Podcast #78 Show Notes: Cash Balance Plans

Larry Keller

What is a cash balance plan? A cash balance plan is a defined benefit plan. There are two basic types of retirement plans. There are defined contribution plans like your typical 401k and your Roth IRA. They are considered a defined contribution plan because you put a certain amount of money into it and how the investments perform is what you get out of it. With a defined benefit plan, this is like a classic pension that your father or your grandfather had when he worked in the mill, basically all the investment risk is on the company. Yes, you have to put money in that is taken out of your paycheck but the company promises you a certain amount after 20 or 30 years working there. All the risk is on the employer.

A cash balance plan is a type of defined benefit plan. But in reality it is a defined contribution plan masquerading as a defined benefit plan. It is another IRA masquerading as a pension. You have to follow all the pension rules but if you are a high earner, especially in the last half of your career, you can really put a lot of money into these things, all tax deferred. So it behooves you to learn about this type of plan and see if it is right for you.

Before we get into this week’s episode I want to remind you that if you have any questions for the podcast you can record them here.  It will be awesome to get some fresh voices on the podcast. If you have the question chances are that many of the other readers and listeners do too. Answering colleagues’ questions and helping them get this financial stuff right is the part of this job I enjoy the most!

Putting you in touch with the good guys in the financial industry is also very important to me. Adam Grossman is one of those guys. If you are wanting more help with your financial planning reach out to Adam.

Podcast #78 Sponsor

This episode is sponsored by Adam Grossman of Mayport Wealth Management. Adam is a Boston-based advisor and works with physicians across the country. Unlike most other advisors, Adam offers straightforward flat fees for both standalone financial planning and investment management. Whatever stage you’re at in your career, Adam can help you get organized with a personalized financial plan and can help you implement it with a low-cost index fund portfolio.

Adam is a CFA charterholder and received his MBA from MIT, but more importantly, you’ll benefit from Adam’s own personal experience with many of the same financial obstacles and opportunities that face physicians.

To learn more, visit Adam’s website mayport.com/whitecoat to download a free e-book especially for physicians.

Quote of the Day

Our quote of the day today comes from Morgan Housel who said,

Cash Balance Plans

As I stated in the beginning a cash balance plan is a defined contribution plan masquerading as a defined benefit plan. You have to follow all the pension rules that determine how much money you can put into it. That depends on how many employees you have in the company, how many partners you have, how much money they are putting in, how old you are, etc.  Those kinds of things dictate exactly how much money can be put into a defined benefit cash balance plan.

If you are a very high earner and especially if you’re in the last half of your career, 50 plus, you can really put a lot of money into these things, maybe two hundred thousand dollars a year. And that is all tax deferred. Just like a 401k contribution you don’t pay taxes on it now, it goes into that tax protected, asset protected account, and can be pulled out later in retirement, when you have a lower marginal tax rate and spent at that point. It is a great way to catch up on retirement savings.

But because a cash balance plan has to masquerade as a pension there are some rules with it. For example the amount you can put into it is heavily regulated by lots of complicated rules. That is why it is not really a do it yourself project, you’re going have to hire somebody to do it for you. Other rules include if there is a shortfall, the employer has to make it up.
In a typical doctor cash balance plan you are not only the beneficiary of the plan but you are the owner of the business. So you have to make it up when there is a shortfall. That might mean in a down market year you actually have to contribute more into the plan than your typical annual amount. So you want to make sure you have the income flexibility to be able to do that, even in an economic downturn. You don’t want this plan to be committing you to make huge amounts of contributions, although there is some flexibility there, some things you can do if you really get in a fix. But that is the general rule. That is not necessarily a bad thing because it forces you to buy low. When the market is down, you have to put more money into the plan. That is a good thing, just like rebalancing. It is something that helps you in the long run. But be aware that is an issue.

What happens if the market is doing particularly well? Typically these things only credit you for five or six percent a year. And so if the market does really well the extra earnings in the plan actually go into a side fund within the plan. That money is available for the first part of a downturn. When you start losing money the first thing you do before you have to contribute extra dollars into the account is you take it out of the side fund. Now this is all kind of a masquerade because you own the side fund, you own the regular fund, and you are the guy who is responsible for making up the shortfalls. It is all kind of a game played within the pension system but that is the bottom line how it works.

