Becoming a Millionaire by Reducing Your Taxes

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 435 – Becoming a Millionaire by Reducing Your Taxes.

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Thanks and welcome back to the podcast. We're thankful to have you here. Without you, there is no podcast. It's just me spewing information into the void. It's great to have you here. We just did our, I can't call it a webinar. I got to call it a crash course or I get in trouble. Our crash course last night, we're up late presenting that. So, for those of you who were able to participate in that, it was wonderful to have you. We hope that was super helpful.

Those who have no idea what I'm talking about, this is actually going to be available. I think it's going to be on YouTube, isn't it, Megan?

Megan:
Yes.

Dr. Jim Dahle:
I think it's going to be on YouTube. By the time you hear this, it's probably already on YouTube. But we spent about an hour and 15 minutes, myself and Andrew Paulson with Student Loan Advice, presenting material. Then we spent about 45 minutes answering questions from the audience. So, great time. I think we were able to help a lot of people.

Unfortunately, my hockey team tournament for the end of the summer season, our first game ended up being scheduled at the exact same time as the webinar. So, unfortunately, my team lost the game by two goals. I don't actually get to play in the playoffs this year. Very unfortunate.

But it was a great session. So, I think it's worthwhile. Lots of people made sacrifices to be there as well. But I think we ended up having a great presentation and some great discussion afterwards. So, check that out. It's on YouTube.

By the way, a lot of you out there are new to the White Coat Investor world. You may not know about Boot Camp. If you go to whitecoatinvestor.com/bootcamp, you're basically signing up for a free email course. It's 12 emails. One comes a week for 12 weeks. And each of them gives you some information and a task to do.

Now, some of them you've probably already done. Some of you may not have. So, it's information plus something you need to do to get your finances lined up. Like the first one's about disability insurance. If you don't have disability insurance and you need disability insurance, you need to go get disability insurance. Each of them has one of these items.

But you can sign up for this. Get yourself on a fast track being debt-free within five years out of residency and becoming a millionaire down the road. So, sign up for that. whitecoatinvestor.com/bootcamp.

It's interesting to create the titles for these podcasts. And the number of people who listen to a podcast is actually highly dependent on what the title is. It turns out talking about things like your income, how much you're making, especially if we're comparing it to other doctors, very popular. Talk about being a millionaire, very popular. Reducing taxes, very popular. If we talk about helping your special needs kid or if we talk about reducing your burnout, not as popular. It's very interesting.

All my titles from now on are going to be things like becoming a millionaire by reducing your taxes through Roth conversions or something like that. So, be prepared for that. Although, as you know, on this podcast, we hit lots of different subjects. Today, we are going to focus quite a bit on taxes though, because those are the questions you guys are asking and you really drive the content behind this show.

If you want to leave questions, the best way to do that is the Speak Pipe. So, you go to whitecoatinvestor.com/speakpipe and you can record up to 90 seconds of a question and we'll try to answer it on the podcast. We do them by email too. You can always email [email protected] or [email protected] and we'll get your email questions answered as well. I don't think we're quite popular enough that we can run this as just a call-in show every time we do it, but this is the closest thing we can get to that.

401(A) AND SOCIAL SECURITY

Let's take the first question here today. This one's about the 401(a) and social security taxes.

Matt:
Hi, this is Matt from Florida. I am a fellow and finishing up my fellowship going to be finishing in fall of 2026. For the last six years, I've been making mandatory 401(a) contributions by our employer, which is a large academic hospital. As far as I understand, this has been in lieu of our social security taxes. So, instead of having social security tax when I have a paycheck, instead that money would be in front of this 401(a). It's going to end up having about $15,000, $20,000 in it by the time I'm done.

As far as I understand, this is going to be pre-tax and therefore treated kind of like a 401(k). I was thinking in the first six months of my attending, that I'd then be able to roll this over into my Roth IRA and pay the taxes on that or roll it over into my 401(k). Just making sure I'm understanding the 401(a) correctly. Thank you for all you do. Have a good day. Bye.

Dr. Jim Dahle:
401(a)s are relatively common retirement accounts among academic docs. The local university here in Utah, they offer their employees a 403(b) and a 401(a) and a 457(b), a governmental 457(b). So, it's not uncommon for university docs to have this.

In some governmental employers, you actually pay into a state kind of pension system in lieu of social security. I don't know that I know all the ins and outs of exactly who does that and who doesn't do that. Maybe your employer does that.

I don't know that the 401(a) is necessarily a replacement for paying social security taxes. Most retirement account contributions, you are paying social security taxes and Medicare taxes on the money going into those accounts. I guess it's possible that you're not on the money going into your 401(a) or you're not on any of what you're earning because your employer somehow opted out of the social security system in favor of some sort of pension system and maybe that's the form of a 401(a) for you.

I don't know that I know enough to really talk about that, but that's not really your question. That's not what you're curious about. You're finishing your training. You have a tax-deferred account. You're trying to decide whether to convert it to a Roth or not, and the answer is yes. You should convert it because this is a relatively low income year for you.

The rule of thumb for Roth contributions and conversions is that you don't do them in your peak earnings years and you do do them in anything that's not a peak earnings year. So a year that you're leaving training, you're leaving your fellowship, so you got half a year of fellow income and half a year of attending income, is by definition not your peak earnings years. Per the rule of thumb, that would be a good time to do a Roth conversion.

There's lots of exceptions to that rule of thumb. Don't write in hating me for talking about the rule of thumb. I know there are exceptions. I've written about them extensively. One of the main ones that applies to people in training is often if you're trying to keep your student loan payments low so that you can get more forgiven via public service loan forgiveness. That's a real common exception among docs, especially early in their career.

And there are other exceptions. If you go to the website, whitecoatinvestor.com, in the search box in the upper right and you search Roth contributions, you will find my latest blog post talking about just how difficult this decision can be, whether to do a Roth conversion or not, or to make Roth contributions or tax deferred contributions. It can be really complicated, but the rule of thumb works most of the time for most people.

So if you can do a Roth conversion, great. It sounds like you got $15,000 or $20,000 in there. The problem with that is you're going to get a tax bill for this. Maybe it's a $5,000 tax bill, and you're going to have to pay it at least by next April. Maybe you ought to pay a little bit sooner and avoid some penalties and interest, but you're going to have to pay it at least by April.

And the question for you is, is that the best use of your money at this point in your career? Maybe it is, maybe it isn't. Maybe you need to pay off some 15% credit cards. Maybe you want to get going on your student loans, because that's a really high priority for you. Maybe you've got some other retirement account available to you that offers the sweet match you're not going to be getting. In those sorts of situations, maybe this isn't the best use of your dollars.

The problem being a new attending is you have so many good uses for your money, and only so much money to go around. So you've got to decide that, whether that's a good use for your money. But if you can come up with the money, yes, this is a good idea to do.

The worst thing you can do with tax deferred money coming out of training is put it in a traditional IRA. While that's convenient, and you can sometimes lower your investing costs, and you have a few more investing options doing that, you mess up the possibility of doing backdoor Roth IRAs going forward, because that traditional IRA gets calculated in when they do the pro rata calculations on the conversion step of your backdoor Roth IRA process.

That's what you don't want to do. It's okay to roll that 401(a) into your next retirement account. They're not going to demand you do it the day you walk out of the old job, but eventually you're probably going to want to move it out of there. You can just roll it into the 401(k) at the new job, or the 403(b) at the new job. So, that's a reasonable option too, if you can't come up with the cash to pay the taxes on the conversion.

But I do think a Roth conversion of any tax deferred money you have before school, during school, during residency, as soon as you leave residency and are able to do it, that's usually a good move. It's a good idea to get more money into Roth accounts for the most part, but complicated question when you really dive into the details sometimes. Okay.

