the rest. He said that managing your finances well in your early attending years can more than compensate for any financial mistakes made through the training years.
Sponsor: MLG Capital
Full Transcript
Intro:
This is the White Coat Investor podcast, where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high-income professionals stop doing dumb things with their money since 2011.
Dr. Disha Spath:
Hello and welcome to the White Coat Investor podcast. This is your host, Dr. Disha Spath, and I'm here with Dr. Jim Dahle. How are you, Jim?
Dr. Jim Dahle:
I'm doing great.
Dr. Disha Spath:
Good to see you. First, this episode is sponsored by Locum Story. Everyone has a story, different needs, wants, and goals, and how to attain them. Your story determines your solution. Whatever your solution and story, locum tenens should be part of that conversation.
Dr. Disha Spath:
How do you find out if locums is a good option for you? Go to an unbiased, informative source like locumstory.com. You'll learn all the ins and outs of locums, details on travel and housing, assignment coordination, tax information, and more.
Dr. Disha Spath:
You'll also hear first-hand stories from locums physicians from all walks of life, so you get a bigger picture of the diverse options. Get a comprehensive view of locums and decide if it's right for you at locumstory.com.
Dr. Jim Dahle:
Awesome. Well, welcome to the podcast, everybody. By the way, we're recording this the day before Valentine's Day, but as this drops on March 2nd, we are not at home. We're in Phoenix. This is WCICON week. So, I want to reflect that excitement even though we're not actually there yet. In fact, right now we're running around like chickens with our heads cut off desperately preparing for it.
Dr. Jim Dahle:
But as you hear this, it's basically day one of the talks at WCICON. My talk today is on spending in retirement. So, it's a great, great conference. You can actually still come. You can't come in person, although if you walked out, we might figure out a way to get you in. But you can still come virtually. You can sign up for that even today, wcievents.com. If you still want to come, you can come as a virtual guest to the conference.
Dr. Disha Spath:
I'm so excited. It's going to be sunny. We're going to have awesome speakers. Jim, you're going to be talking. Christine Bens is going to be there. We're going to have basically the who's who of Physician Finance there. I'm so excited to hear all the talks and the wonderful information that's going to be there. It's going to be awesome.
Dr. Jim Dahle:
And let's be honest, the networking and the relaxation and wellness and all that is just as good as the talks.
Dr. Disha Spath:
Looking forward to the wellness for sure.
Dr. Jim Dahle:
All right. Now, as we step away from that happy place, I want to talk a little bit more with Disha here, this time, about this comment, one of the comments we saw on the WCI survey this year. Now, we surveyed you guys and we love getting your feedback. I think we had 2,600 people or something answer the survey this year. And one of these comments, however, I think deserves a little bit more discussion. I mentioned it earlier in a Milestones podcast we did a couple of weeks ago.
Dr. Jim Dahle:
But the comment read like this. And this is where we're asking for constructive criticism. They said, “Content more relatable to divorced parents engulfed in debt. Related to divorce, domestic violence, and child custody battles. Content seems currently rose-colored and at times unrelatable to someone like me. But maybe it's not meant for people like me.”
Dr. Jim Dahle:
And that comment hit me pretty hard. I mean, obviously, we're talking about it twice on the podcast now. What are your thoughts when you hear that comment, Disha?
Dr. Disha Spath:
Well, let me start off with saying, obviously our content comes from a place of where we're at. And I will be the first to admit that we are very, very blessed. I have not gone through a divorce. I have kids and a family, and that comes with its own challenges. I can certainly appreciate that you may not be feeling as heard.
Dr. Disha Spath:
But I do want you to know that we do have content out there. I just talked to Monica Scudieri from Grab Your Slice about her divorce and how it changed her financial journey, how she really used that to get herself out of debt and all the struggles that she went through. So, we do try our very best to include stories like that. Even if we can't speak to it personally ourselves, I think it's very, very important that you and people like you feel included.
Dr. Disha Spath:
And you know what? All of us are probably going to be… If we're not going through it now, I'm sure the financial implications of it, it's very valuable knowledge for everyone. And we certainly want to include more stories like that. So, if there are people out there that would like to share their stories about child custody battles, about domestic violence, gosh, please reach out to us because we'd love to feature you and learn from your experience.
Dr. Jim Dahle:
Yeah, divorce is a terrible tragedy on so many different levels. Sometimes it's better to go through it than not to, but it's terrible financially. You're cutting your assets in half. Most docs are then cutting their future income in half, at least for a period like seven years. It depends obviously on that particular divorce agreement. So, it's devastating financially. Do it twice, and it's really devastating financially.
Dr. Jim Dahle:
But the truth is, we're all in a different place. And personal finance and investing is a single-player game. It's you against your goals. It's not you competing against the back surgeon down the street. It's not trying to somehow get a higher net worth than the dual physician family, two surgeon couple that you see at the hospital. That's not what it's about. It's about what you want and how you can get to that point.
Dr. Jim Dahle:
And so, we try to have content that fits everybody within the spectrum of income of our audience, which probably starts at about $100,000 a year with really no cap. There are certainly people who listen to the White Coat Investor that make millions of dollars a year. And we try to have content for them as well. But we also try to have content for the dentist, associate dentist who just came out who's making $120,000 a year. There are plenty of people like that in the WCI audience as well.
Dr. Jim Dahle:
And the other thing I've learned, and this is probably not so much through my work, as the White Coat Investor or my clinical work, but more through a lot of my volunteer work. What I've discovered is just about every family has got issues. Just about every family has got some dark secret in the closet. There's abuse all around us all the time. And if you feel like you're alone, you're the only one in that sort of a situation, I can assure you that you are not and that every family's got issues. And so, hang in there. It does get better. And as you're ready for content at the White Coat Investor, it'll be there waiting for you when you get to that stage of life.
Dr. Jim Dahle:
In the meantime, we'll try to create some more for those in these sorts of situations. And it might come down to something as simple as on the Milestone podcast, we'll celebrate any milestone. Maybe your milestone is getting back to the net worth you had before your divorce. That'd be a fun one we haven't done yet. Someone can come on and we can celebrate that with them.
Dr. Jim Dahle:
All right. Let's get into some listener questions here. The first one off the Speak Pipe today is from Andy. Let's take a listen to that one.
Andy:
Thanks for all that you do, Jim. My name is Andy, and I'm an urologist in the Midwest. I was calling about a solo 401(k) question. I'm in the highest tax bracket and I've been doing some side gig income this year as an expert witness and some surveys, and I've made about $15,000.
Andy:
I've opened up a solo 401(k) and I was looking at contributing to that this year. However, I have been doing the expert witness work at my house and I was thinking about renting my home office to myself for 12 days a year, which would cost with comparable numbers about $9,000 that would be deducted from my net income. However, this would lower my available contribution to my solo 401(k). Should I let the tax tail wag this investment dog, so to speak? Or am I thinking about this incorrectly? Thanks.
Dr. Disha Spath:
So what he's talking about is the solo 401(k). He can do employer contributions to the 401(k) up to 20% of the profits that he makes from his 1099 activity.
