The Truths About Index Fund Investing (According to Vanguard)

Transcription – WCI – 467

INTRODUCTION

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. Jim Dahle:
This is White Coat Investor podcast number 467.

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THE TRUTHS ABOUT INDEX INVESTING ACCORDING TO VANGUARD

Dr. Jim Dahle:
All right. I wanted to spend a few minutes today, before we get into your questions, talking about a paper that came out from Vanguard that I think is pretty important. They titled it Setting the Record Straight: The Truths About Index Fund Investing. It's a 16-page white paper, and I think it's important for people to understand what it says.

In the introduction, they say, despite indexing's universal benefits, the continued popularity of index funds among nearly all types of investors across all markets has given way to debates between staunch proponents of passive investing and those of active investing, as well as some notable misperceptions tied to indexing's growth.

And while the active versus passive debate may further ebb and flow as the ever-evolving investing landscape shifts, the binary labels of index and active remain less significant than the underlying characteristics of the funds themselves that determine fundamental principles of both indexing and active investing.

I think that's an important thing to understand, is why index funds work. And then you can apply the principles that make index funds work to whatever investment you're looking at, whether that's in private assets of some sort, something where you can't buy an index fund, or whether you're investing in boring old stocks and bonds.

So, what are the benefits of index investing? Number one, diversification. If you go buy a total stock market index fund, you're getting, I don't know, 3,500 or 4,000 different stocks. You buy a total international stock market index fund, you're getting 8,000 stocks. You're diversified. If one of them goes bankrupt, you're not going to be hurt very badly. Even if it's Nvidia or Microsoft or one of these top names in the index, it's still not going to hurt you that badly. It's just not as big a deal when you're diversified. So that's the first key benefit.

The second key benefit, and this one's a really important one to understand, is the low costs. The main reason index funds beat actively managed funds is they're cheaper. It isn't that you can't beat an index. They can't do it after accounting for the cost of doing so. You got to hire all these people on fancy computers and send analysts out to check everything out. And after you pay for all that, you can't overcome your own costs of doing that on average. And so that's why over the long run, indexing works.

The third benefit is consistent relative return predictability. You don't have to worry about your manager underperforming the market. You're getting the market return every year, every month, every week, every day, every decade. You're going to get the market return. So, you can quit worrying about whether you're underperforming the market or not. You just get the market return. And so, you literally don't have to watch your managers anymore. I think there's some benefit to that.

The fourth one is potential for tax efficiency. And it's not because something magic happens with index funds. They just have low turnover. And when they're not buying and selling stocks all the time, it's a low turnover fund. Like a total stock market index fund usually has a turnover of like three or 4%. That's it.

Whereas an actively managed fund, it's not unusual to have 60% turnover or 140% turnover. They're just buying and selling stuff in the fund all the time trying to beat the market. And guess what? When you have turnover, you have tax inefficiency. You get distributed capital gains. They can be short-term capital gains. It's naturally much less tax efficient.

And then the fifth benefit is simplicity and transparency. They have a precise, easily understood objective. Track the market index. It's super easy to understand. It's very transparent. And so it's pretty cool that way.

But the reason I want to talk about this paper is because it goes into things that people worry about with indexing. Indexing has obviously become much more popular since I started the White Coat Investor podcast. Since I started the White Coat Investor blog. It's become more and more and more popular every year. And in fact, it's very interesting to take a look at index fund assets as a percentage of market capitalization. In the United States, it's as much as 23% of market capitalization is in index funds, but that's really only 12 to 13% across the rest of the world, particularly in Europe.

And so there's lots of different kinds of index funds. Even if those adds up to 23% of the market, some of it is like a large cap blend fund. Others are style-based funds. They're sector funds. They're global funds, whatever, but they're index funds. And so, I think it's worthwhile looking at some of the concerns people have about index funds. So, let's talk about these concerns that people have about index funds.

One concern is that market cap weighted index funds make the big stocks bigger. People say, “Because everybody's indexing, Nvidia is going crazy, or Tesla is going crazy”, or whatever the stock du jour is. And that reinforces market concentration.

Vanguard argues that is not the case, because indexing is market cap weighted. The market cap weighted index fund invests in each stock proportionally to the stock's market cap weighting. It doesn't make any stock larger than any other and doesn't reinforce concentration. Okay, well, that seems logical, but it's interesting because you show a graph, they show a graph in the paper that shows a percentage of market capitalization against the stock size, and it's not all in large caps. Index funds don't own an outsized share of large caps. They own stocks all over the place as far as market capitalization goes.

Another argument people sometimes make is that the growth of index fund investing inhibits price discovery. Meaning, because everybody's just indexing, nobody's paying attention to what these stocks really ought to be priced at, because we're all just buying blindly, we're just buying all the stocks.

Well, it turns out that's the right technique to do, but you are freeloading on the active investors that are trying to figure out what these stocks are actually worth. But the truth is that the price discovery happens in the buying and the selling. Although 23% of market assets are indexed, it's not even close to 23% of the buying and selling. In fact, index fund trading volume constitutes just over 1% of total trading activity. And in fact, even if you look at active fund trading volume mutual funds and ETFs, that's only about 2% of total volume.

So, what's all the trading happening? It's broker-dealers, it's market makers, and it's other investors that constitute the lion's share of trading activity every day. Trading volumes increased from 38 trillion to about 153 trillion over the last couple of decades.

So yeah, volume's gone up, but guess what? It's not the index funds doing the trading. The actual index fund trading volume is tiny. It's less than 1% or just over 1% now. In 2006, it was well under 1%. In 2024, it's just over 1%. But again, it's 1%. So 99 of the trades being done out there are not being done by index funds. Index funds aren't setting the prices for these stocks. Their volume's a drop in the bucket as far as trading volume goes.

The next thing that you hear sometimes is that this increase in index fund investing intensifies market volatility. And so it's interesting because Vanguard goes through and shows this rise in index fund assets over the years. It was 0% in 1990, it's now 23%. And they plot that against market volatility. Well, there's no relationship. Markets are no more volatile now than they were back then. It just has nothing to do with market volatility.

Another thing people say is that index fund investing limits active managers' ability to perform. They say that the growth of index fund investing enhances the co-movement of stocks, limiting the opportunities for active managers to perform well.

Well, it turns out that the sensitivity of volume in response to the doubling of volatility has basically been stable. Higher volume stuff, it does not necessarily become more sensitive to volume than stuff that is being traded at lower volumes. Really, it's just not related. There's no relationship between the growth of index fund investing and dispersion of stock volatility.

The bottom line is a lot of people talk about indexing like it's creating all these problems in the world. If everybody indexes, it's going to break the markets. Well, we're a long way from everybody indexing. I'll worry about that more when far more than 23% of assets, or I've seen other studies that peg it at a higher number, but it still needs to be way more of the assets and more importantly, way more of the trades happening with index funds before we really have to worry about them breaking the markets so that they don't work.

Index fund investing is taking a free ride for sure on the active fund investors, but what else are you going to do. Are you instead going to take a 5% chance of beating the index fund and that's before taxes? That's really what you're looking at over a 20 or 30 year period of picking actively managed funds that are going to beat an index or picking stocks yourself to beat an index. You got a five, maybe a 10% chance of pulling that off long-term.

That's not the way to bet. The way to bet is stick your money in the index fund, fund it adequately, stick with it, stay with your plan, stay the course and recognize that over the long run, if you'll do that, it's going to work out just fine for you and that this isn't a game you need to get into where you're picking stocks and trying to time the market and trying to pick fund managers.

If you're going to invest in public equities, public bonds, the strategy has been pretty clearly shown that the best strategy is to just buy them all, keep your costs low, keep your taxes low and spend your time actively while investing your money passively.

All right, let's get into your questions. We got a lot of complicated questions in this one. I don't know if this is like a stump the chump episode or what, but let's see if I can get any of these right today.

 

SHOULD YOU LEAVE AN INHERITANCE TO YOUR KIDS OR YOUR GRANDKIDS?

Chris:
Hey, Dr. Dahle, Chris in sunny Florida here, a long-time listener, first-time caller. Thank you so much for the gift of White Coat Investor. My parents both turned 70 this year. I just sat down and had a financial planning meeting with them. I'm pleased to say that they will be well taken care of in their retirement and long-term care. They have north of $5 million in assets. My dad's a retired emergency physician.

My question is about their will. Currently, my sister and I will both inherit equal parts of their estate. I'm named as the executor. I'm 44. My sister's 41. She has two children ages 6 and 10. I have no children. I mentioned to my parents that it would be a lot more meaningful for my nephews to inherit some or part or all of the estate rather than going to me and my sister as they will probably be in their 30s when this inheritance occurs, whereas my sister and I will be in our 60s or 70s most likely.

My parents were a bit resistant to this. It's been the tradition to pass down generationally in our family. They mentioned that I could just gift any money I wanted to my nephews.

My question is, what are the tax ramifications, step-up in basis ramifications, estate tax, all those issues that would occur with going directly to the nephews versus coming to me first and then being passed on to the nephews as a gift?

My second question is, since I'm the executor of the estate, is there any legal reason I can't circumvent the will to some degree and pass some assets on to the nephews as long as my sisters agree with this plan? I hope this question makes sense. Thank you for all you do and have a nice day.