QUOTE OF THE DAY

Our quote of the day today comes from Carlos Slim Helu, who said, “With a good perspective on history, we can have a better understanding of the past and present, and thus a clear vision of the future.” And I think financial history is very worthwhile to learn. Because then when things happen in the markets and you're like, “Oh, this has never happened before. The world's blowing up. I got to sell everything, or I'm going to short the market or whatever.” You realize, “Oh, I've seen this movie before and I know how it ends.”

Now history might not repeat, but it definitely rhymes. Every few years, something terrible seems to be happening in the world. Markets have a huge dive. And if you just stay the course, almost all the time and almost all places, you're rewarded for doing so. Come up with a long-term plan that acknowledges history, acknowledges that you're going to have these challenges going forward. And then you can stay the course with that plan and reach the financial goals you're trying to reach.

Okay. Our next question comes from Eric. Another Speak Pipe question. Let's take a listen.

STRATEGIES FOR USING TAX LOSSES IN RETIREMENT

Eric:
Hi, this is Eric from the Midwest. Can you explain in detail about different strategies on using tax losses in retirement? Do tax losses affect the order of retirement accounts to draw from?

For example, would it make sense to draw from tax deferred accounts to fill the lower brackets up to a certain bracket, let's say 24%. Then if you want more income, sell assets for a capital gain that would otherwise push you into the next tax bracket, which can have significant consequences for social security taxes, IRMAA, and obviously income taxes. But since you have tax losses, this can offset those gains and thus keep you in the 24% tax bracket. Essentially, can tax losses behave as a stealth Roth IRA in this sense?

A second strategy I've been thinking of would be for Roth conversions. I've read it's more beneficial to pay the taxes on the conversion with taxable money rather than from the tax deferred account. If you sell an asset for a capital gain to pay for a Roth conversion, but also use tax losses simultaneously, could this essentially be a tax-free Roth conversion? Am I thinking about this correctly? Thank you.

Dr. Jim Dahle:
Okay, Eric, you've gotten to a level of financial literacy where you're starting to understand how things work. Yes, all these are viable strategies. Tax losses are generally a good thing to have. You don't want to lose the money. If you can avoid losing the money, that's even better than having tax losses.

But presumably you're going to lose some money at least temporarily along the way. Markets go up, markets go down, et cetera. You don't want to deliberately ever invest in something that's going to lose money, but you know you're going to lose money as you go along the way.

When you lose money in a taxable account, you can do what's called tax loss harvesting, in which you do not really change what you're investing in, but you book that loss. And then you have that loss you can use to reduce your taxes. Tax loss harvesting, let's say you buy VTI, the Vanguard Total Stock Market Index ETF. And it goes down in value. Two months after you bought it, it's down 20% already, bummer. Very unfortunate timing.

What you can do at that point though, in taxable accounts, you're not doing this in retirement accounts, is you can sell VTI. And 18 seconds later, you can buy ITOT, the iShares Total Stock Market Index ETF. And what you've done is you've now booked that 20% loss that you can use in various ways, but you didn't really change what you're investing in. You're not selling low. I mean, you are selling low, but you're also buying low at the same time. So you're not changing your investments.

And that's a key aspect of tax loss harvesting, is you don't want to change what you're investing in. You're not trying to sell low. That's not the goal. The goal is to keep your portfolio the same, but grab a tax loss that you can use.

Once you have these tax losses, there are all kinds of ways that you can use them. For example, you can use $3,000 per year. And unfortunately, this has never been indexed to inflation. It's been this the whole time I've been investing, but you can use $3,000 a year against your ordinary income. If you made $300,000 this year, you're only paying taxes on $297,000 of it. So, that saves you like, I don't know, a thousand bucks of tax.

That's a good thing, but there's a limit. You can only use $3,000 a year. If you booked a $30,000 loss, and this was the only way you're using it, it's going to take you 10 years to use up that $30,000 loss, $3,000 at a time.

People start going, “Well, what other ways can I use these losses?: Well, Eric mentioned a couple of ways. A few other ways that I think about, and the reason why I continue to acquire tax losses, despite the fact that I've got enough tax losses that I could live for hundreds of years at $3,000 a year and not run out of them.

The reason I keep doing it is the potential to really have big gains in the future. For example, if we ever sold White Coat Investor, we'd have a big capital gain because our basis in it is pretty darn close to zero. If we sold our house after it had more than a $500,000 gain, $500,000 married, $250,000 single. Then you pay capital gains taxes on anything above and beyond that amount of a gain. That's how a lot of people end up using tax losses, is when they sell something really valuable.

But even if you're just in retirement, spending money from your taxable account, those tax losses can be useful. For example, if you're spending the money, the shares you tend to use up first in retirement are the ones with the highest basis. Especially if you're going for at least a year and there's only a little bit of a gain, well, you might be able to spend $100,000 and only generate $10,000 in gains. And if you've got $30,000 in tax losses hanging around, you don't have to pay any taxes at all to spend that $100,000 because the tax losses will cover that $10,000 in gains and the rest of it was just basis, is money you put in there in the first place, your principal. That's a way that people will use tax losses pretty effectively.

But the strategies you mentioned, Eric, worked fine. If you're doing a Roth conversion, and you want to pay for that Roth conversion using taxable money, well, you can sell appreciated shares, offset those gains with losses you've been carrying forward each year, and offset the tax cost of coming up with that money in your taxable account to pay the tax bill on the Roth conversion.

Be aware though, that the tax bill from Roth conversion is ordinary income. It is not a capital gain. So you can only use up to $3,000 a year against ordinary income. Yes, it can help, but it's helping on the sale of the taxable assets to pay the tax bill. It's not helping on actually reducing the tax bill of the Roth conversion. But yeah, you're thinking about things right. Once you have these tax losses, you start going, “Oh, these are pretty useful.”

It's particularly powerful technique if you combine it with donating appreciated shares to charity. If you're a charitable person, I encourage you to be a charitable person. I think there's lots of great things that happen to you when you give money away. But if you're going to give money away, you are far better off giving away appreciated shares that you've owned for at least a year than you are donating cash.

And maybe the easiest way to do that is through a donor advised fund. Then you just have one big donation once a year or whatever of appreciated shares, and then you can dole the money out willy-nilly throughout the year without having to worry about keeping track of a hundred different charity receipts. You just have to keep that one for when you put the money into the donor advised fund.

Plus it lets you give a little more anonymously, which is really good. I hate getting glossy pamphlets in my mailbox three times a week from charities we've donated to asking us to give you more. I want you to use the donations I'm making to do some good, not to just solicit more donations. I call that charity porn that shows up in my mailbox. I don't want my money being used for that so I try to donate anonymously to avoid that problem.

But anyway, when you donate appreciated shares, if you've owned them for at least a year, you get the full value of the share at the time of donation as a charitable deduction that you use on Schedule A, your itemized deductions. So that reduces your tax bill. And neither you nor the charity have to pay the capital gains taxes.

I'm continually acquiring losses when the market goes down on stuff I've recently bought. And I'm never paying capital gains because I'm donating the appreciated shares to charities.

So, you're flushing capital gains out the top of the account, your tax loss harvesting at the bottom of the account. You combine the two. It's very, very powerful. Reduces how much is going to the tax man, which means you keep more. Your after tax return is higher. You become a millionaire sooner, et cetera. But yeah, there's lots of different ways you can use the tax losses. You've identified a couple of them, and I think both of those methods would work just fine.

Okay. Let's take our next question from Nate, who's also finishing his training, it sounds like. I wonder if he's done now. He might be done now, given that this might've been recorded before July 1st.

MOST TAX-EFFICIENT USES FOR EXTRA MONEY DURING TRAINING

Nate:
Hey, Dr. Dahle. I hope you're doing well. My name is Nate and I'm a final year MD PhD student currently applying for anesthesiology residency. I wanted to ask you a few questions. I'll break it up into different recordings. I've been investing for about 10 years now, thanks to having a father who got me started early on.