Dr. Disha Spath:
When he was talking the thought that came up in my mind was “Why not just deduct the home office?” But the caveat to that is that the home office has to be for exclusive use of your business. So, you're basically using that home office for that business. I'm not sure if he would qualify if he's only doing it 12 days a year. What do you think?
Dr. Jim Dahle:
Well, it depends. Does he use that space for something else? Because when you talk about the home office deduction, the two rules are regular use and exclusive use. So, you got to use it regularly. And the IRS doesn't define that. I don't know, is it once a month regularly? I guess.
Dr. Jim Dahle:
And exclusive means you don't use it for anything else. And that's usually the one that trips people up. I have very little space in my house and we have a place we built for WCI. And I'm not sure it's used exclusively. Portions of it I suppose are, but that's the hard one is exclusive use. Because everybody wants to use their whole house. You don't want to say, I'm only going in that room once a month. That's not a very helpful space in your house.
Dr. Jim Dahle:
But the big problem with the home office deduction, at least if you use the simplified version, is it's not a very big of a deduction. You can only take up to $5 a square foot up to 300 square feet. And so, that's $1,500.
Dr. Disha Spath:
Right. 300 square feet, which is $1,500. Exactly.
Dr. Jim Dahle:
Yeah. It's just not a big deduction. Whereas if you're renting your house to your business, that's a much larger deduction, especially given the value of most doctor houses. Now, if your work is reviewing charts, boy, that might be pushing it a little bit to rent out your whole house for that business. Now, the IRS doesn't require you to make good business decisions, but boy, that one might be pushing it a little bit. I'm not sure how comfortable I'd be with that.
Dr. Jim Dahle:
Now, we do this for WCI, but we also bring over a whole bunch of people and have a meeting. Those are the days that I'm writing this off, renting my house from myself where the business rents the house for myself. So, I'll leave that up to you whether you choose to do that or not. But certainly, that's going to be a heck of a lot bigger deduction than the home office deduction would be for you.
Dr. Jim Dahle:
But I don't think that's really your question. I think your question is “Are you better off never having that taxable income or having taxable income that allows you to make 401(k) contributions?” And I think the answer to that is you're better off not having taxable income.
Dr. Jim Dahle:
The best income you can get is money you don't have to pay any taxes on at all. And when you use a retirement account, you're going to pay taxes on that money. You either pay it an hour or you pay it later. And so, I think you're better off not having taxable income if you can come up with a deduction that you would be buying anyway. You don't buy stuff you don't need or that you wouldn't use anyway. But you're better off with that deduction than you are with more retirement account space. I mean, I'm a big fan of retirement accounts, but I think that's the way the mask is going to work out for just about any legitimate business deduction.
Dr. Disha Spath:
Cool.
Dr. Jim Dahle:
One other thing I think a lot of people in this sort of situation ought to consider, and it might not be worth it for a business that makes $15,000, that may be the case. But you can get a custom-designed solo 401(k). I'm talking about not one off the shelf at Vanguard or Fidelity or Schwab, but a custom designed one.
Dr. Jim Dahle:
So, you're going to spend a few hundred dollars getting it set up. You're going to spend $100 or $200 a year maintaining it, but you can get a plan design that allows you to make after tax contributions and in-plan Roth conversions, a.k.a the mega backdoor Roth IRA. And if you do that, you could put all $15,000 into a Roth account instead of just $3,000 into a tax-deferred account.
Dr. Jim Dahle:
And I think more people ought to think about that because that's probably the right answer for lots of people. A little more complex to deal with. A little bit more cost for sure, but certainly a good option. Plus soon people are going to be able to do Roth SEP-IRAs.
Dr. Disha Spath:
Roth contributions. Yeah.
Dr. Jim Dahle:
So you can just do a SEP-IRA and make Roth contribution there. But again, I think you're going to be limited to the $3,000 in your case if that's what you were doing.
Dr. Jim Dahle:
All right, let's take a question from John who sounds like he's got a similar issue, 1099 income and retirement accounts.
John:
Hi, Jim. I’m looking for help with a question that I cannot find the answer to and you've always given such great advice. I appreciate that over the years. Anyhow, I am an emergency medicine physician. I typically max out my 401(k) every year as well as a defined benefit plan, which is great. However, I've been doing some side hustles and I have some 1099 income.
John:
So my question is twofold. One, can someone that's just working as an individual with 1099 income set up something like a simple IRA or a SEP-IRA or do you legitimately have to have a small business LLC, etc?
John:
And then the second question is, is this going to be worth a headache? If I don't max out my 401(k) through my employer and instead let's say use a third of that funds to set up a SEP-IRA to have a separate piggy bank, if you will, to maybe invest in some alternative asset classes, like some of the real estate funds that you promote through your website.
John:
I was wondering if this would be a good thing or if it's just going to be a massive headache and more paperwork to go through and perhaps create some hurdles to doing things like the backdoor IRA and things like that. Anyhow, I’m just looking for advice on whether or not I should do this. So thanks so much.
Dr. Jim Dahle:
Wow. John, great question. There is a lot swirling around in that question. This is one of those things that we need to go out in the hallway and have a chat for 10 minutes about how this all works so it's nice and straight in your mind and then I think your decisions will be a lot easier. What would you say to him, Disha, in this conversation? Because this is going to take a while I think to touch on all these topics that he's mentioned.
Dr. Disha Spath:
Right. The first thing that came to my mind was you definitely don't need an LLC to start a solo 401(k) or a self-directed 401(k). The solo 401(k), you're a sole proprietor, you can get an EIN from the government and just start that solo 401(k) and start contributing there. And that would've been the advice from us prior to Secure 2.0.
Dr. Disha Spath:
But now that you can do Roth SEP contributions, the reason we would've said don't do SEP-IRA would be because that would put you in the pro rata rule calculation and all that money in the SEP-IRA would count against you in the pro rata rules if you're going to do the backdoor Roth IRA. But now you can do Roth contributions. So, that's going to change up our calculus a bit. Do you need an LLC for a SEP?
Dr. Jim Dahle:
No, you don't need an LLC. The other problem with this whole new Roth SEP-IRA thing is I don't know where to send anybody for one.
Dr. Disha Spath:
Right. They haven't really clarified that.
Dr. Jim Dahle:
I haven't seen Vanguard crowd anything out or Fidelity or Schwab. I mean, yes, Congress has authorized it, but nobody's offering one yet. So, it's not really an option yet, number one. I'm not sure it's better than a solo 401(k) for most people.
Dr. Jim Dahle:
You're absolutely right that lots of docs out there do not need an LLC. I don't know what your side gig is. You didn't mention whether you're just practicing medicine or what. But here's the deal. An LLC doesn't protect you from malpractice. So, you can't just incorporate your practice and somehow you can't be sued for malpractice personally, right? Malpractice is always personal.
Dr. Jim Dahle:
For someone who's just working as a hospitalist, they have no employees, they're just getting paid on 1099, they don't need an LLC. Yeah, it looks a little more official, but who are you trying to impress? They want you whether you're an LLC or not. And you don't need it for a solo 401(k). So, most of the time docs doing that sort of thing can just be a sole proprietor.