Dr. Jim Dahle:
All right. A few things to talk about here. First of all, well done to your dad. An emergency doc, $5 million plus portfolio. That's what's supposed to happen. You make this high income for 20 or 30 years and you put a good chunk of it away, invest it in some reasonable way. You're supposed to retire as a multimillionaire. So kudos to dad, generation one. For doing a good job here, having money to pass on. That's kind of where we all want to be. So that's issue number one.

Issue number two, I think you ought to gift a copy of Die With Zero to your parents. Have them read it, talk about it, let them think about it, and they might change their mind about when and where the money goes, when and who the money goes to.

Certainly we've spent a lot of time thinking about this because it's true. Money is far more useful to inherit in your 20s, 30s, and 40s than it is in your 60s and 70s, especially if you've done a good job yourself and taken care of your own finances. If you get money in your 60s, you at that point are just managing it for the next generation, which is fine, except then they get it in their 60s and the generation after that gets it in their 60s, and nobody can actually make use of this money.

We just build these wealthy families and everybody dies the richest doc in the graveyard, and I don't think that's really the point. The point is to use money to make the world a better place for you, help you have a better, happier life, and help others to do the same, whether you're spending it or whether you're giving it or whatever.

I think it's worth pushing on that point a little bit, since they trust you enough to be the executor, encouraging them to spend, of course, anything they can possibly think of that will make their life happier they should be buying. If they want a hot tub, buy a hot tub. If they want to go on a trip, they should be buying first-class tickets. That much is clear. They are not, almost surely not, going to get through their $5 million. Anything that's going to make them happier, they should be spending.

They should also consider giving money away now rather than later. Now, not so much that they have to worry that they're going to run out or something, but the fact is you can turn money into happiness a whole lot more now than you can later. So have them consider that for sure.

Okay, let's talk about the step-up in basis. The step-up in basis happens when you die. The beautiful thing about passing money generation to generation to generation to generation, not skipping anybody, is that you get that step-up in basis with each generation. Well, that's great, although apparently if you're giving money to people in their 60s, none of them are going to spend it and they're all going to give the step-up in basis to the next generation anyway. I don't know that that's necessarily a reason that you want to give it to every generation.

There are estate tax ramifications as well as generation skipping tax ramifications. That topic is super complicated. If you search generation skipping tax on the White Coat Investor website, I got a long blog post about it. Every time I get a question about this, I got to go back and read the blog post because I can't remember all the details. It's super complicated. But your parents aren't anywhere near that. Their estate tax limit is $30 million. They got $5 million. They're not going to get to $30 million almost surely. So that part is not an issue. And I assume they're in Florida too. I don't know if that's true or not. I don't think there's an estate tax in Florida either. And so, there's really no estate tax issue to worry about.

So yes, if they gave more than $19,000 away, they'd have to file a gift tax return. That's just an informational return. There's no actual tax due. You're just using up some of your exemption early. And so, that would be fine to do as well.

Your real question is, “Should they give it to you or give it to the next generation?” Well, assuming you don't have an estate tax issue either, they can give it to you and you can just give it immediately to the next generation if you want to. It does use up their estate tax exemption. It will use up some of your estate tax exemption. But if you don't expect to die with $15 or $30 million plus, that's indexed to inflation now if married, then it's no big deal to use up some of yours.

Let's say they give you $2.5 million dollars and you decide you want to pass a million and a half of it right away to your nephews, you could do that. You would just use up a million and a half of your state tax exemptions. Probably fine. You probably don't need the whole thing anyway. And so, that would work out fine. But if they will skip you, if they will just give it directly to those guys, then they won't use up your estate tax exemption. And so, that's a beautiful thing about it. And in fact, they won't use up anything of yours because you're not in the direct line. So none of this generation skipping tax stuff applies at all. It may apply to your sister though.

Again, read that blog post. Generation skipping tax is complicated stuff and worth reading about. But again, if we're talking about amounts and $5 million, maybe 10 million when you die, something like that, we are below the estate tax limits. And so all we're talking about is informational gift tax returns anyway, informational estate tax returns and that sort of thing. So, it's not going to be a big deal. It's not going to be any taxes due like it would be with someone with a real estate tax problem.

I think I answered your question. If not, I'm sure I'll hear about it. But those are the things to be thinking about. Thank you for being willing to serve as an executor. It's not as easy as it sounds. The hard part is not managing the brokerage account. That part's relatively easy. Looking at the will, that part's relatively easy. The hard part is sorting things out with family members and their personal stuff. Figuring out what to do with all that crap in the house. That's the hard part.

So, keep that in mind and do what you can in advance. And then when the time comes, recognize that they wanted to empower you to be the executor. Feel free to pull a dumpster up in the driveway and get rid of all the stuff that doesn't make sense to put in some sort of an estate sale. Feel free to use their money to pay for the commissions, to have someone else take care of all that and run an estate sale for you. They've got $5 million. You have to feel like you're spending a bunch of your money and your time taking care of their assets so your nephews can get every dollar out of it that they can. It's reasonable to use some of that $5 million estate to pay for managing that estate.

Okay, another question about estate planning. Let's take a listen.

 

WHAT HAPPENS TO A MORTGAGE AND CHARITABLE GIFTS WHEN YOU INHERIT?

Speaker:
Hey, Dr. Dahle, longtime listener and recidivist caller. Thanks to your team for continuing to put out great content. I have two questions related to estate planning. The first is that if I inherit a house from a family member, what happens to the mortgage that they hold? Am I actually the one who assumes that mortgage or would I need to get another mortgage?

My second question is related to designating a charity as a beneficiary on any type of account that I have. Am I able to name a charity directly and would my executor then just direct the money to that charity upon my passing? Thanks a lot.

Dr. Jim Dahle:
Okay, what happens when you inherit a house? Well, you get the house. You now own the entire house. However, there is a lender with a lien on that house. Let's say the house is worth $600,000 and you inherit it. You've got yourself a $600,000 house. However, the house has a lien on it. $300,000. So if you turn around and sell that house, that's got to be paid off. So you have to give them their $300,000 and you really only inherited $300,000.

Now, most lenders, when they make loans, they're not assumable loans. It doesn't go with the next person that has a house. If you sell the house, they have to get their own new loan. If you inherit the house, you usually have to get your own new loan. They're still going to want to be paid in the meantime while you're doing that.

For a few months, I think it's okay for the estate to be paying on that mortgage. But by the time it passes to you, there probably needs to be a new loan on it or you need to sell it, pay them off and take the cash and buy something else. I think in general, which is what you're asking, that's what you do with the inherited house that still has a mortgage on it. One other great reason, by the way, to have your house paid off in retirement so your heirs don't have to deal with that crap. Who wants to deal with that stuff?

Your second question was about designating a charity as the beneficiary of your retirement account. And I would encourage you that if you're going to do this, you do it with accounts like an HSA, the worst kind of account to inherit, and tax deferred retirement accounts like a traditional IRA. Leave the Roth account to your heirs, leave the tax deferred account to your favorite charity. Because the charity doesn't pay taxes. Your heirs will appreciate inheriting a tax-free asset, and the charity won't mind inheriting a taxable asset because they don't pay taxes.

I think it's fine to do. I think that's probably what we'll end up doing. And yeah, you can just name the heir or name the charity as the beneficiary and it should go right to them. Technically, it doesn't go through probate because there's a beneficiary named, but somebody's probably going to have to tell the charity that they're the beneficiary. I guess that's the executor's role, and to make sure that money gets over there. But that's how it works when you designate a beneficiary. It passes outside of probate, whether that goes to a person or whether that goes to charity.

 

QUOTE OF THE DAY

Dr. Jim Dahle:
Our quote of the day today comes from Edmund Burke, who said, “If we command our wealth, we shall be rich and free. If our wealth commands us, we are poor indeed.”

 

INTERVIEW WITH JONATHAN SPITZ OF LIGHTSTONE DIRECT

Dr. Jim Dahle:
My guest today on the White Coat Investor podcast is Jonathan Spitz, the head of Capital Formation at WCI sponsor, Lightstone DIRECT. Jonathan, welcome to the podcast.

Jonathan Spitz:
Thanks, Jim. I appreciate you having me on.

Dr. Jim Dahle:
Now, you guys at Lightstone do a fair amount of multifamily investing, but you also do quite a bit of industrial investing. Tell us a little bit about why you see that as a great place for investors to invest and what the industrial market looks like these days.

Jonathan Spitz:
Industrial specifically is one of the only property types really outside of data centers that's benefiting from multiple long-term structural tailwinds. What do I mean by that? We believe that these are tailwinds for the asset class that will last not just the next five years, but the next 10 or 20 years.

Those tailwinds really start with Ecommerce. Ecommerce has been one of the biggest tailwinds for industrial real estate over the last 15 years, and we don't think that's slowing down anytime soon. Especially as what we've seen is the speed that distributors and retailers want to get goods in the hands of their consumers continues to increase.

At some point what was 2-day delivery became 1-day delivery and then same-day delivery. In order for businesses to do that, they need to be able to store goods closer to their customers. And so that, again, creates downstream implications for the supply and demand fundamentals associated with industrial real estate.

But secondly, I think what we're really seeing is reshoring. All that really means is the process of bringing U.S. manufacturing and production back to the United States. And so, this is really a trend that I would say is newer, let's call it the last five or six years, but has a lot of room to run.