I have a Roth IRA that consists of the Vanguard target retirement 2065 fund and a taxable Vanguard brokerage account that consists solely of VTSAX. I've been fortunate in that I haven't had to take out any loans due to the MD PhD and that with the stipend and the fellowship grant that I have, I've been making about $48,000 per year.

By living relatively frugally, I'm able to max out my Roth IRA contribution within the first three to four months of the year. What I've been doing is just putting my extra income into the taxable account for the rest of the year, since I don't have a spouse IRA or an employer 401(k) that I can contribute to.

My first question is whether this is the right move for me or whether there's another more tax efficient use of my money that I'm missing. I suppose I'll have a 403(b) as a resident and I should have asked this question several years ago, but just theoretically, is there anything I could have or could be doing differently? Thanks for everything you do. I've learned an insane amount by listening to the podcast. I really appreciate it.

Dr. Jim Dahle:
All right. Good question, Nate. Congratulations on your success. Finishing your schooling is no small feat. It's not just college and medical school for you. It's college and medical school and a PhD. So, it's great that you are accomplishing all this and you're not even that old yet. This is going to work out very well for you.

Plus somebody taught you about investing early in your life. You're coming out of school, you've already been investing for 10 years. You're at least a decade ahead of the rest of us. So this is fantastic. You're going to do great. Recognize this, that you have a fantastic start and you've got the X factor for lack of a better term. You're going to be very wealthy someday.

Because you've become so financially literate so early in your career. You've already got no student loans and you've already got money put away and you're not even done with school yet. So recognize where you're at in stacking up against your peers. You're way ahead of most people.

It's great the stuff you're worrying about, but recognize that a much more likely problem for you down the road is you're going to be one of those people who has just got more money than you know what to do with. And so, it's okay to stop, smell the flowers a little bit along the way, maybe spend a little bit of money on something that's going to bring you joy.

There are things that are going to make you happy that you can do in your 20s and 30s that you cannot do in your 70s and 80s. So maybe consider using some of this money along the way to do some of those things. That's all I'm saying. I'm not saying spend it all. You got to balance future you and current you.

So, find that right balance for you. But optimizing things so you can die the richest doc in the graveyard is not the ideal pathway. Find the balance there. You're not wealthy yet, obviously, but I can see you're headed there. And so, be thinking about these things as you go along. There is nothing wrong with what you're doing.

This is essentially your first question. Your first question is, “Am I doing good?” Yeah, you're doing great. You're killing it. Yes. As much as you can put into a Roth IRA, if it's considered earned income, and it sounds like your stipend being paid for your MD PhD is being considered earned income. If you're paying payroll taxes on it, it's earned income and it can go into a Roth IRA. If you had any tax deferred money, you should do Roth conversions on that. That would be another good use for your money.

And if you want to save and invest more above and beyond what you can put into a Roth IRA and you don't have any employer-provided accounts, yeah, the rest has to go into taxable. There's no limit on how much you can invest in taxable. And so, you're doing a good job.

You've also chosen good investments. I've said before, if I had it all to do over again, I'd just stick it all into a target retirement fund, at least inside retirement accounts. And that's basically what you did. So, perfect. Nice work.

And then of course, once you're starting a taxable account, you got to think a little bit more about the future. Asset location comes into effect. And there's a great blog post all about it. It's super long, tons of detail. Go to the blog, search “Asset location”, and you will find it. And it'll walk you through all the ins and outs of choosing what funds go in taxable versus elsewhere.

But the way to think about this is not to go, “Okay, I have international stocks. What accounts should they go in?” That's not how you think about it. When you're doing asset location properly, the way you think about it is by what should go into taxable next. I think I'm actually answering your second question. I got to be a little bit careful doing this. Let's play your second question first, and then I'll answer that.

OPTIMIZING THE TAX EFFICIENCY AND DIVERSITY OF ASSET ALLOCATION

Nate:
Hey, Dr. Dahle, it's Nate again, the final year MD-PhD student applying for anesthesiology residency. I wanted to continue and ask a couple of additional questions about my portfolio. I've been a bit overwhelmed with all the information about optimizing the tax efficiency and diversity of asset allocation.

First, how important is it for me at 30 years old to diversify beyond VTSAX and the 2065 retirement fund? Second, if it is important, I think I'd like to start by diversifying into international stocks and domestic bonds. Would it be better for me to start doing this in my Roth IRA, where I can contribute only a limited amount per year, or in my taxable account, where the additional funds carry the con of capital gains tax? Am I even thinking about all this correctly? Thank you again.

Dr. Jim Dahle:
Okay. Now you know why people know why I was talking about asset location. Do you need to diversify away from a target retirement fund? No, you don't have to do that. A target retirement fund has international stocks in it, in a reasonable percentage. I don't know which one you're in and what that percentage exactly is, but if it's 10% or 20% or 30% or 40% international, whatever, that's fine. You've already got international stocks in that target retirement fund. But the problem is once you are at the point where you're starting a taxable account, a target retirement fund, super simple solution that works great when all you've got is a Roth IRA, or all you've got is your 401(k), really starts to break down. It's kind of time to start rolling your own asset allocation.

The fact that you've got a taxable account now, it's time to probably be thinking about what does my asset allocation really look like? How much is it going to go into US stocks? How much is it going to go into international stocks? How much, if any, do I want in bonds or real estate or Bitcoin or whatever. And actually write down a written investing plan of how much you want in each of these types of assets. And then you look at your portfolio, what you have, and you divide it up so that your total asset allocation across all of the accounts, at least of your long-term money, matches your desired asset allocation.

Yes, I think it's worthwhile having international stocks. 2025 was a good example of a year, and it's been a while since we had one of these years, but a year in which US stocks did great in 2023 and 2024, and then international stocks did much better in 2025. So if you own them, they're going to have their day in the sun.

And I think it's worthwhile setting that static asset allocation as you go along, so that when international stocks or US stocks or bonds or real estate or whatever you decided to include in your portfolio has this day in the sun, you own it, and you're happy that you own it.

But being diversified means you always own something you're not happy about owning, and that's the way it is. If it's a year where stocks are going crazy, you're bummed that you have some money in bonds. If it's a huge market dive, you're bummed you put so much money in stocks. You always have some regrets when you have a diversified portfolio. But yes, I think it's worth diversifying into international.

That brings us back to this asset location issue. You're asking yourself, “Okay, I've got $20,000 in a Roth IRA, and I got $10,000 in a taxable account, and I want to have one third of my portfolio be international stocks, and the other two thirds be US stocks. What should go in that taxable account?”

There's basically two factors to think about when it comes to international stocks versus domestic stocks being the first thing that goes into the taxable account. This is assuming you're using a very tax efficient low turnover index fund to start with for each of the asset classes.

But the first question is, “Well, which one has a higher yield?” And the reason why is that yield is dividends being paid out every year, and the more dividends that are paid out, the more you got to pay taxes on those dividends. So you kind of want a lower yielding investment in the taxable account. It's a more tax efficient asset class.

When you're comparing VTI, the US stock market index, to VXUS, the International Stock Market Index ETF at Vanguard, the US one has much lower yield. It's a more tax efficient fund. So for that reason, a lot of people will put their US stocks into taxable first, and I think that's probably the way to go.

But there's a compounding factor, and it's called the foreign tax credit, which is ridiculously complicated. There's a blog post on it on the website, search foreign tax credit, you'll find it is super complicated.

But the bottom line is it reduces the tax cost a little bit of that higher yield of international stocks. I don't think it's enough that it's worth putting international stocks, preferably in the taxable before you put the US stocks in there. But that's probably the second asset class, most people move to the taxable account.