Dr. Jim Dahle:
And what you got to understand is if you're being paid on a 1099, you're in business. You are self-employed. You have a small business. The form of that small business is a sole proprietorship. So, don't kid yourself that you're not in business. You are in business. You can write off all your business expenses, you can go open a solo 401(k). Yes, you got to get an EIN, but that's free and it takes 30 seconds. I hope my daughter get one of those for a business she started the other day.
Dr. Disha Spath:
Nice.
Dr. Jim Dahle:
It's just not that hard. And so, you don't need an LLC. When you want an LLC is when you have liability in that business. Like when you're doing rental properties, that's a toxic asset. You want that in an LLC. Internal and external asset protection. And sometimes it looks a little more official to be an LLC, etc.
Dr. Jim Dahle:
The White Coat Investor wasn't an LLC originally. It was a sole proprietorship. And then it became an LLC. Taxed as a sole proprietorship, then it became an LLC taxed as a partnership. Then it became an LLC taxed as an S-corp. So there's all these different entities that there are different reasons you might want, but if you want to just keep things simple, sole proprietorship works very well and it's perfectly fine and you can have your retirement account with that. Okay. So, we talked about that.
Dr. Jim Dahle:
The other thing that doesn't seem to be straight in your head I think is how to choose a retirement account for your small business. And this is a lot easier if you don't have employees. The answer, as Disha mentioned, for a long time has been a solo 401(k). That's what you want. If you don't have employees, get a solo 401(k). It's especially important if you don't have a main gig whose 401(k) or 403(b) you're using to get that employee contribution. This year has $22,500 for those under 50.
Dr. Jim Dahle:
But even if you still have that, a solo 401(k) has been the right answer in the past because it didn't get prorated when you do your backdoor Roth IRA. Now, with this Roth SEP coming out, maybe that issue goes away because a SEP is a little easier to use than a solo 401(k). You don't have to file 5500 EZ once it gets to $250,000. It's a little bit less paperwork to set up. I don't even know if you need an EIN for a SEP. You might be able to open a SEP without an EIN. I think you can. But for the most part, solo 401(k) is the answer.
Dr. Jim Dahle:
So, who's using a simple IRA? A few people with employees use simple IRAs. It just makes sense for their particular practice, their particular business. But if you're a doc and you got no employees, don't use a simple IRA. It's a stupid plan. The contributions are low. You got to leave the money in there for two years before you can roll it out. You don't have those rules with a SEP-IRA. You don't have those rules with a solo 401(k).
Dr. Jim Dahle:
You don't have to set up a retirement account, though. It's not the only way you can save for retirement. You can always do it in a taxable account. Whether you put mutual funds in that account, whether you go invest in private real estate, whether you go buy properties down the street and rent them out, you can do all that outside of retirement accounts. You don't have to use a retirement account. And there's plenty of small medical practices with employees, dental practices where they do a study and they're like, “This doesn't make sense for me to implement a retirement account. I'm just going to save in taxable.” And they do. And that's perfectly fine.
Dr. Jim Dahle:
I think you have to have all those issues straight because all your questions are swirled up into one. And I think you got to divide them out to really answer the questions. In your case the answers are probably no, you don't need an LLC. You probably ought to use a solo 401(k). And that's probably about it for you. I think when you get to the end of it, that's probably the conclusion you will come to as do most docs.
Dr. Disha Spath:
Don't forget about the backdoor Roth IRA, which you can do with any earned income.
Dr. Jim Dahle:
Yes. Remember the proration though, right?
Dr. Disha Spath:
Right.
Dr. Jim Dahle:
No traditional IRAs, no rollover IRAs, no SEP-IRAs, at least tax deferred SEP-IRAs, no tax deferred simple IRAs or that conversion each year will be prorated.
Dr. Jim Dahle:
All right. Well, we often tell the docs, the lawyers, the engineers, the pharmacists, the high-income professionals out there, thanks for what they do. What I don't think we do often enough, and I know a lot of you out there listening are in this category, is thank the spouses and the partners for what they do. Because they're often sacrificing just as much, especially those of you who got in early. And what I mean by that are those of you who married us before we were making the big bucks, went all the way through undergrad and med school and residency and fellowship and suffered right along with us. You don't get thanked enough.
Dr. Disha Spath:
Absolutely.
Dr. Jim Dahle:
And that reminds me this other comment we got from our survey recently. And this person said, “I really want more conversations about decisions with dual learners and kids. I feel frustrated when at least in some WCI articles, male physicians are like, “I travel X weeks a month and play lots of golf and my family life is great without acknowledging that those choices are made possible by a stay-at-home spouse.
Dr. Jim Dahle:
As a mom, I am very aware that one week away by myself is very limited by the fact that my husband has a very full-time job that he isn't interested in quitting, dialing back at this time and we have two small kids. I appreciate that recently there have been a few more diverse voices, but still wonder if that dream of retiring, dialing back, traveling a lot, et cetera, is out of reach if you don't also have a full-time stay-at-home spouse.”
Dr. Jim Dahle:
What would you say to that commenter, Disha?
Dr. Disha Spath:
Well, I will definitely agree with you that it's tough having kids and two working spouses. I would caution you to whenever we post or write or anything on social media, on the blog or whatever, we're putting on some rose-colored glasses and looking at things from a very ideal perspective. In fact, I think my posting on social media goes up when I'm actually not going through a good time in my life but I'm trying to make myself feel better by focusing on the positives.
Dr. Jim Dahle:
I thought it was supposed to be the highlight role of your life. Isn't that what it's supposed to be?
Dr. Disha Spath:
It is highlight roles. Yeah. But I tend to post more highlights because I'm trying to just make myself feel better. Your life is good, stop being in the negative. But yeah, what you're seeing from the outside, it's curated. And we're choosing to focus on the positives, but everyone has their struggles.
Dr. Disha Spath:
This weekend, my kid got strep. I worked all week in primary care. I still have a ton, like over 200 labs to go through for that. I worked a full day as a hospitalist admitting and I was supposed to be writing my book and putting together a presentation for ACP and putting together my two presentations for WCICON and the host script. I still have to do that.
Dr. Disha Spath:
And it's just insanity at all times because my husband also works and he's sitting on his computer, I'm sitting on my computer. My poor child is playing with Legos by himself. Listen, nobody has it all together and it's a constant struggle. And if it looks like somebody has it 100% together and is telling you that, they're probably lying. So, don't worry.
Dr. Jim Dahle:
Amen to that. Here's the truth of the matter. A great deal of the success that Katie and I have had has been due to the fact that she took a pause in her career. When I was an intern, at the end of my intern year, we had our first child who's now 18, in her second semester of college now. And she stepped out of the working world and she stayed home and took care of home stuff, raising kids, keeping the family going, all that sort of stuff.
Dr. Jim Dahle:
And that not only allowed me to concentrate on my medical career, because I'm in the middle of residency at that point, but also permitted me to use time when I had it to work on WCI and build WCI. And so, I look at this comment, and I'm like, “Hey, did Katie write this?” Because we have had this sort of conversation very frequently about how when I'm not working, all of a sudden, I want to go on a trip. I want to go out and play. And she points out, “Well, when you're working, I'm also working.” Now she's working more than I am in WCI but this is when she was not necessarily doing that.