And again, as part of the Big Beautiful Bill, there's incentives in there for businesses to restore manufacturing. And that, again, also has structural long-term demand drivers for industrial real estate because anytime a manufacturer establishes a presence within a market, that then creates a supplier ecosystem that forms around that manufacturer. And again, that they need industrial space as well.

But for us, what we focus on is what's called shallow or mid-band industrial real estate. Instead of acquiring 500,000 square foot to a million square foot facilities, what we want to be buying is multi-tenant facilities that have suite sizes that are anywhere between 10,000 and 150,000 square feet. And the reason why is because they can suit a wide range of uses that really cover a lot of the businesses and industries that benefit from those secular tailwinds I just mentioned.

Everything from the vendor that needs to deliver tires or pallets to BMW, to businesses that support the local economy. I think your local plumber or HVAC contractor to your regional distributor that is distributing goods and services to metros nearby, our businesses can serve all of these needs. And that's why what we've seen is incredibly strong occupancy, even as there's been a lot of supply that's come on the market over the last several years.

Dr. Jim Dahle:
In some ways, the headwinds that retail has faced are actually tailwinds for industrial.

Jonathan Spitz:
Yeah, 100%. And that's something that we've seen play out. And candidly, I think retail is actually in a pretty good spot right now, just because no one's been building any of it. But look, I think this is an important point to mention, because I think it's really important when we're talking about industrial to not paint the entire category with a broad brush. Because yes, Ecommerce is certainly a major beneficiary, and obviously, things like ordering goods online.

And typically, when I'm talking to people in person about industrial, the first question I'll ask is, everybody just name something that you're not ordering online. And usually what you hear is silence for a minute. People have to think, what am I not ordering online today? You can get groceries, shoes, pet food, you name it. Everything moves through that supply chain infrastructure and that distribution network, and that's going to continue to grow.

That being said, there has been a lot of supply in some of these larger class A industrial facilities. And so if someone opens the paper or just reads the Wall Street Journal, what you might hear is a lot of supply, a lot of vacancy right now in the market. And that's true for a lot of these big industrial facilities that are a million square feet, and they were built all on spec. But again, that's why we like to focus on these smaller suite sizes that can really accommodate a wide range of uses from Ecommerce to supporting manufacturing and the local economy.

Dr. Jim Dahle:
Now, a lot of the tenants you have in industrial tend to be longer term tenants. They often invest significant amount of money into improving the space themselves. And most leases tend to be triple net. Can you explain a little bit more about the advantages of the tenants in industrial versus typical apartment building?

Jonathan Spitz:
Yeah. Generally speaking, when people, when you're thinking about industrial leases, I would say, broadly speaking, the larger the space, the longer the lease. So if you're investing in something that's 500,000 square foot or above, you may be dealing with a 10 or 20 year lease, which is great as far, and especially if it's to a credit tenant, like an Amazon, obviously, that helps provide a very durable, predictable stream of cash flows.

Now, the downside is, if rents, rent growth starts to outpace, typically, when you're doing a 10 year lease, there are annual rent escalations built into that, like that lease. Sometimes they're indexed to CPI, sometimes they're fixed at whatever it is, 2, 3%.

Now, what that can mean sometimes for an owner is if you're owning a long term lease like that, you get predictable cash flow. But sometimes you may not, rents may out outpace the rent growth that's built into the lease. Therefore, you're not able to mark those leases to market as rents start to grow.

But one of the advantages to the triple net lease structures that you really see across all of our buildings is that all of the underlying expenses, I think insurance, taxes, a lot of certain parts of repairs, now there's some exclusions for things like roofs or some capex requirements, that is all borne by the tenant.

And so, for instance, if you look at multifamily, what's happened there over the last couple years, what we've seen is property taxes and specifically insurance costs have run way ahead of what most managers were projecting.

What that meant was that the landlord is largely absorbing a lot of those cost increases that can result in lower income for investors. What's beautiful about a triple net lease is the tenants are absorbing a lot of those increases. And so that then can protect investors as far as understanding the predictability and durability of those cash flows that you're receiving.

What I'll say, what we do at Lightstone mostly is we focus, again, back to smaller suite sizes generally means smaller or shorter durations of anywhere between three and seven years.

And we like that sweet spot because, again, if we believe that rents are going to continue to grow, which we do in the segment of the markets that we focus in, we want that ability to mark leases to market quicker, to be able to capture those higher rents as they grow over time.

And that's where we use our hands-on asset management and our leasing teams to be able to make sure that we're getting in front of them. We understand how our properties will hold up if leases need to turn over and how are we underwriting that from managing cash reserves and at the property level.

Dr. Jim Dahle:
Now, Lightstone offers mostly individual syndications of both industrial and multifamily properties to accredited investors with minimum investments of $50,000 to $100,000. Why might somebody choose Lightstone over one of your competitors? What do you see as the advantages of investing with Lightstone?

Jonathan Spitz:
Yeah, I would really boil it down to three things really. One is longevity. We've been in this business for 40 years. We've invested across multiple market cycles. What I can tell you about almost all of our competitors, most of them were born out of the great financial crisis. There's nothing wrong with that, but as an advantage, for us, what that means is we invested through the great financial crisis. We got punched in the face. We learned those lessons.

And unfortunately, a lot of managers are learning those lessons right now because all a lot of managers knew was what a structurally declining interest rate looks like and property valuations rising as a result. That ability that we've seen what other market cycles look like has really served us well as far as how we've positioned our portfolio in the current market environment and how we think about risk management.

Additionally, I would say we put our money where our mouth is. I don't know of another manager that invests 20% of their own capital alongside investors in every deal that they do. We are the largest investor in every property that we offer. Not only are we managing the investment, we are the largest investor in those investments. We are heavily aligned with RLPs.

The last thing I'll mention is just the breadth and depth of our platform. We invest across a number of different asset classes from multifamily to industrial. We've invested in retail, hotels. We own 25,000 apartments, about 12 million square feet of industrial, 5,000 hotel keys, 2 million square feet of retail. That enables us to position capital and make investments to wherever we believe is the best risk-adjusted opportunity for both us and our investors. I think the combination of those things is really what's been resonating with investors today.

Dr. Jim Dahle:
All right, Jonathan. Thank you so much for sharing your expertise. Thank you for sponsoring the White Coat Investor podcast. White Coat Investors who are interested in learning more about investing with Lightstone Direct can go to whitecoatinvestor.com/lightstone and get more information. Thanks again for your time.

Jonathan Spitz:
Awesome. Thanks, Jim. Appreciate you having me.

Dr. Jim Dahle:
Okay, let's take another question about an S Corp.

 

QUARTERLY ESTIMATED PAYMENTS FOR 1099 INCOME THROUGH S-CORP

Speaker 2:
Hi, Dr. Dahle. I'm a fellow transitioning to 1099 income through an S-Corp, and I was advised to skip quarterly estimated payments entirely. The strategy is to let all income accumulate in the business bank account during the year, setting aside 40 to 50% in a high-yield savings account for taxes and retirement, and then in December determining reasonable salary versus distributions and running one large payroll with enough withholding to meet safe harbor rules.

From my understanding, the idea is that withholdings are treated as paid evenly throughout the year, and this avoids penalties, allows the money to earn interest, and enables more precise retirement and income planning once the full year picture is clear.

My question to you, is this a legitimate and reasonable strategy? I've cold-called a few CPAs with this question, and they've all been skeptical, so I'd be curious to hear your thoughts. Thanks for what you do, and I appreciate your insight.

Dr. Jim Dahle:
Okay, great question. There's a few principles to be thinking about here, and it's appropriate for someone to be a little bit skeptical, not that there's anything wrong with this strategy. This strategy is not illegal. Whether it's adequate or not depends on the details of the case.

Let's say you've got this W-2 job, and you make $300,000 at your W-2 job, and you got this 1099 job, and you make $30,000 at the 1099 job. What is the best way to deal with the taxes for that 1099 job? Well, it turns out the best way is to just increase your withholding at the W-2 job. Especially late in the year. Because all withheld money is treated the same, whether it's withheld in January, or whether it's withheld in December. That's not the case with estimated quarterly payments.

If you're making irregular estimated quarterly payments, and they go, “Oh, we got to look at your income for the first quarter, and you only made a tiny estimated quarterly payment then, now we're going to start assessing interest starting in the first quarter last year, because you should have paid that money on April 15th.”

They don't do that for withholding. Whether you're having something withheld after a Roth conversion, or withheld from a paycheck, or anything withheld is all treated in one bucket. They don't look at the date on which it was withheld. So that's the principle. And the idea here is, “Oh, we're trying to take advantage of that fact. Rather than giving the IRS a loan, we're going to keep the money in our account earning 3.5% percent, or whatever you're getting in your high yield savings, until the end of the year before we give it to the IRS as withholding.”

Yes, that's legal. Yes, you can do that. I just question whether it's going to be adequate to do that. And it really depends on the amounts. If you can have enough withheld from that last paycheck, and I don't see why you wouldn't be able to, because you can just set additional withholding at that time if you want, and just send it all in December, you could do that.