Once your taxable account has all of your US stocks in it, and you need something else to move in there, the international stocks are perfectly fine to move in there next. I hope that's helpful as you set up and manage your portfolio in an ongoing way moving forward.

Congratulations, you're doing fantastic. You should be super proud of yourself. And thanks for doing you know, an MD PhD, it's important work that you're qualified to do now. And I look forward to you making contributions to your field.

Okay, let's spend some time talking a little bit more about capital gains and capital gains taxes.

MINIMIZING CAPITAL GAINS TAXES

Andy:
This is Andy in the Midwest. I'm in a surgical subspecialty in a 10-man private group which merged with another private group. This would be great for a long-term future. We had a surgery center which the other group bought into which resulted in a big check after the merger was complete. I'm expected to pay a significant amount of taxes before the end of the year, almost $300,000.

The accountant gave me a financial flyer about a tax loss harvesting strategy fund that might minimize or decrease my taxes. I'd also thought about buying a short-term rental property and trying to depreciate the property quickly in 2025 to decrease my capital gains. Do you know of any good strategies that could decrease my taxes or eliminate them? I've been taxed less harvesting throughout the years but only have maybe $10,000. So there's a significant amount of money left over. I appreciate your response. Thanks for all that you do.

Dr. Jim Dahle:
Okay, great question. First of all, to all of you out there in White Coat Investor land who have no idea what Andy's talking about, don't worry. You're going to pick up on this stuff eventually. He's actually asking a pretty high-level question here and it's going to take a lot of background information to even explain what he's asking for those of you out there to understand it. So, recognize that that just totally went over your head. That's pretty normal and don't worry about it. You're going to figure this stuff out as well.

Andy, the first thing I'm going to tell you is welcome to being a successful professional. Welcome to being a successful investor. The price of making a lot of money is paying a lot of money in taxes. The only thing better than having to pay six figures in taxes is having to pay seven figures in taxes. It's a wonderful thing. It means you made a ton of money and that's a good thing.

So, don't get too crazy trying to reduce your tax bill. The easiest way to reduce your tax bill is to lose money or not make any money. That'll reduce your tax bill, but that's probably not what you're really trying to do. So be careful not to let the tax tail wag the investment horse or the income horse, the job horse, the profession horse, whatever you want to call it.

Your goal in life is not to pay the least amount in taxes that you can. The goal is to have the most after paying taxes that you can. Truthfully in life, there are more important things than money anyway, but as far as money goes, your goal is to have the best after tax outcome that you can. So, if that means making more money and paying more in taxes, that's not a bad thing. Don't go too crazy trying to reduce your tax bill. You'll quickly find that the techniques that really work well don't necessarily result in you having more money after tax.

That said, there's nothing wrong with doing a little bit of tax planning. A little bit of tax strategizing and trying to do what you can to reduce your tax bill. You're already doing something that does this. As we talked about earlier in the podcast, harvesting those losses as you have them.

That usually only means selling stuff you bought in the last year or two or three when it goes down in value. After that, it's never underwater anymore. Grabbing those losses as you go along because somewhere down the road, you might have some sort of capital gain like this. And if you had $300,000 in losses, you could use that to offset $300,000 in gains and you wouldn't have to pay taxes on them. That will help a great deal. You can use an unlimited amount of those capital losses against capital gains. Only $3,000 a year against ordinary income, but it's an unlimited amount against capital gains.

Knowing that, there are smart people out there who are doing strategies of investing that try to get you even more losses than you would get just using a normal buy some ETFs. And when they go down in value, swap them for a similar ETF every couple of months, kind of strategy that I use. These are funds that are specifically trying to harvest as many losses as they can. Now you got to pay a little extra for these most of the time. It's going to cost you more in an expense ratio.

So, if these losses are not very useful to you, that might not be a great thing to do. But if you see yourself down the road as getting a lot of benefit out of these losses, it might be worth paying extra to get them. Perhaps the greatest way to do this, if this is really important to you, and we talked about on the podcast a few months ago, is direct indexing.

And the price for that has gotten low enough that I think you can justify doing it if tax losses are particularly helpful to you in your financial life. If you have lots of uses for these tax losses going forward, that you're willing to deal with some hassle and complexity and additional expense in order to get more, that might be a good way to do it.

And all direct indexing is, is buying all the stocks individually. Because the problem with mutual fund law is when a mutual fund has a loss, it can use it to offset its own gains, but it can't pass that loss through to you. By direct indexing, it can pass that loss through to you. And these other tax loss harvesting strategy funds or advisors work in a similar way.

The idea is every time one of those stocks goes down in value, they have tax loss harvested. It's a little trickier with stocks to get a good tax loss harvesting partner. But as long as they can track the index return relatively well and grab those losses, that's great. It can be a mess if you ever decide you don't want to do this anymore and you got to unwind it. And now you own 400 individual stocks instead of one ETF or two ETFs rather, but it can get you more losses.

Now, can you get very many of them between now and the end of the year? Well, probably not that many. I'm not sure this is going to really offset this one capital gain that you're staring in the face that's going to occur in 2025. I don't know if this is a great way to do it.

Another option, depending on what you want to invest in, is there are these funds out there, these real estate funds that are called opportunities zone funds that reduce the blow of capital gains as well. They allow you to defer them and not pay on any additional gains. There's some benefits there.

You might want to look into that, but you don't want to let the tax tail wag the investment dog. You have to want to invest in real estate before you should go buy into a real estate opportunity zone fund. You shouldn't invest in that just for tax purposes. In fact, you pretty much shouldn't invest in anything primarily for tax purposes. You should be looking at the investment return first. And if it comes with a few tax advantages, great, that's cherry on the top.

If you are interested in real estate, I've told people many times, I think the fastest way to financial independence for a doc, fastest way out of medicine, if you hate your job, is probably to build an empire of short-term rentals. There are significant aspects of a second job. There's significant risk here, including leverage risk, but I think it's a pretty fast way out of medicine if you do it well. But it's not nearly as simple as just throwing your extra money into VTI, max out your retirement accounts. That's way easier.

But yes, one of the things you can do, as you alluded to, Andy, is you can use the short-term rental loophole to decrease capital gains. And all you're doing here is you're basically able to accelerate your depreciation. The combination of bonus depreciation and the short-term rental loophole that allows you to use that depreciation against your income, not just the income from the rental, but your income from these other capital gains that you're facing, will allow you to reduce the tax blow there.

And you could do that. If you've got a short-term rental before the end of the year, and you did a cost segregation study, and you used bonus depreciation to get as much of that depreciation that you're going to get from this rental over the years up front, and use that to offset these capital gains, that would reduce the tax bill this year.

Whether that's worth doing or not really comes down to whether you want to be running a short-term rental empire or not. If you do, great. This is a great time to do it. If you don't, it feels to me like the tax tail wagging the investment dog. It's okay to just pay the taxes on this great windfall you've gotten. Enjoy the windfall. Save some of it. Give some of it. Spend some of it. It's wonderful to have a windfall. Pay your taxes. Be glad you have it. Don't beat yourself up that maybe there was some way you could have perfectly optimized your finances to reduce your tax bill a little more.

But it's worth exploring some of these other options, the opportunities on funds, starting a short-term rental business, looking into direct indexing or other tax loss harvesting strategies, and seeing if those are worthwhile. But be careful. There's a lot of people selling you stuff mostly out of your fear or disdain of paying taxes. Don't make a bad investment just to reduce your tax bill.

Okay, the next question is from Daryl.

FINANCIAL PLANNING FOR INEVITABLE CAPITAL GAINS

Daryl:
Hey Jim, this is Daryl in Dallas. So my wife, who's a doctor, originally found the White Coat Investor a couple years ago, and we've been working on our path to financial independence ever since. I actually come from the tech world, and I've got a bit of a unique situation.