Some doctors combine it with a 401k profit sharing plan. You put fifty five thousand dollars into the 401k, maybe you put another 30, 50, 200 thousand dollars into the cash balance plan and that allows you to really defer a lot of money. The cash balance plans do cost more than a 401k. There is additional expenses associated with them, they might cost twice as much. You have to pay an actuary every year to run some calculations and do some paperwork for the IRS. You can even get a solo defined benefit plan. I know Schwab offers that, I think some other places do as well. I don’t think Vanguard does. But those are the basic options for a defined benefit plan. If you are saving a ton of money into a taxable account and you would rather get some tax protection and asset protection for some or all of that, then I think it’s worth looking into a cash balance plan. For a typical doctor making 200 or 300 thousand dollars and maxing out Roth IRAs , a solo 401k or a 401K at their employer, and maybe investing a little bit of money in a taxable account., I don’t think it necessarily makes sense to go looking for a cash balance plan. But for a very high earner in the last half of their career this may be a great option.

Q&A from Readers and Listeners

Children Earning Income for a Roth IRA Contribution

This reader wanted to know what are the 100% legal and unlikely to trigger an audit ways for his 3 month old baby to earn income so he can contribute to a Roth IRA to start his retirement savings? Remember earned income must be earned. That means you have to do some sort of work to do it. There is very little work that a 3 month old can do. Now as your kids get to be 8, 10, 12, 15 you can hire them to work in your business. Maybe if you are renting apartments you can hire them to turn the apartment, to clean it, to paint it. That sort of thing. If you got some other business maybe you can hire them to do some clerical work. But you have to  have a business. If you are a W2 employee  you cannot do this. You have to actually have some legitimate needs and some legitimate work that is done and you have to pay them a legitimate price to do it. And so for a 3 month old the only thing I can think of is modeling. That is what I pay my kids to do. That is why their pictures are all over the WCI website and I actually keep a time card. They fill out all the paperwork, they get W2s and W3s and fill out everything that has to be filled out, including immigration, that shows that they are legitimately in this country. You have to treat them like any other employee and then of course you have to pay them a reasonable amount. Now luckily child models command a very good hourly salary. If you look online you see that child models get paid up to 100 dollars an hour. So that is what I pay them. But if you start trying to pay your kid thirty thousand dollars a year for modeling that might not fly with the IRS.

Three Important Tips for Young People to Know about Money and Taxes

This reader does a podcast for high school and college students. Over 95 percent of the students said they wish they were taught more about money and taxes. He wanted to know what are three important tips for young people aged 13 to 22 to know about money and taxes.When I hear young people I was thinking my 9 year old and my 3 year old. People that are 13 to 22, they have to know it all. I think the thing to do is to teach people the basics early on and the best way to do that is by example. If they see you managing money well and not having financial stress they are likely to make similar decisions. If they see you not spending all your money they are likely to make similar decisions. If they hear you talking about taxes and investments and savings they are likely to become financially literate.  I think the best thing you can do is model good behavior for them.

Other things to focus on:

  1. Help them to understand where money comes from. I am talking about the fact that if you want to get paid you need to put in some work. Teach them the connection between work and money. That can be through commission or allowance initially then them getting a job.
  2. A lesson on debt. It is hard to understand these large sums of money. Think about a medical student is borrowing four hundred thousand dollars for their education and they have never made more than twenty thousand dollars in their entire life. That four hundred thousand dollars is like Monopoly money. They do not understand just how much work and sacrifice it is going to take to pay off four hundred thousand dollars in after tax money. It is going to take years.  I think it is important to help them understand that debt is not mandatory, it is not normal, and it is not something that has to be done in all but extreme circumstances. Giving them a realistic understanding of how debt works is helpful.