This is one of those kind of optimizer things. Do you need to do that to be financially successful? No. Is it illegal? No. I don't even know that it's against the spirit of the law. It's just the way the law is. Taxes are kind of wacky that way, in that you're supposed to pay as you go. That's the principle they want to see. But it's not actually pay as you go for anybody but those making quarterly estimated payments, and those who are getting paid regularly from their W-2 job. Everybody else, the idea is you got to be in the safe harbor. And the safe harbor is that you've paid at least for a high earner, you paid at least 110% of what was owed last year, or 100% of what was owed this year, or within $1,000 of that, that gets you into the safe harbor.

But it's not like this terrible thing happens if you're not in the safe harbor. A lot of this, especially for those of us with very irregular income like I have, it's a guess. It's a total guess. I don't even get my taxes done until October 15th, and then my tax preparer comes back and says, “Here's what your quarterly payments ought to be.” I've already made three quarterly estimated payments by the time they tell me that. I've already made the one in April and in June and September. And they finally tell me in October 15th, here's what your quarterly estimated payments are supposed to be. Well, that's not helpful at all. Of course, I have to guess, because I had to file three of them already.

And so, a lot of this game is just a guess. And if you don't pay enough, well, guess what? You owe the IRS some interest. It's not the end of the world. If you paid too much, well, the IRS usually isn't going to pay you interest on that sort of thing. And so you just gave the IRS an interest-free loan. Maybe you gave a little bit too much.

I haven't been anywhere near within $1,000 of what my tax bill actually is for at least a decade. And sometimes I'm off by a lot. The important thing is that you don't go spend the money. If you go spend the money that you actually should have paid in taxes, that's a real problem.

But if it's just sitting in your money market fund, oh, bummer. I got to pay 7% interest on this for a few months, and I only earned 4% on it in the money market fund. So what? You got to pay a few hundred dollars or a few thousand dollars in interest, whatever. Not a big deal. You got as close as you could, and that's the way the system works.

Yeah, I think the technique's legitimate, but you got to make sure that the tax bill on what you're actually paying yourself as salary is high enough to cover what you will owe for all that 1099 income. And I think it's totally possible that you could make that happen in lots and lots of situations.

Now, there's lots of other underlying things we could talk about with this situation, like whether it was right to form that S Corp in the first place, whether you're okay just leaving all that money you're earning in the S Corp for the whole year. Most of us go to work and earn money because we want some of it. If you just leave it sitting in that S Corp, not only can you not go spend any of it, but you didn't get to invest it in anything but cash either.

There's downsides to leaving money in there all year, and maybe those downsides will be bigger than whatever benefit you're getting from doing it. But it's not that big a deal to make quarterly estimated payments. You shouldn't be doing backflips to try to avoid, maybe not do backflips is the way to say it. Maybe you shouldn't be bending over backwards to try to avoid doing that. It's not that hard. The form you fill out, it's only got like eight lines on it. It takes 30 seconds to fill out, and then you just go into the online payment system and send it in.

It's not hard to make quarterly estimated payments once you've done it once or twice. You'll realize, “Oh, this isn't anything to be afraid of. I don't need to come up with some crazy scheme to avoid making the payments.” It's just a matter of how many more months you're going to earn 3% on that money versus not be able to invest it in whatever you'd be investing the amount of it that you're investing or in order to spend some of it. That's kind of what you're weighing. So hopefully that helps.

Am I skeptical? Only because I don't know the exact amounts, not because I think it's illegal or something. I don't think it's illegal. It just might not be quite enough for you to take care of your tax bill.

All right. Thanks everybody out there for what you're doing. The reason why you got to wrestle with all these high income problems is because you're doing something that's very valuable in the world. You're treating patients that are sick or they're injured or you're drafting up complicated legal things or you're taking care of somebody's pet that they love very much. And who knows? I don't know what your profession is, but whatever you're doing, it's important work. Thank you for doing it. If no one said thanks today, let me be the first.

Okay. Let's talk about private equity for a minute. Here's a question.

 

HOW TO PREPARE FOR A WINDFALL

Speaker 3:
Hey Jim, thank you for all that you do. I'm a full partner in a practice that will probably be selling to private equity in the next year. I'm only five years out of fellowship and have been opposed to this decision, but will likely be outvoted.

My questions revolve around how to prepare for this potential windfall. The total could be anywhere from $10 million to $18 million per partner. This would likely be split into two payments over three to five years.

My understanding is that this will be subject to long-term capital gains rates. Are there ways that I can plan ahead to reduce my capital gains taxes on this? Additionally, would you change asset allocation or investing strategy after a windfall?

I have historically been nearly 100% equities, but I have some reservations with the strategy once I hit financial independence. I intend to keep practicing for at least 15 more years, and I worry about liability and asset protection going forward when I have so much invested. Thanks for your help.

Dr. Jim Dahle:
Okay. Everybody out there in White Coat Investor land, reach down, pick up your jaw off the floor. That was a pretty impressive number you threw out there. For most of us, that sort of a windfall is life-changing, dramatically life-changing.

It changes everything you've been doing financially up until this point, and I totally understand why your older partners are big fans of this. In fact, maybe you ought to be a big fan of it because that is clearly enough money, I would hope, to make just about anybody listening to this podcast financially independent and never have to worry about money again.

Yes, lots of things should change when you have a windfall of that kind of money. Should you invest differently? Yes. You have much less need to take risk. Now, you have a lot more ability to take risk, but certainly some big chunk of that ought to be forever invested in some safe way, and maybe that's a muni bond fund at Vanguard, or a TIPS ladder, or something like that.

Some chunk of that ought to go into this pool of money that's never going to be lost, that you can live on no matter what happens in the future. Then, of course, the rest, you can invest in some reasonable way, take on a reasonable amount of risk, and consider your financial goals, whether those are philanthropic, whether that is leaving a whole bunch of money to your kids, whether that's living the good life for you.

Certainly, you ought to spend some of that money. Not only now, but later. You can now afford a lot of things that you probably couldn't afford before, and it's okay to buy some of them if you think they're going to make you a little bit more happy. This sort of a windfall, there's a lot to think about. In general, windfall advice is don't do anything for a year. Keep an eye on it, and let it sit in cash and earn 3 or 4% while you figure out how life's going to change, and that's probably still good advice. Obviously, you want to make sure you save enough of it to pay any capital gains taxes due.

Now, if what you want to do with the rest of your life involves practicing medicine, I think that's okay to do. We've been financially independent now for seven, eight years, something like that, and I'm still practicing medicine. I was in the ER yesterday seeing patients, patients that could sue me for a gazillion dollars.

And so, I was a little worried about that. So I wrote a book called The White Coat Investor's Guide to Asset Protection. I learned about asset protection and shared what I learned with all of you, and so I think it's worth reading that book to understand what your risk actually is. It's a lot lower than most physicians think, but it's not zero. It's worth doing some advanced asset protection planning.

Now, you should still do the things that most people out there do or should be doing typical White Coat Investor kind of stuff. You ought to be maxing out retirement accounts because you get to keep those in bankruptcy. You ought to title your properties properly. If married, that usually means tenants by the entirety if your states allow it. You ought to have umbrella insurance if you don't already.

This is a time when you might consider going “Maybe I ought to have a $5 million policy instead of a $1 million policy.” You do things like that, but this is probably enough money to also consider some of the more advanced asset protection techniques. Now, these are often coupled with estate planning techniques. We're talking about things like grantor trusts. These irrevocable trusts, the asset no longer belongs to you. So if you get sued for practicing medicine, you don't lose that asset because it's not yours anymore. It belongs to this trust.

The downside, of course, is it's irrevocable. It's going to be in that trust, but you might be able to set it up as a spousal lifetime access trust. And so the beneficiary is your spouse, and theoretically, they'll still share those assets with you for the rest of your life. So, there's some ways to maybe get around and be able to use some of that money, even though you gave it away, legally speaking.

Some people look at forming family LLCs or family limited partnerships, and those have some estate planning benefits, as well as some asset protection benefits. Certainly, it seems reasonable to look into some of the domestic asset protection trusts, but this is all worth a discussion with an estate planning attorney in your state. That's just kind of general windfall advice. That's not the question you asked, though.

The question you asked is, “How can I pay less in capital gains taxes?” Because this is going to put you in the top capital gains bracket for sure. That's 23.8% when you include the PPACA taxes. That's just federal, plus your state. In my state, it'd be another 4.5% or so is what I would pay. So I'd be paying, whatever that works out to be, 28% something, a little over 28%, I'd be paying in taxes for that sort of a windfall.

So yeah, it's a lot of money. Instead of getting $10 million, now you're only getting $6 or $7 million. It's a lot of money, and it's reasonable to think about ways that you might be able to avoid or delay those capital gains taxes.

Luckily for you, I published a post in February of 2026 about 10 ways to avoid or at least delay capital gains taxes. What are those 10 ways? Well, the first one is to just cheat on your taxes. Tax evasion works great. So you get caught, then you go to jail. And I can't think of a windfall that's worth going to jail for, so I don't really recommend that one.

Here's another thing you can do. You can use tax losses to offset your gains. If you've been tax loss harvesting with your taxable portfolio as you go along, maybe you saved up a few hundred thousand, maybe even a few million in tax losses, and those can all be used to offset those capital gains. You now don't have to pay capital gains taxes on however many losses you have.