My first job outside of college was at Amazon, and as part of that comp package, I got a bunch of restricted stock units, or RSUs. I've held on to most of them over the years, except for a portion that we sold to buy our house back in 2015. And in that time, they've more or less 15X'd in value. We've got about $140,000 worth of holdings, of which the capital gains equivalent is almost $131,000. And of course, it's also our largest single holding in that one stock.

As we're thinking about preparing for retirement over the next 20 years or so, I'm really wondering what to do to try and mitigate the capital gains liability that I'll have, and really just kind of de-risk our portfolio. I know it's a good problem to have, but better start thinking about it sooner rather than later. Thanks.

Dr. Jim Dahle:
Okay, Daryl, good question. Again, a little bit like Nate's question. You're looking at these capital gains as a bad thing. This is not a bad thing. You made money. Awesome. Wow. You made all this money. This is great. Your investment 15X'd. This is a good thing.

Paying your taxes and moving on with the rest of the gain left over after paying taxes is a beautiful thing. You do get to take advantage of long-term capital gains rates, which are lower than ordinary income rates. So, that'll help soften the blow a little bit. But you don't have to look at this as a problem that needs to be solved. This is a win to be celebrated, not a problem to be solved. I think it's important to start from that perspective.

Now, what can you do to reduce the impact of these capital gains? Well, there's two things that work really, really well. Well, three things that work well, but you don't want the third one. The third one is just losing money. The stock goes to zero and now it's worth nothing. Now you have no gains. You don't have to pay any taxes on it, but you don't want that.

The two things that you might want that work really, really well to reduce this bill, this tax bill, is one, if you give money to charity, stop doing that. I don't want you to stop giving to charity. I want you to stop giving cash to charity. I want you to use these shares for your charitable gifts. You own them for at least a year. So you get the full value when you donate it as a charitable deduction. No point in donating cash anymore. You should be donating these appreciated shares. That's a great thing to do if you're a charitable person. If you're not a charitable person, shame on you. No, I'm just kidding. If you're not a charitable person, though, that doesn't work.

The other thing you can do, which works really, really well, which you might not like all that much, is die. If you die, your heirs get to step up in basis of death. That works really well for them. Doesn't work so well for you if you were hoping to actually spend this money at some point, but it works really well for them. That gets you out of the capital gains as well.

Otherwise, your options come down to some of the stuff I was talking to Andy about, who has got a big capital gain. They've already realized this year, and he's scrambling to figure out how to reduce it somewhat. If you've got tax losses, because you've been tax loss harvesting your other investments as you go along, you can use those losses to sell some of these shares and come out with no tax bill and be able to diversify your account, especially since this is your largest holding.

That's what I worry about more than anything, is that it might be worth realizing these gains just so your portfolio isn't all in one stock, especially if that's your employer still. That's a terrible lack of diversification where your daily income and your portfolio are all tied up in the fortunes of one company. That makes me nervous right there. It might be worth just paying some taxes in order to improve your diversification in your portfolio. Don't let the tax tail wag the investment dog.

Other things you can do, though, as you go along. First of all, you have to stop. Once you find yourself in a hole, stop digging. Are you reinvesting your dividends into this stock? Stop that if you are. Make sure you're not buying more of it. If you have any tax lots with a loss or not much of a gain, you can sell those right now and decrease the impact of that legacy holding on your portfolio.

What I would expect over the years is you add money to other investments. This will become a smaller and smaller portion of your portfolio. It doesn't bother me to hear that someone's got $100,000 or $140,000 in a single company stock if they've got a $4 million portfolio. I can live with that lack of diversification. When you've got a $200,000 portfolio and $140,000 of it is in one stock, that's a bit more of a problem. You're weighing tax costs versus getting more diversified now.

I hope that's helpful in a discussion of what to do about those capital gains. You've got the legacy investment problem is what we call this. If you search legacy investment on the website, you'll find a discussion of the various methods you have to deal with this issue that you've got without just selling and paying all the capital gains on it.

Capital gains are good things. They're not bad things, but they're worth planning for doing some tax strategizing a little bit to minimize the impact of that stuff.

If you need professional help with these sorts of strategies, we keep a list of tax strategies on the website. You go to the website, recommended tab, go down to tax professionals. I think it's called tax services. You'll find a list of tax strategists. These are people that can help you deal with issues like this. They're not all that cheap. A lot of them charge as much as a good financial advisor, but they can help you come up with strategies that can help you reduce tax bills like this.

Often, those strategies will more than reduce your tax bill by more than the cost of paying the tax strategist. If you really get into a complicated situation with a lot of money and you're looking for a professional to really help you walk through the impacts of various strategies, those are some people that can help you.

All right. I think our time is now short. I got to get on an interview here, so we need to wrap up this podcast.

SPONSOR

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All right. Don't forget about that boot camp. That 12-week email course is totally free to you. whitecoatinvestor.com/bootcamp is where you sign up. Get yourself on the fast track to being debt-free and becoming a millionaire.

Thanks for those of you leaving us five-star reviews and telling your friends about the podcast. A recent one from Ben came in saying, “The best finance podcast for doctors. I'm so grateful to Dr. Dahle for providing so much financial knowledge at zero cost. I've been maxing out tax-protected accounts with index funds for years, but listening to these episodes has helped me see that there's so much more to personal finance than that. Applying this knowledge will enable me to work less and spend more time with my wife and four kids who I did not see very much during residency. Thanks for creating something that is such a blessing for my whole family.” Five stars.

Oh, thanks so much. That's a kind review, Ben. We appreciate your kind words. And more importantly, we appreciate the review because it's going to help other people just like you find this podcast.

All right. We're going to see you next time. Keep your head up and shoulders back. You've got this. The White Coat Investor community is standing behind you. We're here to help you. We'll see you next time on the podcast.

DISCLAIMER

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

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 238 – Hand surgeon becomes multimillionaire.

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Welcome to the Milestones to Millionaire podcast. This is where we feature your stories and highlight what you've accomplished, the milestones you've reached and use them to inspire others to do the same.

You can apply to be on this podcast. Go to whitecoatinvestor.com/milestones. We'd love to tell your story or to have you tell your story rather and see what lessons we can learn from it.

Oh, by the way, today's the day. As this podcast drops, this thing drops September 1st. You know what today is? Today is the day to buy your WCICON26 tickets. This is technically the start of the early bird ticket sale where you can get the best deal. That goes until September 23rd.

But let me be honest with you. The last time we had WCICON in Las Vegas is sold out in 23 hours. Maybe this one's going to sell out too. You might not want to wait until September 23rd. We would love to have you there.

This is going to be an awesome WCICON. We are not in a hotel on the Strip. The Strip is not that far away. You can get there if you want to go down there and do strip stuff. You want to see shows or strip stuff or go gambling or whatever. You can do that. You can get there, it'll be a short Uber ride.

But we're not there. We're out in Summerlin. It's a great resort. There's going to be some awesome activities. We're actually going to be going around and doing some cool stuff that I love to do about Las Vegas, like getting out Ford Red Rock. And it's going to be pretty awesome. But it's the same cool stuff about every WCICON. It's a chance to meet your people. It's a chance to learn about personal finance and investing, maybe finally do that thing you haven't gotten around to doing yet, whatever that might be. And maybe make a few little tweaks to your financial plan.

But a big chunk of the conference, this thing is called the Physician Wellness and Financial Literacy Conference. That wellness part is a big part of the conference. A lot of people say the best stuff they went to was the wellness, anti-burnout kind of stuff to help you not only do well while you're doing good, but to thoroughly enjoy your career and to be able to extend it. As long as you need or want it to be extended.

Okay, early bird pricing, you get $300 off an in-person pass to the conference. It's $1,699 general, because the regular price is $1,999. It's $2,199 premium. It gets you some other cool stuff, including coming to a pretty cool premium dinner we do there. The regular price on that is $2,499. So, you're saving $300 if you buy this before the 23rd. And it may be that everybody comes on the early bird pricing this year, especially if we sell out super-fast again, like we did the last time we were in Vegas.