Dr. Jim Dahle:
And so, the truth of the matter is that high-income professional, whoever is out there doing all this work and the other person is taking care of business at home, you've got to take some time off just to cover their job so they can take some real time off. Katie's going on a trip this September. She's going to Africa, going to go climb Kilimanjaro, do some safari stuff. This is an all-girls trip.
Dr. Disha Spath:
Awesome.
Dr. Jim Dahle:
They're all going out to do this trip. It's going to be awesome. But what does that mean? That means I'm staying here and taking care of the kids. And it's a two-and-a-half, three-week trip. And I'll work a shift or two or three during that time. I'm working day shifts now. And so, when the kids get out the door, I can get over to the hospital or they can get themselves out the door, or I can have a friend help our youngest one get out the door to school and I'm back by the time she gets home.
Dr. Jim Dahle:
But the truth of the matter is, without making specific exceptions for those times, it's just not going to happen. And I think those of us who go to work with a high-income professional, we sometimes forget that. That some of your time off needs to be used to give that stay-at-home spouse a break.
Dr. Disha Spath:
Yeah, it's true. It's always a balancing act. Even if you have someone staying at home, you have to work with them. If you have that your spouse is working full-time, it's tough. There's never going to be enough time and there are always going to be reasons why you can't achieve your goals. But you've got to focus on the fact that when you believe, you can achieve something, that's when you achieve it. You have to believe it first.
Dr. Disha Spath:
So, focus on that goal, find that goal, and then work on the balance. The balance is never going to be perfect. The balance is consistently going to need to change day-to-day, depending on what's happening. We're going to be talking a lot about how to get that balance or maintain that balance. At the WCICON23 actually on Saturday is going to be all about burnout and balance. So, that's going to be awesome.
Dr. Disha Spath:
The truth of the matter is there's no such thing as finding perfect balance. It's just a matter of, it's a struggle, it's the journey. The journey is balancing these things and finding solutions that work for your family.
Dr. Jim Dahle:
Yeah. There's an advantage to having a dual income for sure. You make more money. A lot of financial stuff gets easier. You can pay off student loans faster, you can build a nest egg faster, all that sort of stuff. But there's also costs. Childcare is not the least of them. And there are a lot of things, a lot of benefits too to having a stay-at-home spouse, a stay-at-home parent as well, both financial and non-financial benefits.
Dr. Jim Dahle:
So, there's advantages both ways. Don't feel like the grass is always greener on the other side of the fence. It isn't always greener on the other side of the fence. I think I've mentioned it before. I work with two general surgeons, a husband-wife team. And I tell you what, when a kid gets sick, it's a major tragedy figuring out whose cases are going to get cancelled that day because someone's cases are getting cancelled.
Dr. Disha Spath:
Exactly. And especially in these COVID days where you don't want to expose the grandparents or anything. But I will say Josh stayed at home the first two years of our marriage and they were the two most difficult years of our marriage. It was the first, the second, and third but anyway, we decided…
Dr. Jim Dahle:
Because he was home or that's why he was home?
Dr. Disha Spath:
No, he was doing his master's and I was working full-time. We had a new-born and we were about to have another one. So, it made sense to just not do childcare for us and for him to stay at home and do his master's, but man, it was tough on him. As soon as I'd walk in, he'd be like, “Here are the kids, have fun. I'm taking some time off.” And I'd be like, “But I'm exhausted.”
Dr. Jim Dahle:
Yeah. Being a stay-at-home parent is not easy.
Dr. Disha Spath:
No, it's not.
Dr. Jim Dahle:
It's hard.
Dr. Disha Spath:
Yeah. I think we can balance better when we both work.
Dr. Jim Dahle:
I don't know if I could do it. I mean, now the kids are older, maybe I could, but when they're three, five and under, I don't know. That was a tough job.
Dr. Disha Spath:
It's tough.
Dr. Jim Dahle:
Okay. Let's talk some more about retirement accounts. That's what you guys call in questions about. You don't call in and ask us for our opinions on whether your spouse should stay at home or not. So, we'll talk about retirement accounts. Here's one from Leslie.
Leslie:
Hi, Jim. My name is Leslie. I'm a pediatrician in New York City. Thanks for all you do. My question is about 401(k) retirement plan that we have at my office. I'm a partner with another doctor, and then we have another maybe 30 employees. We've only had this 401(k) plan for five years before I even discovered White Coat Investor. And it's not a good plan. It's through John Hancock, and the options have high fees. Currently, I'm paying, or I believe we're all paying 1.5% per year in fees. I'm looking to switch us out and I just wanted advice on how to do that and where to get started. Thanks so much. Bye-bye.
Dr. Disha Spath:
It's all you, Jim.
Dr. Jim Dahle:
Wow. Well, I'm sorry you're in this situation. This is a really common situation. People become financially literate and they're like, “Oh crap, I've been ripped off.” In my case it was, I had a fee-based financial advisor. Not a fee-only, right? There's a difference. Fee-based means you're paying commissions too. I had a whole life insurance policy. This sort of stuff happens to all of us when we figure it out finally and we're like, “Ah, crap, I'm paying 1.5% expense ratios.” I had a bunch of actively managed mutual funds I had to get rid of.
Dr. Jim Dahle:
This happens to everybody. So, don't beat yourself up about it. But yes, you want to change. You need a different plan in that practice for a couple of reasons. Number one, you want your money to grow faster so you can retire someday. Maybe that's the most motivating thing for you.
Dr. Jim Dahle:
But there's another reason you need to fix that plan. And that is that you have a fiduciary duty to your employees to provide them a good retirement plan. And this is not a good retirement plan. You are breaching your fiduciary duty and they can sue you for it.
Dr. Disha Spath:
Don't scare her. She already wants to switch.
Dr. Jim Dahle:
I know. Isn't this crazy, right? She just figured this out, and now all of a sudden she's got all this liability she didn't even know she had. So yeah, you got to get this changed. They're probably not going to sue you, especially if you're making changes, but they could is my point.
Dr. Jim Dahle:
So, here's how you do it. You've got employees, I assume, right? Because if you don't have employees, you just go get a solo 401(k). If you have employees, you need to get a study of your practice. A study of your business. And the study is essentially to help you decide what kind of 401(k) to put in place or whether to put a SEP-IRA in or a simple IRA or no plan at all. Those are basically the choices that you come down to.
Dr. Jim Dahle:
And who does that? Well, professionals do that. This is not a do-it-yourself project once you have employees. You need help. You need a team that basically puts together the plan. It includes a third-party administrator. It includes an actuary, usually. It includes a record keeper. There's a custodian for the assets because you're not going to hold onto them personally. And there's often an advisor, sometimes an advisor that helps share that fiduciary duty with you.
Dr. Jim Dahle:
But anyway, the way you do this is you go to whitecoatinvestor.com, you go to the recommended tab, you scroll down to where it says retirement accounts and HSAs. And on that page, you'll find four or five companies that do this. This is what they do. They come in and they study your practice. They study your business, figure out what your goals are, what you want, help you choose between those retirement accounts and implement one.
Dr. Jim Dahle:
These are companies like iQ401k, that's FPL Capital Management. Wellington Retirement Solutions with Tapke Asset Management and Perion, CarsonAllaria Wealth Management. These companies. And when we put in the WCI 401(k), this is who we went to. We went to these companies and they helped us design it and we had to choose one of them eventually. But these are the companies we go to because this is what they do all day long.