Now, there are interesting strategies out there to try to get more of these losses. Most popular one right now is direct indexing, which we talked about in a recent podcast. There are pluses and minuses to direct indexing. Aside from the expense and the worries about tracking error, you have to recognize that most of the losses come up front. This isn't something you keep getting for decades and decades and decades. But you might want to consider that to try to get a few more losses you can use to offset the gains.

Now, if you hold the asset till you die, this is way number three, you get a step up in basis of death. It doesn't sound like that's going to be an option for you. I wouldn't recommend death as a way of getting a step up in this asset. But if you and all your partners held it until death, you would get a step up in basis at death.

Another option, which doesn't sound like it's going to work for you, is to give appreciated assets instead of cash to charity. You could theoretically, before it's sold, give away part of your share of this company to a charity. So, whatever goes to charity, you don't have to pay the capital gains taxes on. If you're very charitably inclined, you might want to look into that.

Another option for those who own a whole bunch of individual stocks with large capital gains is to do what's called a 351 exchange, where you're basically exchanging it into an exchange fund, an ETF, that takes everybody's appreciated stocks and gives them some sort of diversification for it. Not an option for you.

A 1031 exchange is typically used when you swap from one real estate investment to another real estate investment. I don't think this is going to be an option for you for your practice, but if part of this sale is also the practice land, you might be able to do a 1031 exchange with it.

Method number seven is a 721 UPREIT exchange. Again, it's done with real estate. Same thing with number eight, a Delaware statutory trust, but number nine might be an option for you, which is an opportunity zone fund. And this is a way to take some money in some of these capital gains you got, invest it into an opportunity zone, which is a type of real estate fund, and get some beneficial capital gains tax treatment out of that.

They changed these recently. They work a little bit differently than they used to, but basically you get a deferral of your long-term capital gains and you get a partial step up in basis. Your basis goes up 10% after five years, 15% after seven years. So that might be an option if you're interested in investing in real estate, you might look into an opportunity zone fund.

A deferred sales trust, you kind of have this happening in that you're not getting all the money in one year. And so, you can kind of spread it out a little bit. You only pay taxes when you actually get the capital gains. And by spreading it out a few years, that might help you with that. That's kind of it.

If you're going to get a capital gain, you have to pay taxes on it. And if you want to keep the money, if you want to give it to charity, it's fine. If you want to delay it by exchanging it into something else, but I don't think that's an option for this practice except for going into an opportunity zone fund.

I think you're basically going to bite the bullet and you're going to have one year with a really high tax bill. You're going to have a really high income and a really high tax bill. Just be glad you get to pay at the lower long-term capital gains tax rates rather than ordinary income tax rates. So you're going to lose 23.8% instead of 37%. Better than a kick in the teeth. There are worse things than having to pay taxes, like not having to pay taxes.

I hope that's helpful to you and answers your question about what to do with it. I understand how you feel about selling, especially early in your career. Now, this is probably a very profitable practice and chances are good you're going to make less money afterward as somebody's employee, an employer, these private equity folks, you're probably going to have less control over your work environment. You're probably more likely to get burned out afterward.

In general, the younger partners are against these sorts of sales and the older partners are very much in favor of them. That's probably pretty typical, but you also get the benefits. This is a big lump sum of money you get relatively early in your life and there are benefits to that.

Now you can invest it any way you want. It can be more diversified than having it all in this practice and you can use it to have a really cool financially independent life. Congratulations to you on your success on this upcoming windfall. Great job being an owner, buying into that practice or whatever you did to build it up, to make it so valuable. Well done. I say to you, well done and sorry you have to pay taxes on your good fortune.

 

SPONSOR

Dr. Jim Dahle:
As I mentioned at the beginning of the podcast, SoFi could help medical residents like you save thousands of dollars with exclusive rates and flexible terms for refinancing your student loans. Visit sofi.com/whitecoatinvestor to see all the promotions and offers they've got waiting for you.

SoFi student loans are originated by SoFi Bank, N.A. Member FDIC. Additional terms and conditions apply. NMLS 696891.

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Thank you for leaving us five-star reviews. A recent one came in from Adam Henry who said, “Young doc improving his financial wellness. Incredibly important information for maintaining a healthy financial lifestyle. Highly recommended.” Five stars.

Thank you for that. Thank you for telling people about the White Coat Investor. We know that we grow primarily through word of mouth, from you telling your friends and peers and people that trust you about the White Coat Investor and we thank you for sharing that trust they have in you with us. We'll try to do all we can to not violate that trust you've placed in us.

Keep your head up, your shoulders back. You've got this. We'll see you next time on the White Coat Investor podcast.

 

DISCLAIMER

The White Coat Investor podcast is for your entertainment and information only and should not be considered financial, legal, tax, or investment advice. Investing involves risk, including the possible loss of principal. You should consult the appropriate professional for specific advice relating to your situation.

Transcription – MtoM – 270

INTRODUCTION

This is the White Coat Investor podcast Milestones to Millionaire – Celebrating stories of success along the journey to financial freedom.

Dr. Jim Dahle:
This is Milestones to Millionaire podcast number 270.

This podcast is sponsored by Bob Bhayani of Protuity. He is an independent provider of disability insurance and planning solutions to the medical community in every state and a long-time White Coat Investor sponsor. He specializes in working with residents and fellows early in their careers to set up sound financial and insurance strategies.

If you need to review your disability insurance coverage or to get this critical insurance in place, contact Bob at www.whitecoatinvestor.com/protuity today. You can also email [email protected] or just call (973) 771-9100.

All right, welcome back to the podcast. This is the Milestones to Millionaire podcast where we celebrate your successes and use them to inspire others to do the same. If you'd like to be on the podcast, you can apply at whitecoatinvestor.com/milestones.

All right, it's annual survey time. You can fill out our annual survey now through May 6th. This is really important for us. We go through all of the responses we get, and we usually get a couple thousand responses. And we go through them because it is so important for us to be doing what you need.

And so, if you have a few minutes to tell you about yourself and share your feedback, we use that to improve the White Coat Investor community, to improve how we're offering new services. We want to know how we can serve you better, how we can improve WCI for you, what would make WCI better for you. We want your feedback.

We'll actually bribe you for it. 20 random entrants receive a t-shirt. Five people will win a WCI course totally free. So you can get prizes for doing this, but mostly you can help yourself by improving WCI. You can help those following after you. The link is whitecoatinvestor.com/wcisurvey.

Now, we also ask some net worth questions, things like that. It's all anonymized. Don't worry about that. But it enables me to put together a post that people like to see that kind of shows where people are at financially in the White Coat Investor community. Obviously you can skip any question you want in there and it's all anonymized data, but it's very helpful not only for producing content, but also for helping us make sure we're doing the right thing for you. Again, whitecoatinvestor.com/wcisurvey.

All right, stick around at the end of this interview. We're going to talk a little bit about FSAs and dependent care. A little bit of a nuanced topic we're going to talk about.

I'm really excited about this episode. In fact, this might be my favorite Milestones episode we've ever done. There is so much cool stuff in this interview, but it gets even better because it turns out, I found out right after we finished the interview, that this is a little bit of the rest of the story.

So let me take you back to the beginning of the story. Let's go all the way back to, and this is in my email box, September 13th, 2019. I get an email from today's interviewee. The email says, “I love your podcast. My name is Frank. I'm currently a fellow living in D.C. and have a financial question. I did my residency in Brooklyn and now fellowship in D.C. That's five plus years of living in very expensive cities. I actually make less as a fellow, but pay more in rents than when I was a resident.

I'm so close to getting that high-paying first job, but I don't know if I can make it financially another 10 months. I didn't make the smartest decisions financially as a medical student and resident. I'm maxed out with credit cards. I was recently married. I had to move to D.C. Licensing costs, board prep, board costs, $1,500 each for my written and orals, student loans, fellowship interviews, and the list goes on.

My wife works, but it's not a lot. She has her own credit card and loan debt. Right now, I'm stressed out.” Sorry, I'm a little emotional reading this. “About being able to pay rent, to go along with being in a new city and fellowship. My question to you is what are my options? I can't take out any more credit cards. I'm trying to set up locums, but my fellowship does not really allow for much extra time, plus the process in setting it up and finding a gig is taking a long time. Should I try to get a personal loan from a bank? Are there any other types of loans that you could recommend? I'd rather take out another loan and be at ease than stress out my entire fellowship when I can finally see the light at the end of the tunnel. Thanks for your time.”

This was in response to an email we'd sent out with Financial Boot Camp. With our Financial Boot Camp, we always invite people to email back if they have any questions, and he did. He sent this email in, and reading my response is very short like most of my responses are and talks about some of the things he can do. Practically, I gave him good advice to help solve the problem. What I didn't do was show nearly as much compassion for the situation he was in as I should have.

I told him, “You're doing a good job. You already admitted that you screwed up a lot financially in the past.” I told him the second part was to set up a plan to live like a resident on his attending income in a year and told him that if he would do that, he could clean up this mess.

I told him, it's definitely a mess you've got, but you can clean it up. You'll just live like a resident for a year. Then step three would be to get through this year, his last year of fellowship.

I told him, your options for this year are to have your wife work more, to moonlight, sell anything you have of value, live as cheaply as possible, and take out a personal loan. I referred him to one of the WCI advertisers, SoFi, that we've had for a long, long time. I even gave him a link, whitecoatinvestor.com/sofiloan. I don't even know if that link still works. Let's double check it before I put it on the podcast. Yeah, it still works.