You can teach kids about all kinds of things and they learn best by doing. My kids all have retirement accounts and bank accounts. They have a bank account at the local credit union. They have a 529 account for their college. They have UTMA accounts, which is money that I’m putting together for their 20s. They have Roth IRAs for any money they earn. They do some babysitting for a neighbor, that money goes into a Roth IRA. I give them a daddy match so they get the same amount of money from me to spend. But anything that is a legitimate earned income goes into the Roth IRA. And then when those statements come every month or every quarter I hand it to them. They realize that they are not making much money in the credit union savings account and that their 529s are doing pretty well. They get to learn about asset allocation. They get to learn about savings, they get to learn about investments, they learn about mutual funds.  I’m still talking about my 9 and 11 year old here. I’m not talking even about my teenager. By the time they walk out of the house they are going to know more about money than most adults do. I think that is the way you teach young people about money and taxes. It all starts at home. You can do it as well with other family members or friends. I do some volunteer work with a youth group and I talk to them about money, investing, jobs and those kinds of things as well.

The Best Mortgage Loan

This question came from an Army pathologist who is a civilian now. He wanted to know which mortgage loan would be best for him. A conventional home loan, a physician loan or a VA loan?

The best deal is almost always going to be a conventional loan. That is because it has stricter guidelines. You have to put 20 percent down to get a conventional loan if you do not want to pay private mortgage insurance. Because you are willing to meet all those requirements you usually get the best deal on the loan. There are a lot of people that are competing for your loan and you can get the very best rates and terms on that loan.

A conventional mortgage loan is almost always better than a physician mortgage loan. The physician mortgage loans are for doctors who do not want to put 20 percent down, because they have a better use for their money like maxing out retirement accounts or paying off student loans, but without having to pay PMI. You put down 5 percent or 10 percent, you don’t pay PMI and you get a halfway decent loan. It is not as good as what you can get get with a conventional loan though if you are willing to put 20 percent down.

A VA loan is generally not that good of a loan. You would think it would be this great service for our veterans but it has got a pretty high fee associated with it. The terms are not always that good. Like a physician loan you don’t have to put 20 percent down on it though. In this doctor’s case because he was disabled in the military, he gets out of that finance charge. So it is possible the VA loan is a better loan for him than it is for most people. But it is easy to compare to the conventional loan. If the rates dramatically better, the terms are dramatically better, than sure go with the VA loan but otherwise in this situation with a 20 percent down payment I would probably just do a conventional mortgage loan.

Getting Better Returns in a 529 Account

This reader’s 529 account in Rhode Island has achieved 2 percent growth over the last year and he was wondering if I had any guidance or experience on the best way to reallocate this type of investment for a better return. I can’t promise anyone higher returns. I can give them a more aggressive or less aggressive asset allocation than what they are in and if the market does well, the more aggressive one will give you higher returns. If the market does poorly the less aggressive one will give you higher returns. But I don’t have a crystal ball. I just can’t answer that question.

But there are a few things I can discuss. First of all keep in mind that Rhode Island has two 529 plans. This is not unusual, a lot of states have two 529 plans and when they do, there is one that basically has no load funds in it and low expenses. This is the one that do it yourselfers use. And there is one that is sold by commission salesmen masquerading as financial advisers.
The one that is bought rather than sold, the one the do-it-yourself investors use is called College Bound saver and the one that is sold by salesmen masquerading as advisers is College Bound 529.

A couple other things to keep in mind:

  1. Expenses matter. Know what the expenses are in your investment accounts. Understand what your expense ratios are on those mutual funds and understand what you are actually invested in. In this docs case he is basically in a target retirement or lifecycle type investment which is a reasonable thing to do. However, it sounds like he wants to take on a little bit more risk and be a little bit more aggressive if he’s frustrated that he didn’t get the market returns in the last year. And so I suggested a little change in the allocation rather than being in this target retirement type mutual fund of funds. Put a third into a total stock market fund, a third into a small mid-cap fund, and a third into an international fund. That would then be a 100 percent stock portfolio in that 529. Obviously there is risk there. I feel like you can take a lot more risk in 529s than you can with your retirement money even though the time horizon is shorter. The reason why is because the consequences are so much less. There are other ways to pay for college. They can take out loans, they can go to a less expensive school, they can work during the summers and while they’re in school, you can cash flow some of it from your current earnings. There is just so many other ways to pay for college, I don’t feel like you have to be super careful with it.
  2. Just because you live in a state doesn’t mean you have to use their 529. Look at the 529 carefully to see what kind of tax benefits it offers you. In Rhode Island, you only get a deduction for the first thousand dollars you put into a 529 per kid. So if that is the case and you want to save ten thousand dollars a year, why not put a thousand dollars into the Rhode Island plan, max out your tax benefit there, and put the other nine thousand into a better plan like the one in Utah or Nevada or California or New York. Those ones are known for rock bottom expenses and nice Vanguard or DFA mutual funds. Get whatever your state is going to give you as a tax deduction and go elsewhere with the other money if you’re in a higher cost state plan.

Staying in a Bad Job Just for PSLF

A child psychiatrist with 350,000 thousand dollars in student loans is going for public service loan forgiveness. She is five and a half years in but deeply deeply unhappy in her nonprofit job. She can’t find another nonprofit job nor nonclinical opportunity that would qualify. She is toying with the idea of going for profit at least temporarily to see if private practice is a better fit for her.  She wanted to know what I would do. Wait it out in the nonprofit? Try for profit and potentially lose out on some public service loan forgiveness years?  Go for profit and never look back?

It sucks to have a job you don’t like and feel like you’re stuck there with the handcuffs on because you really need the public service loan forgiveness. But she only makes two hundred thousand dollars a year and she owes three hundred fifty thousand dollars in student loans. That is a lot of money and she has the possibility of getting that all forgiven in just four and a half more years of working there.

It reminds me of the job I had when I came out of residency. I would see up to six patients an hour. I did little of what I was trained to do. I worked the equivalent of one point five full time equivalents for 120,000 dollars per year nights, weekends, holidays, and evenings. My employer dictated I live in a state I didn’t want to live in. My employer sent me for up to five months at a time to a country where people were trying to kill me, didn’t let me off a half mile by half mile compound, and forced me to do exercise, dumb training, and wear a camouflage uniform. When I came home my second child didn’t know who I was. Deeply unhappy described how I and most of my colleagues felt about that job a great percentage at the time. But at the end of my four years my “student loans” were forgiven. So when I look at 350,000 dollars as a child psychiatrist, I think it may just be worth sucking it up and stay in an job you don’t like for another four years.  It is just a lot of money. Of course keep in mind you could also check with some other options for a public service loan forgiveness eligible jobs, military jobs, those kind of contract positions are usually also eligible as long as you’re directly employed by them. I wouldn’t do something I was unhappy doing for 20 years but I might do it for four. It is a difficult situation she is in. I empathize with her a great deal but I think in my case I’d really be considering sticking it out especially since there’s a decent chance that she is not going to like it any better in the private sector.

Ending

I hope that you find these Q&As from readers and listeners helpful. Would you have answered differently?

Full Transcription

[00:00:00] 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. Here’s your host Dr. Jim Dahle.

[00:00:19] Welcome to the Whitecoat investor podcast number 78 – Cash balance plans. This episode is sponsored by Adam Grossman of Mayport Wealth Management. Adam is a Boston based adviser and works with physicians across the country. Unlike most other advisers Adam offers straightforward flat fees for both standalone financial planning and investment management. Whatever stage you’re at in your career Adam can help you get organized with a personalized financial plan can help you implement it with a low cost index fund portfolio. Adam is a CFA Charter holder and received his MBA from MIT. But more importantly you’ll benefit from his own personal experience with many of the same financial obstacles and opportunities that face physicians. To learn more visit Adam’s website Mayport dot com slash white code to download a free eBook especially for physicians.

[00:01:06] Our quote of the day today comes from Morgan Housel who said good investing is about earning pretty good returns that you can stick with for a long period of time. That’s when compounding runs wild.