Dr. Jim Dahle:
And you'll find that upfront it seems like it costs a little bit more because these John Hancock folks are like, “Oh, there'll be no charges to set this up.” Well, the reason there were no charges to set it up is because the fees are all under the table. They're charging you expense ratios of 1.5% instead of 0.05%. That's where they're making all their money. And in the long run, it's going to cost you a whole lot more.
Dr. Jim Dahle:
So, better to spend a few thousand dollars to get it set up, maybe a few hundred or even a few thousand a year to keep it going. But you can pay for that out of the practice. You can pay for it with pre-tax money rather than have it be constantly eroding your account value. So yeah, you need to go get a new 401(k). Sorry, that'll be a little bit of work. It's not too bad though. Lots of other people have done it before you, you can do it too.
Dr. Disha Spath:
And seriously, great job on learning this stuff and then identifying the problem and you're already fixing it. It's awesome.
Dr. Jim Dahle:
Yeah, for sure. You got to fix this stuff at some point.
Dr. Disha Spath:
Yeah.
Dr. Jim Dahle:
All right. It's February as we're recording this. January and February around here are like non-stop backdoor Roth IRA questions. So, I think here's another one from Sophie that's come in recently.
Sophie:
Hi there WCI team. My name is Sophie Herbert and I'm 54. I have an IRA backdoor question. On December 15th I contributed $7,000 from my Wells Fargo bank account into a traditional Fidelity IRA. Then on December 22nd I converted that $7,000 and 2 cents actually to the Roth IRA.
Sophie:
Today, January 13th, 2023, I just realized that there's an interest earned at BIC insured deposit at Wells Fargo, QPI RQ for $3.17. Not sure what to do with that. If you can give me a little insight because I know you just said in your tutorial that anything not done in the calendar year can be a little bit more complicated into the 8606 form. So, contribution and conversion should be done in the calendar year, which I’m not sure what to do with that $3.17. Any insight will be absolutely welcomed. Thank you for your time. You guys are awesome and happy New Year.
Dr. Jim Dahle:
I guess we got a little bit of a lag. We still got Happy New Year's running in March 2nd.
Dr. Disha Spath:
Still New Year problems.
Dr. Jim Dahle:
This is the pennies in the backdoor Roth IRA issue. And this has got to be, I don't know, a third of the questions we get about backdoor Roth IRAs. Guess what? Accounts are paying interest again. And so, when your money makes money, there's money left behind. If you put $6,000 in a traditional IRA and it sits there for a week before you convert it to a Roth IRA, it's going to earn some interest. And it used to be that was like 37 cents and you just ignored it. Now, it's like $4 and it actually causes you to be prorated. It's not that big a deal to get prorated on $4.
Dr. Jim Dahle:
But the easiest way to deal with it is when you see that money left behind in the account, it’s just to convert that as well in the same calendar year. So, you put it in the traditional IRA on December 15th, you move it to the Roth IRA on December 22nd. On December 28th, you see, “Oh, there's $4 in there” and you move that into the Roth IRA too. I think that's probably the best way to deal with this sort of thing. Obviously, it's too late for this person to do that and so this person's going to be prorated. Now, that's not a big deal because it's only $4.
Dr. Disha Spath:
Wait, hold on. I think what she said was she transferred from Wells Fargo to Fidelity for her IRAs and then she got some interest payment into Wells Fargo.
Dr. Jim Dahle:
Oh, well, that's no big deal, if it's not in the IRA. So, you made some interest in your bank account. That's great. Congratulations.
Dr. Disha Spath:
Yeah. Yeah. I don't think that's going to matter to the pro rata rule.
Dr. Jim Dahle:
Yeah, it won't. I can't tell exactly what kind of account she's got the $4 in, whether that's an IRA at Wells Fargo, whether she misspoke and it's the IRA at Fidelity, which is the way we usually get this question, or whether it's just not an IRA at Wells Fargo, in which case, well, you made $4 in interest, congratulations. You'll have to pay taxes on that interest, but that's it.
Dr. Disha Spath:
Yeah. If that's just simple interest in your savings at Wells Fargo, that'll just be taxed at your regular tax rate. And yeah, you'll get a form for it at the end of the year. That shouldn't be a big deal at all. And I don't think that should come into your pro rata calculation at all.
Dr. Disha Spath:
Now, if it's at your traditional IRA and you just had a little bit of interest in between, I think you said you contributed $7,000 and then you converted $7,000 and 2 cents. That should not be a big deal at all. That rounds down.
Dr. Jim Dahle:
Yeah, that's what it used to be. It used to be nobody made any interest because the money market funds and the IRAs paid anything. So they really didn't have to worry about it. Now, it actually pays something. So, you get a few bucks.
Dr. Jim Dahle:
But here's the deal. Being prorated is not illegal. It's not that bad. A little tiny proration, right? You put $7,000 into an IRA, you convert it to a Roth IRA and you leave $4 behind. Yes, you're going to get prorated, but the consequences are nothing. Whereas if you had a $400,000 SEP-IRA and then you put $7,000 into a traditional IRA and then move that $7,000 to a Roth IRA. You thought you were putting after-tax money into that Roth IRA, you weren't. It was almost all pre-tax money and you're going to pay taxes on that Roth conversion because you got prorated. That's a much different story than if you're leaving behind $4 in your traditional IRA.
Dr. Jim Dahle:
And so, it's important to understand how the math works on the proration. You can see that as you work your way through form 8606. But not that big a deal if it's just a few bucks.
Dr. Jim Dahle:
By the way, all of you first year medical and dental students, if nobody has handed you the White Coat Investors Guide for Students yet this year, you need to sign up to be the champion for your class. You have until March 17th, that's the last day. And all you have to do as the champion, seriously, all you have to do, you give us your mailing address, we send you a few boxes of books, you pass them out to your class. That's it. That's the whole commitment. Hey, it's no big deal. You can sign up whitecoatinvestor.com/champion.
Dr. Jim Dahle:
We're hoping to distribute a copy of that to every first-year medical and dental student in the country. Last I checked, and it's been a few weeks since I checked, there were still a hundred schools in the country that do not have a champion for this year. So, if you haven't gotten a book that's because your school doesn't have a champion and we can't just ship them to the school. We need to ship them to an individual. So, please sign up.
Dr. Disha Spath:
That's awesome. I wish somebody had handed me a how-to guide to get my stuff together financially as a student. Oh my God, that would've saved me so much money.
Dr. Jim Dahle:
Yeah. I think this might be the most impactful thing we do at the White Coat Investor, quite honestly. Everyone's like, “Oh, why didn't I learn this earlier? Why didn't I learn this earlier?” Well, when would you like to get this information? As a first year. So, let's get it to you then. We're trying. We're trying, but we need your help.
Dr. Jim Dahle:
Okay. Another Backdoor Roth question. This one from Mark.
Mark:
Good evening, Dr. Dahle. My question relates to funding a backdoor Roth IRA. My wife and I are two business professionals with high incomes. Every year we max out both our 401(k)s and our backdoor Roth IRAs. We would like to save 20% of our salaries so we first fill the 401(k)s, then the IRAs, and lastly, a taxable brokerage for any overage. In years past to fund the backdoor Roth IRA, we built up $13,000 throughout the year in the savings account and on January 1st, would do the backdoor Roth IRA.