There's a meals and activities pass that doesn't include any sessions. That's a $599 general or $799 premium. That's specifically designed for your partner that wants to take this retreat with you, but doesn't want to attend the sessions. If your spouse or significant other actually wants a full conference registration, we give you a 20% off that. They have to be purchased together. Then you not only get an incredible retreat, but you get to learn together and meet other couples in the same stage as you. Most of all, make those goals for your next step on your financial journey together.

All right, you can sign up for that at the website. You can go to wcievents.com. There'll be links on the website you'll see there. We'll put links in the show notes. Come, come to WCICON. It's going to be super fun. It's going to be awesome. I'm looking forward to meeting you. It's one of my favorite things to do all year is to talk to WCIers in person, hear your stories, hear about your triumphs, hear about your challenges. And it really does affect the content we design for the whole next year to try to help you to be financially successful.

Okay, we have got a great interview today. It's one of my favorites that I've done in a long time. It's a dock in late career. And we don't get as many of those as I'd like to. We get all these people that are “We got back to broke” and that's great. We're thoroughly thrilled to celebrate you getting back to broke. Or we meet these people that are like super hardcore folks that are already multi-millionaires that you're eight out of residency or something.

But the beautiful thing about this interview is this is somebody that's been at it for a long time, maybe didn't do everything perfectly right, but has still managed to be successful in the end. So, take a listen to this. And because this gentleman also happens to own an annuity, I thought we'd spend some time talking about annuities afterward. Stick around afterward. We're going to talk about annuities.

INTERVIEW

Our guest today on the Milestones to Millionaire podcast is Greg. Greg, welcome to the podcast.

Greg:
Thanks, Jim. Appreciate it. Glad to be here.

Dr. Jim Dahle:
You're in my favorite specialty right now. As podcast listeners know, I've been seeing a hand surgeon and you are a hand surgeon.

Greg:
Yes, yes. Yes, I am for 33 years.

Dr. Jim Dahle:
Tell us what part of the country you're in.

Greg:
In the Midwest.

Dr. Jim Dahle:
Okay, very cool. And tell us what milestone we're celebrating today. It's pretty remarkable what you've accomplished during your career.

Greg:
Yes, I'm excited. I've accomplished, or my wife and I, we've accomplished a net worth of close to $3.4 – 3.5 million.

Dr. Jim Dahle:
Awesome. It's, as usual, increased a little bit since you first applied to be on the podcast. It always takes us a few weeks to get on. When the market's good, the market's good.

Greg:
Absolutely. Yes, sir.

Dr. Jim Dahle:
Congratulations to both of you. That's pretty awesome. Give us a sense of what your net worth's made up in. How much of it is your house and how much is investments, et cetera?

Greg:
Okay, good question. I've been trying to do my homework in preparation for this, but it's made up of, our house is probably about $650,000 and it's paid off. And then the rest is made up of various investments, about $2.4, 2.5 million in terms of cash. And it's spread out in terms of, my company was bought by another company. Our hospital company was bought by another company. And we have about $640,000 in a 401(k) with this company. And then the other is cash in various accounts with another investment company. We are with Fidelity. Fidelity is the new company that assumed the 401(k). And so, the funds are with them. 401(k) is with them. And then the other $2.4 million is with another company.

Dr. Jim Dahle:
It's mostly in some sort of tax protected accounts, some IRAs, a SEP IRA.

Greg:
Absolutely.

Dr. Jim Dahle:
And at least a little bit in annuities, yes?

Greg:
Yes, yes, very much so. I've come to learn more in annuities than I actually wanted after I learned about it, thanks to you.

Dr. Jim Dahle:
It usually happens after people buy them, unfortunately.

Greg:
Exactly. And so, I've been obviously reading a lot about it. As a matter of fact, I'm taking your Fire Your Financial Advisor course actually right now. And I'm a little late in my career, but I'm taking it and it's still very, very beneficial.

Dr. Jim Dahle:
Very cool. Very cool. Well, this is pretty awesome. You're a multimillionaire. When you were a kid, did you ever think you'd be a multimillionaire?

Greg:
Absolutely not.

Dr. Jim Dahle:
Tell us a little bit about your upbringing.

Greg:
I'm the oldest of four siblings. Grew up, mom, divorced, remarried, stepdad. We were never poor that I knew of. We were never poor, but we had a modest upbringing. Family paid the bills and there were no vacations. They covered the expenses and that was that. We went to church, got a job when I was a teenager and work was an honorable thing. And so, I've been working since I was about 15 or 16.

Dr. Jim Dahle:
How would you characterize your level of financial literacy when you came out of your medical training?

Greg:
Probably marginal. When I finished medical school, I was in about $100,000 of debt at the time and that was in 1986. It was very interesting. I was actually talking to my medical student about this earlier today that I didn't know that much about it. And when I would ask people about it, even trainers, no one had much to tell me.

And once I went into practice, after I finished my fellowship, we had an old senior doctor in the cafeteria who I talked to about finances. And basically, he said, “The ownership is on me. I'm responsible for my own retirement. Don't listen to what other people tell you and take control of my life.”

Dr. Jim Dahle:
And tell us how you've implemented that advice over the last few decades.

Greg:
Well, I've tried to become financially literate. I even asked some of my colleagues. We would, for example, be at an orthopedic meeting and I would say, “Hey, what do you know about investments and things like that? Or who are you following in terms of investment?” And one of my colleagues actually practices in Dayton, Ohio. And he said, White Coat Investor. And I said, oh, I don't know about them.

At that point in time, I did like everybody else do. I looked up the information, subscribed and started paying attention. I will admit before you came along, probably I started listening to Dave Ramsey and I had a patient in my office who was reading a book The Total Money Makeover. And I asked her about the book and this was around 2019. And I said, “What do you know about the book? What do you like about the book?” And she says, well, he tells you about financing and investing and getting out of debt. I said, do you like the book? She said, yes.

And so, we were on a trip to Hawaii, my wife and I, and I read the majority of the book on the way to Hawaii. And my wife said, it must be a pretty good book. You've never paid this much attention to a book. And so, I started following Dave or listening to Dave. And then I started following you around the same year, actually around, I think it might've been 2019 or something like that.

Dr. Jim Dahle:
Very cool. Did Dave talk you into paying off all your debts?

Greg:
You know what? I was on that trend ahead of time. My financial advisor at the time told me that I should pay off my house. But before he told me that, I actually was already making an extra principal payment per month. It just made sense to me. And I was paying, honestly, an extra $4,000 or $5,000 a month. And then I refinanced it and ultimately paid it off in 2019.

Dr. Jim Dahle:
Very cool. Now, is your wife also employed working? What is her contribution to this look like?

Greg:
Well, my wife is a retired educator, loving supporter wife and a retired educator. And she retired in 2009. And so, her fixed income is her retirement pension from the school system.

Dr. Jim Dahle:
Very cool. So how have you guys worked together on your finances over the years?

Greg:
Well, that's an interesting point because we are both, I don't mind saying this, we're both alpha personalities. And we've been married about 25 years almost. And I talked about combining finances. And so, we get together to go over things on a regular basis. But we have sort of a his, hers, and ours account. And my name's on her account and her name's on my account. And it's really not my account, obviously. That's the way it works. And we reconcile things together and it works out pretty well.

Dr. Jim Dahle:
Give us a sense of what your household income has ranged from over the last three decades.

Greg:
Over the last three decades, probably between $500,000 and $600,000, including when she was working full-time.

Dr. Jim Dahle:
Okay, so pretty good income most of that time. And do you have any idea how much of that was going toward savings or paying off debt or building wealth most of that time?