[00:01:16] If you’ve got questions for us for the podcast you can record them at speak pipe dot com slash Whitecoat investor. That link is also found on the podcast page on the main website but it would be awesome to get some other fresh voices on the podcast. If you can leave us a message that would be great. We’ll pipe it into the podcast.

[00:01:34] Our first question today comes from Steve on Twitter. He says I have a 3 month old son. What are the 100 percent legal and unlikely to trigger an audit ways for him to earn income so I can contribute to a Roth IRA to start his retirement savings? Let’s say with and without access to an LLC.

[00:01:53] Well here’s the deal. Earned income must be earned. That means you have to do some sort of work to do it. There’s very little work that a 3 month old can do. Now as your kids get to be 8, 10, 12, 15 you can hire them to work in your business. Maybe if you are renting apartments you can hire them to turn the apartment, to clean it, to paint it. That sort of thing. If you got some other business you know in your practice maybe you can hire them or do some clerical work. But here’s the deal you’ve got to have a business. If you’re just a W2 employee this isn’t going to work. You have to actually have some legitimate needs and some legitimate work that is done and you have to pay them a legitimate price to do it. And so when you get down to something like a 3 month old the only thing I can think of is modeling. That’s what I pay my kids to do, to be models, that’s why the pictures are all over the white coat investor website and I actually keep a timecard. They fill out all the paperwork, they get W2s and W3s and fill out everything that has to be filled out, including immigration kind of stuff that shows that they are legitimately in this country. You know you got to treat them like any other employee and then of course you have to pay them a reasonable amount. Now luckily child models command a very good hourly salary. If you look at surveys and you look at stuff on the Internet you see that child models get paid up to 100 dollars an hour.

[00:03:15] So that’s what I pay them. I pay them $100 dollars an hour. But you’re not going to able to pay your 3 month old to clean your office. You know it’s just not going to work. So you’ve got to be a little bit careful with that and I wouldn’t go crazy with it either. You know you start trying to pay your kid thirty thousand dollars a year for modeling that might not fly with the IRS.

[00:03:34] Next question comes from Dr. Mulik, also on Twitter, who says I do a podcast for high school and college students. I’ve a huge stack of their questions on my desk and over 95 percent of them said they wish they were taught more about money and taxes. What are three important tips for young people aged 13 to 22 to know about money and taxes.

[00:03:54] You know when I hear young people I was thinking like you know my 9 year old, my 3 year old. You know people that are 13 to 22, they got to know it all. I mean by the time you’re 22 you’ve been an adult for four or five years. You got to know this finance stuff if you’re going to win at adulting right? But I think the things to do is to teach people the basics early on and the best way to do that is by example if they see you managing money well and not having financial stress they’re likely to make similar decisions. If they see you not spending all your money they’re likely to make similar decisions. If they hear you talking about taxes and investments and savings they’re likely to become financially literate. And so I think the best thing you can do is model good behavior for them.

[00:04:38] Other things that you probably ought to focus on. One – help them to understand where money comes from. And I’m not talking about you know our fractional banking system where you put your money into a bank and the bank lends out even more money based on your deposit. I’m talking about the fact that if you want to get paid you need to put in some work. Teach them the connection between work and money. All right. And then maybe by paying them commission, some sort of allowance and maybe by getting them a job encouraging them to work and those sorts of things. So I think that’s the number one lesson.

[00:05:11] Number two lesson that I think young people should get is about debt. It’s just hard to understand these sums of money. I mean think about a medical student is borrowing four hundred thousand dollars for your education and they’ve never made more than twenty thousand dollars in their entire life. That four hundred thousand dollars is like Monopoly money. They don’t understand just how much work and sacrifice it’s going to take to pay off four hundred thousand dollars in after tax money. It’s going to take years, years of their life that really is going to exact a price from them. And so I think it’s important to help them understand that debt is not mandatory, it is not normal, and it is not something that has to be done in all but extreme circumstances. And so I think given them a realistic understanding of how debt works is helpful.