Mark:
Rather than have that money sit in a savings account for the entire year, would I be better off to invest that money in the taxable brokerage account throughout the year and then sell $13,000 every January to fund the backdoor Roth IRAs? If so, does it make sense that I should be selling the assets with long-term capital gains? What are the implications if I sell a loss as I would've had to do this January? Thanks.
Dr. Jim Dahle:
All right. What do you recommend to him?
Dr. Disha Spath:
Well, I can tell you, we don't invest the money we're going to be putting into a Roth IRA at the beginning of the year just because it's too much headache. And also, anytime you put money into a brokerage account, you take the risk of loss. And I don't want to lose that money. I want to invest it. I believe strongly in investing with a time horizon in mind. And I don't usually put money in a brokerage account that I need in like a year or less than a year.
Dr. Jim Dahle:
Yeah. Here's the deal. You're doing a backdoor Roth IRA. So, if you have to do your Roth IRA through the backdoor, it means you're making at least what? A couple hundred thousand dollars. You're saving, you said 20%. You're saving at least $40,000 or $50,000 a year.
Dr. Jim Dahle:
What's a monthly savings amount for somebody that's saving that sort of money? And maybe it's more, I don't know, that's like the minimum amount you're making because you're telling me you have to do a backdoor Roth IRA. So, in reality maybe you're saving $100,000, I don't know.
Dr. Jim Dahle:
But the point is, every month you're probably saving at least $6,000 or $7,000. Maybe your monthly savings for January goes into her backdoor Roth IRA. And maybe your monthly savings for February goes into his backdoor Roth IRA. And maybe your monthly savings for March through August go into the 401(k)s and your monthly savings for September through December go into the taxable account.
Dr. Jim Dahle:
Now, that's kind of how our savings look. It's not as easily automated. But by the time you're having to do your Roth IRA contributions through the backdoor, you're kind of past the automation point. You've already got complicated finances.
Dr. Jim Dahle:
I wouldn't necessarily be putting $500 a month toward the IRAs. Come on. You make $200,000 plus, you can put it all in at once. You make enough money to do that. And so, I would encourage you to not be saving up for these Roth IRA contributions over the course of the year, but to use the money that you are ready to invest then to make the Roth IRA contribution. And I think that'll work out better for you.
Dr. Jim Dahle:
If you choose to do this, if you choose to put $500 a month away and put it in the taxable account, then yes, it's good to have long-term capital gains, meaning something you've had for at least a year. Obviously, you're going to pay a lower tax rate on that, but you're also more likely to have more significant gains. And so, those are kind of offsetting factors.
Dr. Jim Dahle:
I don't think most people do what you're talking about doing, though. I think most people do what Disha and I do. Either have it in cash, you're saving it up in maybe November and December in cash and just let it sit in cash. So, you put it in the Roth IRA or this is just the money that you invest for January that's going into the Roth IRAs. And I hope that makes sense.
Dr. Jim Dahle:
Okay. Let's talk about Roth versus traditional. This one's from Tim.
Tim:
Hi Jim, this is Tim in Salt Lake City. I had a thought about the age-old question of investing in Roth versus traditional tax-deferred accounts. We normally think that tax-deferred accounts make sense if you will be paying a lower marginal tax rate in retirement than you are in your working years. And I imagine that's usually the case, but I was wondering if there's another reason why people might generally prefer to use tax-deferred accounts.
Tim:
If your income drops before retirement age, maybe due to disability or decision to work less, then it seems good insurance to have a good tax-deferred account because now you'll be able to draw on that money potentially before retirement age through all the various means that you can do so at a lower marginal tax rate.
Tim:
I wonder if some people get hooked on the idea of tax-free withdrawals from Roth, but then don't end up benefiting that much from them because they end up needing their retirement funds early when they're at a lower marginal rate. So, do traditional retirement accounts, tax-deferred accounts serve as a sort of insurance against a drop in income earlier in life? Thanks for your thoughts.
Dr. Jim Dahle:
I think Tim, from Salt Lake City used to be Tim from San Francisco. I think we've had lots of his questions on the podcast over the years. But it's good to have you here locally, Tim. It's good to have you. Your comment feels like less a question and more a pontification, which is probably right. What do you think about that as one of the reasons to use tax-deferred accounts, Disha?
Dr. Disha Spath:
Yeah. I think that's the right way of thinking. The Mad Fientist has a post on Roth conversion letters because that's kind of the strategy he used to retire early. I think he retired in his 30s. He does the FIRE lifestyle so his living expenses are low. And so, he converts his pre-tax to Roth once a year to take advantage of those pre-tax dollars at a lower income. And certainly, that's a strategy that a lot of early retirees use to get more Roth money into their accounts when they retire early.
Dr. Disha Spath:
I'm not sure. If you actually wanted to withdraw the money from pre-tax, you would still have to pay penalties. But it's a good way to get more Roth money anyway to do those conversions.
Dr. Jim Dahle:
Yeah. Roth is the sexy one, right? Everyone loves Roth. Tax-free. Who doesn't want tax-free income in retirement? Certainly, if you got to inherit $100,000 in a traditional IRA or $100,000 in Roth IRA, you'd rather inherit the $100,000 in the Roth IRA, no doubt about it.
Dr. Jim Dahle:
But it is true that there are times and places where tax deferred is the right answer. And for a very high earner, let's say somebody that's in one of the upper brackets, 35%, 37% bracket or whatever that has no retirement savings, tax-deferred is almost surely the right answer for you because you don't have that much in retirement.
Dr. Jim Dahle:
So, there's not going to be that much coming out of these retirement accounts filling up lower brackets. And so, it makes a lot of sense for everybody to start the retirement savings with tax-deferred accounts when you're in those upper brackets, because you're almost surely going to get that money out at a lower tax rate than what you're saving when you put the money in.
Dr. Jim Dahle:
And if something bad happens to you, you get disabled, you don't work as long as you think you're going to work, your income drops, whatever, then yeah, you're really happy you did tax deferred instead of prepaying those taxes at 35% or 37%.
Dr. Jim Dahle:
Now, as you go throughout your career, you become wealthier and wealthier and all of a sudden you realize, “Wow, I got a ton of money and everything I take out of retirement accounts now in retirement is going to be in the top bracket.” Well, you're kind of to the point where you've got a super saver problem and those people ought to be doing Roth all the time.
Dr. Jim Dahle:
But for the most part, early on and during your peak earnings years, the answer is going to be tax-deferred accounts for most people. There's a reason it's the rule of thumb. Now, are there all kinds of exceptions we can all come up with? Yes, there are exceptions. And if you're an exception, do Roth. But this is like the anti-exception, right? This is someone who is a high earner for five or six or seven years and then is done. Yeah, man, tax-deferred is the way to go for you for sure.
Dr. Disha Spath:
Absolutely. I totally agree.
Dr. Jim Dahle:
All right, our quote today is from Paul Samuelson. He says, “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.” Why is that so hard to remember? People forget that. They want their investing to be exciting and an exciting investing is usually bad investing.