I sent that email back. No response, nothing, just into the ether. Seven years later, he applies to come on the Milestones to Millionaire podcast. Let's hear the rest of the story.

 

INTERVIEW

Dr. Jim Dahle:
Our guest on the Milestones to Millionaire podcast today is Frank. Frank, welcome to the podcast.

Frank:
Thanks for having me. I really appreciate it.

Dr. Jim Dahle:
All right. Tell us what part of the country you're in, what you do for a living, how far you are out of training.

Frank:
I'm from the northeast New York, New Jersey area, metropolitan area. About five and a half years out of fellowship training. I did general surgery and I did a surgical critical care fellowship. And then I've had trauma surgery, emergency general surgery jobs for the last five years.

Dr. Jim Dahle:
Very cool. Well, thank you for doing that. Number one, thank you for doing it in New Jersey. New Jersey is not the easiest place for doctors to live financially, but they definitely do need doctors there. So, thank you for doing that.

Frank:
I grew up in New Jersey, so that's kind of how I got here.

Dr. Jim Dahle:
Easy to stay home. Yeah. Okay. Well, tell us what milestone we're celebrating with you today.

Frank:
It's a couple. I paid off all my student loans or I got them forgiven, I should say. And got back to broke. I didn't quite reach the half a million, but I figured those two milestones were at least a good start.

Dr. Jim Dahle:
Yeah, you're doing great. Okay, well, take us through the student loans. Take us back to medical school and give us the numbers.

Frank:
I came out with $315,000 in student loans. And back when we started the PSLF, there was no fancy website like they have now, where you have these nice bar graphs and shows exactly the payment you made like one second ago. There was yearly emails where they sent you “Yeah, we received your payment. Sure.” Even if I asked for proof, they never really actually gave any in the beginning there.

And actually, it was very difficult to get started. And a lot of those $0 payments that we know and love in the beginning didn't really count. All of it didn't transfer. It was multiple phone calls until I got all my loans over to the PSLF platform. And it actually made it very difficult and had a lot of problems throughout because it broke it down to about 15 different loans. Just based on the way they crossed over, it made it a real big problem when they fixed the system and like, “Oh, you missed a payment here, missed a payment there.” And they forgave a certain amount of payments where they just took it off the top.

But because I had 15 different loans “Oh, we give you 15 free payments or 15 free flubs we'll fix for free.” And that turned into one month for each of them. So it actually really messed it up and lots of phone calls.

Dr. Jim Dahle:
So you came out a decade ago. What IDR did you enroll in initially? Do you remember?

Frank:
I forget. I forget exactly which one, but it was the income-based payments.

Dr. Jim Dahle:
IBR or PAY or I don't even think REPAY existed.

Frank:
REPAY didn't exist.

Dr. Jim Dahle:
No.

Frank:
It was IBR.

Dr. Jim Dahle:
When you started, nobody had ever received public service loan forgiveness. The first people eligible would have been 2017, 2018. You would have started making payments in 2015, 2016-ish. And what do you think? Were you worried when you started hearing all these people saying only 1% of people applying or getting PSLF, et cetera? Did that worry you at all?

Frank:
Well, you guys helped, of course, all your information was great, but it made sense that no one got it because it wasn't enough time yet because it was 10 years. And then as I got closer to the time where people were getting it, they did say a lot of it was because they didn't qualify or they didn't do enough payments or they didn't have enough or they didn't sign up the right loans. I was pretty confident that I had the right type of loan and in the right spot.

I knew all my paperwork was in the right place. I just was worried about policy change or someone taking it away. But once I got to the seven, eight, nine year mark, I was like, I got to think that I'm in deep enough that even if they change the policy, that'll be grandfathered in.

But it definitely was a problem. And it definitely was scary in the beginning, but I really didn't have any other choice. I'm like, well, I just have to deal with it later if it doesn't go through because I have no money, being a resident in New York city in Brooklyn.

Dr. Jim Dahle:
Well, it wasn't like you were going to pay them off as a resident anyway.

Frank:
Right. It was just hope for the best at that time. So it worked out.

Dr. Jim Dahle:
Okay. Very cool. Well, the timing for you worked out pretty good given when you started. Because you made these little tiny payments in training. And then about the time you became an attending, you came into the student loan holiday with zero dollar payments. And you got three and a half years of those as an attending.

Frank:
I'll say that too loud. I don't think they could take it back because I have the proof that says they're all forgiven zeroed out. But yes, I got very lucky in that regard where I actually never made a payment with an attending salary because of the way they re-verified your income. They kept getting pushed back, I guess, because the website was being fixed. It was right around that time. They pushed back the income verification once the payments restarted. I was still on a fellowship residency salary when the payments restarted. So they never asked.

And it was right after I made the 10 years of payments when they wanted to know how much I made now. There were multiple years where I wasn't attending, where it was zero dollars because of COVID, which was really nice. And then once I got back, it was only like $500 a month or something like that because my salary is so low.

Dr. Jim Dahle:
Your timing couldn't have been more perfect.

Frank:
Couldn't have been. It was perfect. Again, it ended right at the end.

Dr. Jim Dahle:
Yeah. How much did you get forgiven? What was the balance when it was forgiven?

Frank:
It was $405,000.

Dr. Jim Dahle:
$405,000. And how much do you think you made total in payments approximately over the course of the prior 10 years?

Frank:
I was trying to look that up. There's not a good way, but it was all like less than 1% of each loan was paid. My highest payment each month was $500.

Dr. Jim Dahle:
Do you think you even paid $30,000?

Frank:
I think that's a good number. But it's pretty close. It's definitely not more than that. I just didn't have it at the time.

Dr. Jim Dahle:
There was a Parent PLUS loan involved as well. Tell us about that.

Frank:
Yes. That was also interesting. Once I was paying the loans, I had them all set up. My dad was like “We have this Parent PLUS loan that's on me because he had to do it for undergrad.” And for whatever reason, I didn't know how to do it or what was going on then because I was an undergrad.

Dr. Jim Dahle:
You thought he was paying your tuition and he was borrowing it.

Frank:
Yeah, he's like, “Well I've been paying some”, but I guess the terms weren't great or whatever happened. I don't know the circumstances, but he kind of dropped it in the middle. And I was like, “Oh, we got to figure this out.” And luckily, when they revamped the PSLF, they included a lot of people and you can do back payments. And he happened to always work for a town because he's a building engineer inspector. So he always worked for a town. And luckily, he had the payment proof. And he went from zero to finishing off before me because he always was making minimum payments and this and that. And deferments, I guess, because when it got to be too much at times.

And that's when they fixed up to 15 deferments or payments that you missed or something that just kind of like a blanket fix a certain amount. Where it didn't help me, it really helped him. And we actually finished his prior to finishing mine. He had about a year or two of $1,000 payments or so because his income was more towards the end. So he actually probably paid a good amount of it. But he got $115,000 on top of the $400,000 that I got forgiven.

Dr. Jim Dahle:
And it was paying for your education though.

Frank:
Yeah, it was not for him in any way, shape or form.

Dr. Jim Dahle:
It was all for me. So you got PSLF and you helped your dad get PSLF.

Frank:
Yes.

Dr. Jim Dahle:
That's pretty awesome. That's the first time we've had that milestone on this podcast. That's pretty cool.

Frank:
Again, it's some luck involved, but it was a lot of work back and forth to make sure they got it counted. Because now we're going back eight years of his payments and eight years of his employment where towns worked for before. But luckily it was all like a government municipality job. So it all qualified.

Dr. Jim Dahle:
$500,000 plus when you total the two of them together.

Frank:
Yeah. If we paid a couple percentage of that probably is being kind. So we really got lucky.

Dr. Jim Dahle:
Yeah. So, what's your net worth now? You say back to broke, but you've had $400,000 or depending on how you look at it, $500,000 swing in your net worth.

Frank:
It's about $400,000 to $450,000. About $300,000 of that is 401(k) and 457(b) retirement. And then the rest is I have about $20,000 emergency and then $50,000 or so in just cash on hand. And then the rest is in the house, which helps with the net worth, but also it's a big chunk of it as we're building it.

Dr. Jim Dahle:
You've had more or less a million dollar swing in net worth since you came out of training five years ago.

Frank:
Yeah.

Dr. Jim Dahle:
Pretty awesome. What's the range of income you've seen in that time period?

Frank:
When I started my first job, it was about $315,000. And then after two years, I got a different job. And I went from New York City to New Jersey and went up to about $440,000. And now it's about almost $500,000.

Dr. Jim Dahle:
So pretty typical general surgeon kind of salary.

Frank:
Yeah.

Dr. Jim Dahle:
Okay. Very cool. Tell us, obviously you got into the details of PSLF. You figured out work. You didn't bail on it. You stuck with it. It paid off. But you've also accumulated close to half a million dollars in the meantime. Tell us your secrets to success. You say you became financially educated listening to this podcast and reading WCI and that sort of stuff, but you still had to do it. Tell us how you became so financially successful.