Greg:
Probably not enough. It probably was not enough. It's in both of our second marriages. We married 25 years ago and I've been in practice 33 years. So not enough until later on, I started being really, really committed once I started paying off the debt.

I didn't have really good advice early on. And so I was doing what I thought doctors should do. Things that you talk about doing, like buying cars, taking trips and things like that. But I changed my ways in terms of some of those things. And now we're debt-free and it's a wonderful feeling.

Dr. Jim Dahle:
Very cool. Well, congratulations to you. It's pretty awesome what you guys have accomplished. It demonstrates a lot of important lessons, I think. You don't have to be perfect, but eventually you got to figure it out and do a few things right. And if you do that and combine that with the high income of a doctor, it usually works out pretty well.

Greg:
Exactly, exactly. It really does. But learn to pay ourselves first. And we certainly commit to our church. We do a fair amount of giving as you do as well. And things have worked out well. We have 10 grandkids, the joy of our life. Two of those kids, one is in college and we help them with their 529s. And so, we're there to help them out.

And interesting thing I was telling my student earlier today, we have a 19-year-old grandson who was in college at one of the colleges in our region and started the 529 for him. We've given him some financial literacy books already and talking to him. And he's taking it on pretty well.

Dr. Jim Dahle:
Very cool. All right. Let's say you've got a medical student in your office like you do today. Or there's a bunch of them out there. They want to be successful like you. They want to get to the end of their career and be a multimillionaire. What advice do you have for them?

Greg:
Pretty simple. One, live a lesson you make, obviously. And ask questions. Be engaged. I wrote down on my paperwork here, subscribe to the White Coat Investor. Honestly, I applaud what you have done for those of us that are in this space, for the students and physicians and doctors, engineers, et cetera. It's very, very valuable information.

But become financially literate. Don't listen to everything that everybody tells you. Don't buy a doctor house too soon. We did not do that. But I talked to a lot of my students and my residents who finished and find out a couple of years later they've bought a $900,000 house, their forever house that they're not going to be in forever and things like that.

But one of the things is that when I'm a program director, a former program director, and so when students come on my service, believe it or not, I asked them all the time. I said, “Do you know who Jim Dahle is? Have you ever heard of the White Coat Investor?” And young lady said today. She said, oh yeah, oh yeah, I follow him. I said, good. And so, I bring it up all the time. I've given lectures to the house staff as well. And so I'm actively involved in trying to pass the word along.

Dr. Jim Dahle:
Very cool. Well, thank you for what you're doing, not only for medical students in their financial education, but also in your clinical practice. Obviously hand surgeons are near and dear to my heart this year. I appreciate what you're doing.

All right. Well, what's next for you in your financial goals? You got retirement plans ever, or are you going for financial independence or what's your next goal you're working toward?

Greg:
Well, I'm probably older than you think. I've been in practice 33 years and we're in a good place financially. Now I don't really know how to turn it off. In a sense of my schedule has slowed down some. I had some shoulder surgery a year and a half ago. So, some things are a little more technically difficult, but I'd like to work toward a net worth of about $5 million, but I don't know if I'm going to make it because I think I'm going to probably slow down and do some teaching at the university level or something like that.

Dr. Jim Dahle:
Well, the beautiful thing about what you've already done is you now have a whole bunch of money working with you toward that. So, just a little bit of time may help you achieve what you're hoping to achieve, even without a lot of additional contribution from you. Well done. And thank you for being willing to come on the podcast and share your story to inspire others.

Greg:
Well, thank you very much. I'm really excited and honored to be your guest. Thank you so much.

Dr. Jim Dahle:
Okay, I hope you enjoyed that interview as much as I did. It's really fun to do late career milestones, especially with a great doc. And in fact, he was having a little bit trouble getting connected initially with all the tech junk you got to do to get on this podcast. And he had a medical student in the office and she helped him out. We're going to send her a book for helping him get on the podcast because I thought it was a really great interview and I'm glad we took the time to do it.

FINANCE 101: ANNUITIES

All right, I promised you we were going to talk about annuities. Annuities are almost a bad word in the personal finance space because the vast majority of them are products designed to be sold, not bought. And that's a problem because there's a whole bunch of people out there hawking them so they get commissions on them. And they hawk them in all kinds of different ways. Radio shows seem to be popular and seminars and steak dinners seem to be popular ways to sell these things to retirees and near retirees.

The truth is that not every annuity is bad and there are purposes for some annuities in some financial plans. And so, it's worth knowing what they are, at least in general. And if you're in one of those situations where it might make sense for you, it might even be worth buying one.

So, let's talk about annuities. They come in a lot of different flavors, but all of them are some sort of an insurance product. Some sort of investment characteristic. At its most basic level, an annuity is just a pension purchased from an insurance company. You give the company a lump sum and in return, it pays you a guaranteed amount every month or every year until you die.

As an insurance product, the company generally pays a commission to the agent selling it to you. That agent unfortunately often masquerades as a financial advisor, but at least while selling you the annuity, it's functioning as a salesperson, not an unbiased advisor. That's important to understand.

The annuity is also backed by the insurance company. If the insurance company goes away, so does the annuity and its guarantees, except it's provided by a state insurance guarantee organization, which generally only protects a limited amount of an annuity's value.

As a general rule, it's best to think of an annuity, at least the classic buy a pension from an insurance company annuity as a way to spend your money, not as a way to invest it. The investment returns are generally not that good, but the purchaser finds the guarantees to be valuable.

So, how do annuities get taxed? Not very well is the bottom line. It depends on whether it's inside or outside of a retirement account. If it's in a retirement account, it gets taxed the same way as a retirement account. If you buy it with Roth IRA money, all the proceeds like everything else that comes out of the Roth IRA is tax-free. If you buy it in a tax deferred account, all the proceeds when they come out are tax deferred.

That means you pay taxes on them at ordinary income tax rates when the money comes out of the account. If you buy it with taxable money, that's a little bit different, has its own unique taxation. Part of the monthly payout is interest and part is the tax-free return of your principal. That interest is paid at ordinary income tax rates. There's a ratio of this principal payout to the total payout. That's called the exclusion ratio.

Now, if you decide to just surrender an annuity and just take the money out of an annuity, basically you pay taxes on all of the earnings at ordinary income tax rates. You also are probably paying a penalty because these are designed for retirement. So you've taken them out before age 59 and a half. You're also paying a 10% penalty on those earnings, plus ordinary income tax rates on any earnings.

It's not a great thing to buy if you're going to surrender this thing before age 59 and a half. But growth inside the annuity is tax deferred. So you don't pay any taxes on any interest, dividends or capital gains or whatever, while the money is still in the annuity, only when you withdraw.

Keep in mind though that it takes many years of tax deferred growth, especially if the asset inside the annuity is relatively tax efficient. To make up for the fact that when you take the money out, you pay ordinary income tax rates on the earnings, not lower capital gains rates, long-term capital gains rates and lower qualified dividend rates.

Okay, so what's the problem with annuities? The main problem with annuities, it's the same problem I have with whole life insurance. It's the way it gets sold, okay? And as I said earlier, it tends to be a financial product that's sold, not one that's bought. And so, it's often sold inappropriately. It's sold to people by making them afraid of higher returning, but maybe more volatile investments like the stock market or real estate.

It's also sold by pointing out the cool bells and whistles added onto the annuity. And by making people afraid of paying taxes, those are kind of the ways it gets sold. Unfortunately, those bells and whistles are often not worth what you pay for them. And they also make it difficult to compare one annuity to another in any sort of fair way.

And the worst part about it is people are often convinced to exchange from one annuity to another, to another, to another. And of course, each time you do that, you generate a new commission for the agent that of course has to come from your returns. And the commissions on these things are typically in the one to 10% range. So, if you put $100,000 in there, that person's probably getting $5,000 or $6,000 or $7,000 or something to sell it to you. The more complex the annuity, the higher the commission tends to be.