Dr. Disha Spath:
It's because of Hollywood. Apparently, all investors are dealing and waiting for the bell to ring at Wall Street and making 5,000 calls according to Hollywood, right?
Dr. Jim Dahle:
Last night was the Super Bowl. So, I watched the Super Bowl and I noticed there were no ads for crypto at the Super Bowl this year.
Dr. Disha Spath:
Yeah. Surprisingly.
Dr. Jim Dahle:
Yeah. That's what happened to exciting investments. They sponsored the Super Bowl last year and this year there's nothing. I think one of the college football bowl games was a crypto bowl as well. And that didn't happen this year either. So, exciting investments are exciting. They do tend to come and go. They don't tend to be good in the long run.
Dr. Disha Spath:
We might get trolled by a whole bunch of crypto people on Twitter. I'm just saying. After this drops.
Dr. Jim Dahle:
Yeah. Exactly. Well, I'm not sure which is worse. Getting trolled by the crypto bros or getting trolled by the whole-life salesman. But we get both all the time.
Dr. Jim Dahle:
All right. We've got a military doc, Ryan. Thanks for your service, Ryan. Let's see how we can help you.
Ryan:
Hi, Dr. Dahle. I have Roth and 529 questions for you. I'm a military doc in my early 40s PCSing this summer, at which time my wife will be leaving her clinical pharmacist job. This year, we are in the low end of the 24% tax bracket and will dip into the 22% tax bracket for the next three years while my wife isn't working.
Ryan:
When I retire and get a real job in four years, we will be in the 32% or 35% bracket. Before we PCS, we will max out her non-matched 401(k), which will have about $75,000 at that time. We plan on rolling all of her 401(k) into Vanguard within the 60-day limit to ultimately end up in her Roth IRA to grow tax-free for at least 16 to 20 years. Could you let us know whether or not this needs to be done all at once into her Roth or can we use a rollover IRA to spread out the backdoor taxes over 2023 and 2024?
Ryan:
Finally, we have a single 529 in my wife's name that we plan on using for our two children as well as one semester of tuition for our six nieces and nephews by changing the beneficiary every one to two years. Knowing we have one Post-9/11 GI Bill for our two kids and that all these beneficiaries are at least to four years apart in age, is this approach wrong? And instead, should we open additional 529s allocated to each child? Thank you so much.
Dr. Jim Dahle:
What the heck, man? You just fit an entire financial plan into a minute and a half. Which piece of that you want to take, Disha? Because there's about six pieces I think we need to talk about.
Dr. Disha Spath:
There's some rules here that I'm not familiar with. He said the required six-month window for the rollover. Does he have to roll everything over into an IRA?
Dr. Jim Dahle:
The 60-day window. Here's the deal. Never do a rollover. Technically a rollover is when you take possession of the money and then you've only got 60 days to get it into the other account. Whether the other account is a rollover IRA or a Roth IRA or some other 401(k), whatever it is, you only got 60 days. And if you botch it, it's like you just took the money out of the retirement account and you got to pay the taxes due plus penalties if you're under 59 and a half.
Dr. Jim Dahle:
So, that is not the good way to do these transfers. What you want to do is just contact the institution that it's going to and have them pull the money over directly. So, you're doing a direct transfer and not actually taking possession of the money. They might take longer than 60 days, hopefully not. It usually happens in about three weeks, but then you never take possession of it.
Dr. Jim Dahle:
So, you don't have to worry about the 60-day time limit. You don't have to worry about the fact that you can only do one a year. And you won't get burned having to pay penalties. So, always do direct transfers. The only reason anybody would ever purposefully do a rollover would be if they're trying to use that money in between.
Dr. Jim Dahle:
And I've seen some crazy people try to close a real estate transaction using that money during that 60-day period. And you can imagine what happens when your closing gets delayed or the mortgage doesn't come through or there's a hold up with the inspection or whatever, and now you're caught holding the bag paying penalties. So, don't do that. 60 days is not a long enough time period, but that's what he's talking about.
Dr. Disha Spath:
Oh, okay. I didn't know if it was like a military-specific rule or not.
Dr. Jim Dahle:
No, that one applies to everybody.
Dr. Disha Spath:
That's good to know actually, because I've rolled over a couple of retirement accounts now and the direct transfer was never an option that I was told about.
Dr. Jim Dahle:
That's weird. They always wanted to send you a check?
Dr. Disha Spath:
Yeah. And then it was a complete headache because then I get a check and then the next institution would want a different form and then blah, blah, blah. And the form didn't have the right information, which Secure 2.0 now fixes, that form has to be standardized, but doesn't go into effect till 2025, I think. But yeah, that's great information. Thank you for sharing that.
Dr. Jim Dahle:
Yes, for sure. All right. I don't know where to start with all those questions. I guess we could talk about the 529s to start. Do you put it all in one 529? I don't do that. I've got a gazillion 529s. I've got 34 nieces and nephews and I have a 529 for every one of them as well as one for each of my kids. I don't have one for my spouse and I don't have one for me.
Dr. Jim Dahle:
The nice thing about putting it all into lower generations originally is there's not later this weird gift tax stuff you might have to worry about if you have an estate tax problem and when you move it to that generation. So, I just started with the next generation. I think that's a good place to start your 529s.
Dr. Jim Dahle:
In Utah, we get a tax credit of 5% basically, whatever we put in a 529. But there's a limit. You only get it on the first $4,000 that goes into an account. And so, it would be stupid for me to put it all into one account. Then I'd only get a tax credit on the first $4,000 that went into that account. Whereas if I spread it about among 38 accounts, then I get it for the first $4,000 that goes into each of those accounts.
Dr. Jim Dahle:
And so, I'm a big fan of not putting it all in one 529. I don't know why you'd want to do that. I guess it's only one account to manage, so that's nice. But it's not like these are hard-to-manage accounts. They're kind of set it and forget it. So, I don't know that I would do that. Do you have 529s for your kids, Disha?
Dr. Disha Spath:
Yeah, absolutely.
Dr. Jim Dahle:
Do you have one or do you have multiple?
Dr. Disha Spath:
No, I have one for each. Yeah.
Dr. Jim Dahle:
One for each. Yeah. I think that's the way most people do it.
Dr. Disha Spath:
Yeah, it's pretty easy. But I'm not sure, he said he had an account for his wife. I'm not sure that already has money in it that they're trying to figure out.
Dr. Jim Dahle:
Yeah, it sounds like this is what he's got is this account for his wife and then the plan is to later change the beneficiaries, split it into multiple accounts. Which I don't know, maybe it came from her parents.
Dr. Disha Spath:
Yeah.
Dr. Jim Dahle:
529s haven't been around that long. So maybe that's what it is. If that's what it is, then you're kind of stuck dividing it up at some point. Whether you do it this year or next year or whenever. I guess it doesn't matter. But if you're starting these accounts, just start them for the next generation.
Dr. Jim Dahle:
I get these people who are like, I don't know, they're just really worried about this or something and they start them before the kids are born. They're like, “We might have kids someday, let's start a 529. I'll put it in my name and I'll front-load it. I'll put five years' worth of contributions into it and then later we'll change the beneficiaries.”