[00:05:57] But you can teach kids about all kinds of things and they learn best by doing. My kids all have retirement accounts and bank accounts. They’ve got a bank account at the local credit union. They’ve got a 529 account for their college. They’ve got UTMA account which is money that I’m putting together for their 20s. They’ve also got Roth IRAs for any money they earn. They go shovel for the neighbor. They shovel off their porch. They do some babysitting that money goes into a Roth IRA. I give him a daddy match so they get the same amount of money from me to spend. But anything that’s a legitimate earned income goes into the Roth IRA. And then when those statements come every month or every quarter I handed to them and they look at them and they realize that they’re not making much money in the credit union savings account and that their 529 are doing pretty well. And so they get to learn about asset allocation. They get to learn about savings, they get to learn about investments, they learn about mutual funds. And I’m still talking about my 9 and 11 year old here. I’m not talking even about my teenager. And by the time they walk out of the house they are going to know more about money than most adults do. And so I think that’s the way you teach young people about money and taxes. It all starts at home. You know you can do it as well with other family members or other friends. You know I do some volunteer work with a youth group and you know I talk to them about money and investing and jobs and those kinds of things as well. And started some investment accounts for nieces and nephews, 529 accounts for them and try to use those to teach them about investments and about match and about money and about those sorts of things.

[00:07:25] Lots of things you can do there. All right. Speaking of loans make sure you’ve checked out our student loan refinancing resources. We have the best links on the Internet the best deals on the Internet for refinancing student loans. They can be found on the main website. If you go to the tabs at the top under recommending the first link is student loan refinancing. So go check that out if you need to refinance student loans and you’re looking for a good deal from a highly regarded company. Also if you need advice, if you’re in a complex situation with your student loans for instance you have a really large student loans, you are thinking about going for public service loan forgiveness. You’re married to another decent earner. You’re not sure which income driven repayment plan you should be in or how you should file your taxes or whether maybe the 20 year or 25 year forgiveness programs available under pay or repay might actually work for you. You’re the type of person that ought to get advice about your student loans. And I’ve got three or four people listed there on the student loan advice page under that same tab that recommendations tab that can help you with your student loan. So check that out if you’re dealing with student loans.

[00:08:35] All right next question this one comes in by e-mail. I love your website. Great work. I found it two years ago but was already frugal and had some financial savvy. That’s great. I was an Army pathologist but a civilian now. I’m nine years out of residency with no debt and with savings, so that’s great. I have an excellent credit score. Don’t care. Hope you don’t either. I could put down 20 percent on a home if I chose. OK. So maybe the credit score does matter for this Doc since he’s going to buy a home. My question is What do you think would be the best home loan in that situation? A conventional home loan, a physician loan or a V.A. loan? I have a disability rating that absolves me of the finance charge. Thanks for all your guidance. We’ve messed up many things financially but are now moving in a better direction.

[00:09:15] OK well here’s the deal with mortgages right. The best deal is almost always going to be a conventional. That’s because it has stricter guidelines. You have to put 20 percent down to get a conventional loan. If you don’t want to pay private mortgage insurance. And so because you’re willing to meet all those requirements you usually get the best deal on the loan. So a conventional mortgage loan is almost always better than a physician mortgage loan. Now these physician mortgage loans are for docs who don’t want to put 20 percent down because they have a better use for their money like maxing out retirement accounts or for you know paying off student loans that sort of thing, without having to pay PMI. So you get to put down 5 percent or 10 percent, you don’t pay PMI , and you get a halfway decent loan.

[00:09:57] It’s not as good as what you can get get with a conventional loan though if you’re willing to put 20 percent down. There are a lot of people that are competing for your loan and you can get the very best rates and terms on that loan. And so that’s almost always best. A VA loan is generally not that good of a loan. You’d think it would be this great service for our veterans but it’s got a pretty high fee associated with it. The terms aren’t always that good. Kind of like a physician loan you don’t have to put 20 percent down on it though. In this Docs case because he was disabled in the military. He gets out of that finance charge. So it’s possible the VA loan is a better loan for him than it is for most people. But it’s easy to compare, just compare it to the conventional loan. If the rates dramatically better, the terms are dramatically better, than sure go with the VA loan but otherwise in this situation with a 20 percent down payment I’d probably just do a conventional mortgage loan.