If you're buying the “good” annuities, the single premium immediate annuities or SPIAs, that commission might only be one to 3%, but more complex ones can definitely be higher. And they're built into the price of the annuity. So you're not writing a separate check for it, but the money's going from you to the agent either way.

Are they a good investment or not? Well, what are the reasonable uses for an annuity? This is probably what we ought to talk about. I mentioned a SPIA, single premium immediate annuity. This is giving a lump sum to an insurance company in exchange for a stream of income, a guaranteed stream of income until you die. They might pay you, depending on your age and interest rates, they might be paying you 6% or 8%. Often something higher than a 4% safe withdrawal rate, but there's no money left over when you die, number one. And number two, they're usually not indexed to inflation. Like you might be able to index withdrawals from a more traditional portfolio.

But the beautiful thing about this is this puts a floor under your income or your retirement income, your spending, et cetera. You've already got a floor with social security, but this adds something to it. So, it's not crazy to put some money into these things to raise that amount of guaranteed spending that you can do in retirement. And even if you live till you're 93 or 103, you won't run out of money because this thing's still going to be paying.

Some people do buy a SPIA with some of their retirement money, and that's a totally reasonable thing to do. Especially if you're borderline on saving enough or maybe didn't quite save enough. The one big downside here is you give them a lump sum of money in exchange for that payment stream. If you die three months later, the lump sum is still gone. So, you're not leaving any of this money behind your heirs. You're using it to buy that income stream.

You also got to be a little bit careful about not buying these things too early. The rates change over time, so you got to look up current rates. But if you buy it at age 50, you might only get 4% a year out of it. Whereas if you could wait till 60 or 65 or 70, you can get a much higher rate, 6% or 8% plus. So, most people tend to buy these in the 65 to 75-year-old range.

Bear in mind, if you're in a particularly low interest rate environment, you might not be getting an awesome deal on them. Whereas if interest rates just went up a whole bunch, it might be a good time to kind of consider buying an annuity and locking in that income stream at a little bit higher rate.

Who are these things ideal for? Someone who does not want to take much risk with their investments. If you got all the money in bonds anyway, well, these are going to return about as much as that over the long term. Someone who needs permission to spend the rest of their portfolio. By locking in this floor under your spending, this gives you a chance to say, “Oh, well, I can spend more on a trip to Europe or take the kids on a cruise or upgrade this car or something”, whatever. Because you know you've got the mandatory spending covered with the SPIA and your social security.

Also somebody who needs some permission to take risks with the rest of their portfolio. If you feel like you can put more money into stocks or real estate or whatever, because you got the SPIA covering the low risk stuff, then that might help you to stay the course with a little bit more aggressive investment portfolio. And then of course, those who don't have quite enough money, it can be a great way to be able to spend as much as you possibly can in a guaranteed way without running out of money. That's who I think these are particularly good for.

Okay, the second type of annuity that might be a reasonable purchase is called the deferred income annuity or a DIA. And the best way to think about this is as longevity insurance, even more than a SPIA. Because with the DIA, when you give the insurance company the money, you don't start getting payments immediately. You don't get them for a while and you can vary how long that while is. It might be five years or 10 years or 20 years or whatever.

But the point is, because you don't get paid for a while, if you live long enough to actually get the payments, they can be really big. So, let me give you an example. This is from when I wrote a post a few years ago. And this was when interest rates were lower. If you bought a DIA at age 60, they didn't start paying you until 90, it would actually pay you over 60% of what you put into that annuity.

So, if you put $100,000 in and it would pay you $6,100 a month. That's over 70%, I suppose. By letting it sit there for a while and letting most of the people who buy it die, you can get really high payouts. So, it functions as this longevity insurance. If you do happen to live to 90, you know you've got a whole bunch more money coming that's going to help you take care of whatever your expenses are at that point.

You can set that up so it's buy them at 40 and it pays out at 70 or buy it at 60 and it pays out at 65 or 80 or whatever. You can buy them in any kind of different amounts. So that's a reasonable thing to do. And those rates are probably even a little bit higher now than they were when I last priced them in 2021.

Another type of this is called a QLAC, Qualified Longevity Annuity Contract. All that is, is a DIA, a Deferred Income Annuity Inside a Retirement Account. It's not really a new type of annuity, it's just a DIA. And Secure Act 2.0 made some changes to how much of that you can buy. It's a little bit easier to buy these with retirement accounts than it used to be if you want this sort of longevity insurance.

Another type, a third type of reasonable uses for an annuity is what's called a MYGA, a Multi-Year Guaranteed Annuity. And the way to think about this is as a CD alternative. If you're buying CDs with part of your money because you really like that low risk kind of investment, you might want to consider MYGAs instead.

Often the rate is a little bit higher than you can get with the CD. And the cool thing about it is, as it pays interest, as it makes money, as long as you're not taking out of the annuity, you don't have to pay taxes on it. Whereas a CD is going to pay you every whatever, every month, every quarter, whatever. And you have to pay taxes on it as it grows. That's not the case with a MYGA.

And when you get to the end of the term, whatever it is, one year or five years or whatever, you can exchange it into another MYGA and not pay taxes on it. So, it's a little bit different from how CDs work. They're getting taxed all the time as they go along, MYGAs do not.

And so, some people choose that that is what they want to invest in for that very safe portion of their portfolio. And I think that's a reasonable thing to do for any money that you need longer, for a period longer than a couple of years from now. But you don't want to risk any principal with. This is probably a better option in a lot of ways than CDs or buying a treasury bond directly or something like that. So, something to consider.

Okay, the last one is a low cost variable annuity. Now the variable ones definitely fall on the more complex side of annuities with the attendant higher commissions and other fees and difficult to understand structures. But there's two reasonable uses for variable annuities. And both of them, of course, require you to find a low cost variable annuity, which most of them aren't.

Vanguard did them for a while, they've gotten out of the business. And Jefferson National was doing them for a while, they got bought out by Nationwide. So I think most people doing this are actually looking at Fidelity these days.

But people might buy them to exchange out of a whole life policy. If you got some cash value that's a lot less than your basis, maybe you exchange it to a variable annuity, and that allows it to grow back to basis tax free. And then you surrender the annuity and it's making lemons out of lemonade for sure. But some people do that when they're getting out of a whole life policy they never should have bought.

And the second is if you have a really tax inefficient investment that you can't fit into your retirement accounts. Classically, that might be a refund, or maybe it's your tips or something like that. You really don't want it in your taxable account. So you decide I can get this low cost variable annuity and the fees on the annuity will be less than the taxation might be on this investment. That's not a crazy thing to do either.

But you don't want to be buying most variable annuities, you don't want to be buying fixed index annuities, you don't want to be buying super complex annuities. These are products made to be sold, avoid them. Somebody tries to talk your parents into them, talk them out of them. If they want to be buying annuities, you need to make sure they're getting the right kind for whatever their need happens to be. And it's probably a very straightforward SPIA that you can compare to other SPIAs and make sure they're getting the best deal possible.

Okay, I think we beat annuities to death. It's not crazy if you have one. If you happen to buy one, like I suspect Greg did, that may not have been the best thing. Now you got a different question, right? How best should I use this? And it might be exchanging it into a SPIA or something like that might be the best of your annuity at that point. You can also exchange them into long-term care insurance if that happens to be right for you. I don't think that's probably right for Greg. I think he's probably wealthy enough, he can self-insure that risk. But if it's right for you, that might make some sense as well.

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All right, thanks for being a Milestone Millionaire listener. It's interesting. I find that these are not quite as popular as the regular White Coat Investor podcast that drop on Thursdays, but hopefully I enjoy doing them at least as much. And so, I hope more and more people enjoy listening to them as well.

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