Frank:
You've said it to me a hundred times, live like a resident after you graduate. I truly did. I bought a Tempur-Pedic bed and a big screen TV. But other than that, I lived next to the hospital in a townhouse, or not a townhouse, an apartment. It was about $2,500. And then even after that, because my wife's parents lived around that hospital, we lived with my wife's parents for about a year. And they're like a mother, daughter part, just to save for a house, even when we had a kid. There was a good three, three and a half years there where we lived $2,500 to almost nothing per month, at least on rent.

Dr. Jim Dahle:
Yeah. Both sides of the family got involved in this thing. Your dad had the Parent PLUS loan. Her parents had you live with them for a year. But you know what? You add it all together and you can build a lot of wealth together when multiple generations work together.

Okay. So how did it feel to look on the PSLF website and see it go from $405,000 to nothing?

Frank:
Oh, man. It's funny that you say that because I don't know if you recall, but they just revamped the website. The website was down right as I was done. After 10 years of waiting, 10 plus years of waiting, I couldn't exactly get it because they're in the middle of that three-month period where they were redoing the website and they were backlogged. I had to wait a couple of months, but I had my dad's payoff first. That was a nice victory. And then it was just surreal when the $404,000 where I think it was up to, just went away the next day. They didn't go down easy. A couple of emails, like, “Hey, is it done? Is it done? Are we done? I have my payments. No, it's not popping up.” They're like, “Yeah, we'll get to it.”

And then all of a sudden, one day it came. And like you said, it's $500,000 swing. I always believed it was going to get forgiven. And I just tried to stay positive on that, even though people read things about policy change. But I kept positive and knew that I was this far along. It was very meticulous on making sure everything was in the right order every step of the way. But I know that it's the government, anything can happen. But I was pretty prepared. So I knew it was going to happen. And it all worked out at the end.

Dr. Jim Dahle:
You had kind of an interesting experience with a house. You guys have kind of done a semi-custom house. Tell us about that experience and the lessons you learned from it.

Frank:
Right. As much as you can be financially responsible and save towards something, if you don't have a plan, an exact plan, how you use that you can get knocked down a peg or two.

We found this house in the town that actually I grew up in. There were eight custom houses that were being built. The builder owned the property and the houses. And then we sold it as you can change the options. You can do this. You can do that. You can make it your own. You just can't change walls. This is what he said. So you can put whatever you need. You can change whatever you want outside, inside.

And what we didn't know when we tried to get out of them, it wasn't very clear is what actually comes with the house. Because you can change and upgrade stuff. But we changed the floor to floor B. Obviously, the house comes with a floor. How much credit do we get? And how much more is the floor B? Because we like floor B. What does it come with?

And every step of the way was met with, “Oh, don't worry. We'll figure it out.” And we're so far into it at that point. We really like the house. We already met the people on the block. And it just kept getting, “Yeah, yeah, yeah.” And it turned into a huge bill at the end because it was very not forthcoming with what came with the house and how much extras would be. And then got very aggressive about it when we complained. He's like, do you want this house? I can get out of it right now. So we kind of just went along with it as it went. And it ended up costing a lot more out of pocket than the house, what we thought.

All that money we saved, the down payment, and obviously for upgrades came and went pretty fast. And we almost went to legal battles because he put in extras and then charged us later. And it was very shady about it. It ended up being a beautiful home. But we just paid way more than we thought. So it kind of set us back.

And now you have the mortgage, it's hard to recover like it was when you're living with our in-laws. And on top of that, it took two years to build. So, if it's not your property, you can't get a mortgage rate. You can't lock a mortgage rate until you move in. When we budgeted for it, it was at 5.25%, the payment was way less than it was two years later, 6.5%, 7%. And I added an extra $1,500, $2,000 a month for the payment. It was hard to plan for that, but it also set us back, all the kind of good work we did. I was back to broke at that point.

Dr. Jim Dahle:
Yeah. You had an experience with a pump and dump scam too. Tell us about that and maybe what doctors can do to avoid the same mistake.

Frank:
Yeah. It's a little embarrassing because I should have seen it coming. If it sounds too good to be true, it probably is. And it came from a simple Google search. I think I Googled a stock to learn more about it. And then it went to a Facebook group that turned into a WhatsApp group that had stock advice and they gave charts and they justified it. And I’m now reading the charts.

That's what I wanted to get into, how to read the charts and make some predictions, just trying to dip my toe in the water and try to learn. And they would give you advice in a trial period. I was like they're not asking for my money yet. You do it your own through Robinhood based on their advice. I was like, “Well, what harm could it be?”

And in the first couple, they gave you winners. And they're like, “All right, this is the last of the trial period”, which I probably should have saw coming. I put way more into it because they hadn't given sound advice. They were justifying it. They gave information that was all, I guess probably copied and pasted from somewhere else. And they lured you in. I put a bigger chunk because it was the last one, and then it rose. And then within an hour, it went from like $10 to 10 cents.

Dr. Jim Dahle:
Basically, your FOMO got the best of you.

Frank:
Yeah, it was stupid. It was more embarrassing and obviously took a financial hit. But it wasn't bankrupt or anything like that. I wasn't injured. Nothing bad happened. At least that's how I'm choosing to treat it. But it was a pretty humbling moment. And just be careful. And if it sounds too good to be true, it is. Only get certified advice or backed by either someone else that you know that experienced it or through you guys, because it's easy to lose focus for one second and think they can't get you and then they get you.

Dr. Jim Dahle:
Yeah. This sort of thing is not that uncommon. We've seen people show up in the Facebook group, somehow they snuck into the Facebook group. And then they post a link to another Facebook group or a link to a WhatsApp group. They get you out of the WCI Facebook group where really there's a lot of people looking out for you into something else.

Frank:
Yeah. That's exactly what happened.

Dr. Jim Dahle:
It happens. But we've deleted those sorts of things numerous times over the years out of our Facebook group.

Frank:
And they're really sneaky. Even after they do it to you, they try to get you more. They're like, “Oh, this is a recovery group. We messed up, going to this like a crypto thing.” They are relentless. And even if you call them out, they deny it. It was tough, but it was a lesson learned. But yeah, they can be very tricky. Like you said, it was a Facebook group that turned into a WhatsApp group and then they lured you in with some actual positive success.

Dr. Jim Dahle:
Yeah. Well, this is the Milestones podcast. We're going to celebrate your successes and learning's good, making mistakes, especially early on with small amounts of money, relatively small amounts of money is good.

But that's not what we're celebrating today. We're celebrating the fact that despite making a few mistakes here and there, despite being in a pretty rough financial situation when you come out of training, you have had a swing in your net worth of close to a million dollars since you got out of training. That's pretty awesome.

We congratulate you on that. We thank you for being willing to come on the podcast, share your experiences, positive and negative with the rest of the White Coat Investor community. Congratulations on your success. Very well done. You should be proud of yourself. And again, thanks for coming on the podcast.

Frank:
Thank you so much. I appreciate it. I hope people can learn both good and bad. Just don't lose focus for a second because you do a lot of hard work to gain all that money. You want to keep it and spend it on things that make you happy.

Dr. Jim Dahle:
I hope you enjoyed that interview as much as I did. Frank has come a long way since he sent me that email in 2019. He's had a net worth swing of a million dollars. Yeah, he's like, “I'm a little embarrassed about the stock thing” and maybe reading back through the email, he gave me permission to read that on this podcast. He's like, “It's a little embarrassing, some of the stuff I've done, but it's real.” Because so often we have people on this podcast who again, good for them. It's wonderful. But they basically did everything perfectly. They screwed up nothing.

Frank's journey is far more like mine. I screwed up mortgage. I screwed up a mortgage refinance, just about got taken advantage of there. I bought a house when I shouldn't have bought a house. I ended up with a fee based instead of a fee only financial advisor. I bought whole life insurance as a medical student. I made lots of screw ups like I know many of you have as well.

But Frank is coming from a place he's in his last year of fellowship. He's got his credit cards all maxed out. He's taken out a personal loan to pay the rent. And he actually, him and his wife say that's the best thing they ever did. He said he wiped it out in his first years in attending along with all that credit card debt because he did take my advice. He lived like a resident that first year once he came out.

But he was not in a great place. What was his net worth? If you take the $400,000 in student loans, another $100,000 that his dad had on him. He's got credit card debt. He's now got a $40,000 personal loan he's using to pay rent in DC. He's not in a great place.

And where is he now? He's close to half a million dollars in net worth. He's gotten PSLF. He stayed the course with it. He learned every detail he could about it. He made sure he kept all his paperwork, checked all the boxes. And he ended up only having to pay about $30,000 of those student loans because he paid attention to the details. He became financially literate. He became financially disciplined.

It's a very powerful combination. When you can get those two things, it's like having a superpower in our world because so few people have them. And then you combine that with a physician's salary and miracles happen. Financial miracles.

When his children grow up, they're not going to have any sense that there was ever this period of life when they were maxed out on their credit cards and having to take out a personal loan to pay the rent to finish his training in DC.

He's basically changed his family because he paid attention, became financially literate, did the hard things and has overcome any mistakes he made by doing the important things, getting the big things right.

I want to encourage you to do that as well. Get the big things right. You can screw up some stuff in your life and it's going to be okay. You're going to have a physician's salary. That's going to hide an awful lot of errors if you can just learn to manage it well.

Now, he admits he even now sometimes feels like he's living paycheck to paycheck. And obviously, it's easier not to do that in a medium-sized town in Indiana or Texas than it is in New Jersey. But he's not out of the woods yet, but he's building wealth. He's got a great income. He's on a great path to financial success.