[00:10:50] Next question pertains to 529 accounts. We have an infant. We’re currently contributing into a 529 account in Rhode Island. That account has achieved 2 percent growth over the last year it’s been open and which given the large growth in other investing spaces seems poor. I realize the short term is not the focus point for this type of investment but the account does allow for asset exchange to other funds. And I’m wondering if there’s any guidance or experience on the best way to reallocate this type of investment? If the best course is let it ride, that’s great, less work for me. But if we’re losing out on gains it could be realized with a simple change in allocation that I would prefer not to be. Looking for any advice. Thanks for all the great content. Don’t use my name. All right. I usually don’t use names on people that e-mail me questions.

[00:11:33] But this is an interesting question right. This doc is like I want higher returns. OK. I can’t promise you higher returns. I can give you a more aggressive or less aggressive asset allocation than what you’re in and if the market does well the more aggressive one will give you higher returns. If the market does poorly the less aggressive one will give you higher returns than what you’re in now without a crystal ball. I just can’t answer that question.

[00:11:56] But we can do a few things we can talk about. First of all keep in mind that Rhode Island has two 529 plans. This is not unusual, a lot of states have two 529 plans and when they do, there’s one that’s basically gotten no load funds in it and low expenses. This is the one that do it yourselfers use. And there’s one that’s sold by commission salesmen masquerading as financial advisers. Rhode Island is the same way they have two 529. I think the one that is is bought rather than sold, the one the do it yourself investors use is called College Bound saver and the one that is sold by financial advisers or rather salesmen masquerading as advisers is college bound 529. I couldn’t tell from what this doc posted in the first e-mail which one he was using. But it turns out he was in the right one anyway thanks to a follow up e-mail.

[00:12:47] A couple other things to keep in mind. Number one expenses matter. So know what the expenses are in your investment accounts. Understand what your expense ratios are on those mutual funds and understand what you’re actually invested in. You know each mutual fund invests in different types of asset classes and in this docs case he is basically in a target retirement or lifecycle type investment which is you know a reasonable thing to do. However, sounds like he wants to take on a little bit more risk and be a little bit more aggressive if he’s frustrated that he didn’t get the market returns in the last year. And so I suggested a little change in the allocation rather than being in this target retirement type mutual fund of funds. I suggest the team I want to put a third into a total stock market fund that he has there, a third into a small mid-cap fund, and a third into an international fund that would then be a 100 percent stock portfolio in that 529. Obviously there’s risk there. The market turns around he’s going to lose money but in a 529 I feel like you can take a lot more risk than you can with your retirement money even though the time horizon is shorter. And the reason why is because the consequences are so much less. There are other ways to pay for college. They can take out loans, they can go to a less expensive school, they can work during the summers and while they’re in school, you can cash flow some of it from your current earnings. There’s just so many other ways to pay for college. I don’t feel like you got to be super careful with it because if you take a big loss right as they enter college is just not that big a deal. Cash flow the first year or two and give the market a couple of years to recover and then use the money to pay for their third and fourth year or keep cash flowing it if there is a long bear market and use that money for their sibling. I mean there’s just so many options and so much flexibility with college. I feel like you can take a little bit more risk there and it sounds like this doc wants to anyway.

[00:14:33] The other thing to keep in mind is just because you live in a state doesn’t mean you have to use their 529. Look at the 529 carefully see what kind of tax benefits it offers you. In Rhode Island, you only get a deduction for the first thousand dollars you put into a 529 per kid. So if that’s the case and you want to save ten thousand dollars a year why not put a thousand dollars into the Rhode Island plan, max out your tax benefit there and put the other nine thousand into a better plan like the one in Utah or Nevada or California or New York. You know those ones that are known for rock bottom expenses and nice Vanguard or DFA mutual funds. So that’s something to consider as well especially if you’re in a higher cost state plan. Get whatever your state is going to give you as a tax deduction and go elsewhere with the other money.