Dr. Jim Dahle:
Come on. You got 18 years to save up for college. It's not that expensive. If you have the money now to front load a 529, you're not going to have any trouble saving up for college for these guys. Even if they go to Harvard and even if they go to dental school afterward, you're going to have enough money.
Dr. Jim Dahle:
So you can wait until they're born and a few more weeks until you can get a social security number for them and open them with them as the beneficiary from the beginning. If you want to front-load them then for five years, that's okay with me. But just starting them before they're born, I think is just nonsense. Go save in your taxable account. The money will be there. I mean, congratulations, if you're that wealthy that this is even an option for you. Because when my kids were born there was no way I could put money in a 529 for them.
Dr. Disha Spath:
Nope.
Dr. Jim Dahle:
About 90% of the money that went into their 529s has gone in the last three or four years I think. We just didn't have the money. And I think that's the way most people are.
Dr. Disha Spath:
Yeah. We were too busy paying for my school still three years later.
Dr. Jim Dahle:
Yeah. And we got student loans. What else was he asking about? He was asking about Roth conversions. And so, here's the deal. You're in the military. We talked earlier about tax-deferred versus Roth. And the general rule of thumb is in your peak earnings years, you want to use tax-deferred. Other years you want to use Roth.
Dr. Jim Dahle:
Well, it doesn't sound like you're in your peak earnings years yet. It sounds like you're going to get out of the military and make more money later. And so, that means everything you're doing now should be Roth. And that's the general rule for most military members. It was such a lame thing when I was in.
Dr. Jim Dahle:
We had the TSP. TSP is great. At that time it was the cheapest 401(k) in the country. Even Vanguard and Fidelity didn't have these super low cost expense ratios. I think the expense ratio at one year in the TSP was like 0.025 or something. It truly was the cheapest one in the country, but they didn't have a Roth option the whole time I was in.
Dr. Jim Dahle:
That didn't come until after I got out, which was a real tragedy because military members often will have a pension that fills up those lower brackets, number one. Number two, they're not taxed that high. A good chunk of your pay is allowances. There's basic allowance for housing, basic allowance for subsistence, that's not taxed. When you get deployed, a big chunk of your income isn't taxed.
Dr. Jim Dahle:
Most of them, if they're smart, have chosen a state that doesn't have a state income tax, so they're not taxed. So, of course you want to use the tax-free account. Military members almost always should be 100% Roth all the time. If they have some tax-deferred money, they probably ought to convert it, which you are doing. So, kudos to you. That's the right move. You do want to do a Roth conversion.
Dr. Jim Dahle:
How long do you want to spread it out over? That's up to you. It is reasonable. If it's a big conversion, just spread it out over two or three or four years, that's fine to do. Keep in mind if it's sitting in a rollover IRA, it's going to cause a proration of a backdoor Roth IRA if you do one of those each year.
Dr. Jim Dahle:
And so, maybe you just wait and don't do the conversion step of the backdoor Roth IRA for three or four years, which is fine, or whatever. But keep that in mind that if it sits in a rollover IRA for a few years, it will cause proration of any conversions that you do. It doesn't matter in the end. As long as you convert it all, it's all the same.
Dr. Disha Spath:
Yeah. Can he transfer portions of it to the IRA and then convert it?
Dr. Jim Dahle:
It's all about the 401(k), right? If the 401(k) lets you do these partial withdrawals, if you're like, “Okay, I want to convert $80,000 this year, let's pull $80,000 out of that old 401(k) into the Roth IRA and that's it, that's what we're going to do.” Great. And the next year you take another $80,000 out or whatever. Yeah, you can do that as long as the 401(k) allows it. They may say if you're going to take $80,000 out, you got to take it all out. 401(k)s can have weird rules a lot of times.
Dr. Disha Spath:
That's true. It's very different.
Dr. Jim Dahle:
But there's lots of opportunities in the military for some cool tax arbitrage stuff. When I got out, I had a bunch of tax-exempt money, after-tax money basically sitting in my TSP, and I pulled it all out along with all the tax-deferred money and then I put the tax-deferred money back in. Because you're not allowed to put tax-exempt money into the TSP. And so, I still have a TSP in there, but I was able to get the tax-exempt money out and convert that to a Roth IRA.
Dr. Jim Dahle:
So, lots of cool opportunities while you're in the military. Thanks for serving. There's a reason you're in the lower tax brackets because we don't pay you that well to be in the military. So, thanks for being willing to do that for us and defend our freedoms.
Dr. Disha Spath:
Yeah. Thank you so much.
Dr. Jim Dahle:
All right. Well, I think we're out of Speak Pipe questions. Is there anything else you're feeling like telling the audience today, Disha?
Dr. Disha Spath:
Keep your head up, shoulders back. You've got this and we can help.
Dr. Jim Dahle:
Yeah. I like that, I like that.
Dr. Disha Spath:
It's a good ring.
Dr. Jim Dahle:
All right. Well, we should tell you about Locum Story. I like Locum Story. They're one of my favorite advertisers because they seriously sell nothing. You go to the website and you're like, “Who's even sponsoring this?” You have to look around and figure out who's sponsoring it. But it's just answers to your questions.
Dr. Jim Dahle:
Maybe you're curious about locums and how it might fit into your career story, but do you know all the different reasons physicians choose locums and how it works for them? At locum story.com, you can hear first-hand stories as diverse as physicians themselves.
Dr. Jim Dahle:
There's not one solution for everyone. The variety of opportunities might surprise you. Locum Stories is an unbiased educational resource, has tools that let you explore trends in your specialty and compare different locums agencies. There's even a simple quiz to see if locums is right for you. Do your own research at locumstory.com. It's easy.
Dr. Jim Dahle:
All right. Thanks for those of you who've been leaving us a five-star review, telling your friends about the podcast. We've got a recent one from Mindy Goo, just this month actually that said, “Great podcast. Super informative and helpful podcast. I just saw the link for Pearson Ravitz, one of the advertisers on the website. I really thought he had been saying Pearson Rabbits.”
Dr. Disha Spath:
Oh, no.
Dr. Jim Dahle:
I guess I need to pronounce myself a little bit better. But we do appreciate the five-star review, so thank you for that and for spreading the word about the White Coat Investor.
Dr. Disha Spath:
Yeah. And sorry to Stephanie.
Dr. Jim Dahle:
Well, for those of you who are at the conference, you're probably not listening to this. You're probably sitting in a conference class or out by the pool or something. We do want to meet you while you're here. Come see us. And for those of you who are not at the conference, you can still come virtually if you want. Sign up at wcievents.com.
Dr. Jim Dahle:
Otherwise, we'll try to package it up in a few weeks and you can get a hold of that content along with CME. Use your CME fund to buy that. And otherwise, we'll tell you all about it in one of these episodes after we come home from the conference. So, thank you for listening. We'll see you next time on the White Coat Investor podcast.
Dr. Disha Spath:
Keep your head up, shoulders back. You got this, and we can help. Have a good day.
Disclaimer:
The hosts of the White Coat Investor podcast are not licensed accountants, attorneys, or financial advisors. This podcast is for your entertainment and information only. It should not be considered professional or personalized financial advice. You should consult the appropriate professional for specific advice relating to your situation.
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