And that's where I want you guys to be. And that's why we keep making these podcasts every week. And that's why we're working hard here at White Coat Investors. There are 19 of us working here now.

As I record this, we're a few days from going to WCICON. We're building pallets in the garage. Katie and I are squabbling about where in the garage the pallets get built because I want to be able to shoot hockey pucks down there. And she's like, “You got to chill. Quit touching my pallets.”

And so, it's a stressful time for all of us here at WCI. But the reason we go through that stress is because we hear these stories about families like Frank's, where what we're doing is changing their lives. And that's the whole point. And sometimes I forget that. And I should be better when I email you guys back about showing compassion or recognizing what you're going through. I'm going to try to do a little bit better with that.

 

FINANCIAL BOOT CAMP: FSAS

Dr. Jim Dahle:
I promised you at the top of this podcast, we're going to talk a little bit about FSAs, and we're going to talk a little bit about dependent care kind of situations. Let's get into that now.

Dependent care FSAs or flexible spending accounts are slightly different from healthcare FSAs. One of the big differences is that you can still use a dependent care FSA, even if you use a health savings account, a high deductible health plan with a health savings account or HSA. That's not the case if you're using a healthcare flexible spending account.

But like all flexible spending accounts, this is use it or lose it money. So, never put more into one of these FSAs than you're going to spend that year. There is a slight amount that you can carry over year to year but for the most part, don't put anything in there that you don't know you're going to spend in this given calendar year.

A flexible spending accounts for dependent care can be used to care for your dependents, whether they are children or whether they are older. For example, some of the things they can be used for include adult daycare centers, afterschool programs, au pairs, babysitting, babysitting even by your relative. If the relative is not a tax dependent.

A before afterschool program, childcare, custodial elder care, day camp, dependent or elder care while you work to enable you to work or to look for work. Elder care in your home or someone else's. Extended care, which is a supervised program before or after regular school hours. A housekeeper who cares for your child. Obviously only the portion of the payment attributable to the childcare you can use the FSA for.

A nanny, you can use. Nursery school you can use it for, overnight care you can use it for with documentation that the care is employment related. You can use it for payroll taxes that are related to eligible care. You can use it for preschool. You can use it for registration fees once the care has been given. Senior daycare, sick childcare and transportation to and from the eligible care if it's provided by the care providers.

But there are lots of things you can't use it for that you might think you can use it for. Activity fees, no go. Babysitting that's not work related. So you can go on a date, no, you can't use it for that. It's got to be care of the dependents while you work.

Babysitting by your tax dependent. If it's your child or if it's your spouse or your parents that are dependent on you tax wise or for tax purposes, that's a no go. Dance lessons, can't do that. Day nursing care, you can't use it for that. You can't use it for educational learning or study skills services, field trips, housekeeping or maid services.

You can't use it for kindergarten tuition or language classes. You can't use it for meals, foods or snacks. You can't use it for medical care. This is the dependent care FSA we're talking about. It can't be used for medical care.

You also can't use it for nursing home care or piano lessons or private school tuition or kindergarten tuition or any kind of tuition like that. Respite care, can't use it for that. Sleep away camp, you can't use it for that. And if the transportation to or from the care is provided by somebody other than the care provider, you can't use it to pay for that. Tutoring, no, this is not for tutoring. This is for dependent care.

A few other things to keep in mind with these dependent care FSAs is the limits change every year. They may be adjusted upward with inflation. They were particularly high during the pandemic and are now significantly lower than they used to be.

But there's lots of things that you can use it for. Just make sure you don't put more in there than you think you're going to spend this year. They do have to be your dependent, but they can be your parent or they can be your child, anybody who's actually dependent on you that needs these care services.

Check the limits each year, but if your employer offers this and you are actually spending that much money on dependent care, then go ahead and use it. This is probably a better tax break than a lot of the other dependent care stuff out there, like the dependent care tax credit, for instance. This is probably a better deal for you.

By the way, if both you and your spouse are working, but one of you makes more than the social security wage limit, and you both have a dependent care FSA available to you, have the person with the lower income use theirs, because that is likely to save you significant amount of payroll taxes. Because it lowers their taxable income and they pay less in social security tax than if the higher earner that's above the wage limit were paying for it out of their taxes, because they'd only be paying Medicare tax.

I hope that's helpful. FSAs are a great tax break. Might as well take advantage, if your employer is offering one, just know what the limits are and what the valid uses for it are.

This podcast was sponsored by Bob Bhayani at Protuity. One listener sent us this review. “Bob has been absolutely terrific to work with. Bob has quickly and clearly communicated with me by both email and or telephone with responses to my inquiries usually coming the same day. I have somewhat of a unique situation and Bob has been able to help explain the implications underwriting process in a clear and professional manner.”

Contact Bob at www.whitecoatinvestor.com/protuity. You can email [email protected], you can call (973) 771-9100 to get disability insurance in place today.

Thanks for what you're doing out there. It's important work. Keep your head up and your shoulders back. You've got it. You're going to overcome whatever financial thing you are facing right now and you will soon be celebrating your own milestones. Whether you do it with us on the podcast or not, you'll soon be celebrating your own financial accomplishments. Get them done. See you next time on the podcast.

 

DISCLAIMER

The White Coat Investor podcast is for your entertainment and information only. It should not be considered financial, legal, tax, or investment advice. Investing involves risk, including the possible loss of principal. You should consult the appropriate professional for specific advice relating to your situation.

This is the White Coat Investor Podcast: Financial Boot Camp, your fast track to financial success.
Let’s talk about donor-advised funds, or DAFs. What is a DAF? It’s a vehicle where you can move money from your brokerage account into a dedicated charitable account. That transfer is permanent. You can’t take the money back out and use it for personal spending. However, it is treated as a charitable contribution for tax purposes. That means you receive the charitable deduction in the year you fund the DAF, even if you don’t distribute the money to a charity right away. You’ve essentially committed to giving it to charity eventually, so you get the deduction upfront.

While the money is in the DAF, it can be invested and grows tax-free. Neither you, the DAF, nor the eventual charity pays taxes on the earnings. When you’re ready, you can recommend grants from the DAF to qualified charities. In most cases, the DAF provider will follow your recommendations as long as the recipient is a legitimate charitable organization. You don’t receive an additional tax deduction at the time of the grant since you already received it when you funded the DAF.

Like any charitable donation, the most tax-efficient assets to donate are appreciated shares you’ve held for at least a year. When you donate appreciated investments, you avoid paying capital gains taxes, and the charity or DAF doesn’t pay them either. On top of that, you still receive a deduction for the full fair market value of the donation. This can be a very powerful tax strategy.

That said, you should not donate to charity solely to lower your taxes. You typically don’t come out ahead financially. For example, if you donate $100, you might save $35 in taxes, but you’re still out $65. The primary motivation should always be a genuine desire to support a charitable cause. If you don’t care about the mission, don’t donate, whether through a DAF or otherwise.

If you do have charitable intent, a DAF can be incredibly convenient. One major benefit is timing. You can take the deduction in a high-income year, such as after selling a business or during peak earning years, and distribute the money to charities later. This allows you to maximize the tax benefit when it matters most.

Another major advantage is simplicity. Instead of tracking multiple donations to different charities throughout the year, you typically only need to track one contribution to the DAF. This significantly reduces paperwork, especially if you’re donating appreciated securities. Some smaller charities may struggle to accept in-kind donations, but a DAF can handle those transactions easily and then distribute cash grants to the charities.

An additional benefit is anonymity. If you’ve ever donated regularly to charities, you know they often follow up with frequent marketing materials asking for more donations. With a DAF, you can give anonymously. The charity doesn’t receive your personal information, which helps avoid unwanted mail and marketing while ensuring more of your contribution supports the mission rather than fundraising efforts.
Of course, if you’re not itemizing deductions and instead take the standard deduction, donating to charity won’t provide a tax benefit, and using a DAF won’t change that. But if you are itemizing, a DAF offers the same deduction as direct giving with added convenience and flexibility.

As for which DAF to use, there are several good options. Vanguard Charitable is one we’ve used. It’s relatively low cost, typically charging around 0.6% to 0.7% on the first few hundred thousand dollars. While that fee exists, it’s often still lower than the taxes you would pay if those assets remained in a taxable account. One downside is the higher minimums. Vanguard typically requires a $25,000 initial contribution and has a $500 minimum grant size, so it’s better suited for larger donations.

Fidelity Charitable is another strong option with lower minimums. It generally allows you to start with around $5,000 and make grants as small as $50, making it more flexible for smaller or more frequent donations.

A newer option is Daffy, which has also gained attention for its low fees and ease of use. It appears to be a solid alternative based on early feedback.

Overall, you can likely find a DAF that fits your needs among Vanguard, Fidelity, or Daffy. Each offers slightly different features, costs, and minimums, so it’s worth comparing them based on your giving style.

Hope that helps you better understand donor-advised funds and decide whether one makes sense for your situation.

The hosts of the White Coat Investor are not licensed accountants, attorneys, or financial advisors. This podcast is for entertainment and informational purposes only. It should not be considered professional or personalized financial advice. You should consult the appropriate professional for advice specific to your situation.