[00:15:20] All right next question. Can you talk about cash balance plans on the podcast? What is a cash balance plan? A cash balance plan is a defined benefit plan. Remember there’s two basic types of retirement plans. There are defined contribution plans like your typical 401k, your Roth IRA, that sort of stuff is considered a defined contribution plan because you put a certain amount of money, a certain contribution, into it and that’s the part that’s fixed and however the investments perform that’s what you get out of it. With a defined benefit plan, this is like a classic pension that your father had or your grandfather had when he worked in the mill and basically all the investment risk is on the company. Yes you had to put money and it’s taken out of your paycheck but they promise you a certain amount after 20 or 30 years working there. And so all the risk is on the employer. What a cash balance plan is a type of defined benefit plan. But in reality it’s a defined contribution plan masquerading as a defined benefit plan. It’s another IRA masquerading as a pension. That’s what it is. And so you’ve got to follow all the pension rules and those determine how much money you can put into it. And that depends on how many employees you’ve got in the company, how many partners you have, how much money they’re putting in, how old you are. All those kinds of things dictate exactly how much money can be put into a defined benefit cash balance plan.

[00:16:52] But if you are a very high earner, you know you’re ophthalmologist making six hundred thousand dollars, or a plastic surgeon making a hundred thousand dollars. And especially if you’re in the last half of your career 50 plus, you can really put a lot of money into these things like maybe two hundred thousand dollars a year. And that is all tax deferred. Just like a 401k contribution and you don’t pay taxes on it now it goes into that tax protected, and asset protected account, and can be pulled out later in retirement. When you have a lower marginal tax rate and spent at that point it’s a great way to catch up on retirement savings.

[00:17:27] But because it has to masquerade as a pension there are some rules with it. For example you know the amount you can put into it is heavily regulated by lots of complicated rules. That’s why it’s not really a do it yourself project, you’re going have to hire somebody to do it for you. But other rules are: If there’s a shortfall the employer has to make it up. And in a typical Dr cash balance plan you’re not only the beneficiary of the plan but you’re the owner of the business. And so you have to make it up when there’s a shortfall. And so that might mean in a down market year you actually have to contribute more into the plan than your typical annual amount. So you want to make sure you have the income flexibility to be able to do that even in an economic downturn. So you don’t want this plan to be committing you to make huge amounts of contributions although there’s some flexibility there and you can close the plan and there are some things you can do if you really get in a fix there. But that’s the general rule. That’s not necessarily a bad thing because it forces you to buy low. Right. The market’s down. You’ve got to put more money into the plan. That’s a good thing. It just you know just like rebalancing. It’s something that helps you in the long run. But be aware that that’s an issue.

[00:18:39] What happens if the market is doing particularly well? You know I mean typically these things only credit you for five or six percent a year. And so if the market does really well the extra earnings in the plan actually go into a side fund within the plan. And so that money is available for the first part of a downturn. You know you start losing money the first thing you do before you have to contribute extra dollars into the account is you take it out of the side fund. Now this is all kind of a masquerade because you on the side fund you own the regular fund and you’re the guy who is responsible for making up the shortfalls. And so it’s all kind of a game played within the pension system but that’s the bottom line. That’s how it works. And so what stocks do is they combine it with a 401k profit sharing plan. You put fifty five thousand dollars into the 401k, maybe you put another 30, 50, 200 thousand dollars into the cash balance plan and that allows you to really defer a lot of money. The cash balance plans do cost more than a 401k. There’s additional expenses associated with them might cost twice as much, for instance. You have to pay an actuary every year to run some calculations on and do some paperwork for the IRS. You can even get a solo defined benefit plan, a personal defined benefit plan. I know Schwab offers that, I think some other places do as well. I don’t think Vanguard does. But those are the basic options for a defined benefit plan. So if you’re saving a ton of money into a taxable account and you’d rather get some tax protection and some asset protection for some or all of that then I think it’s worth looking into a cash balance plan. For a typical Doc making you know 200 thousand dollars three hundred thousand dollars and Maxing out Roth IRAs and a solo 401k or a 401 K at their employer and maybe investing a little bit of money in a taxable account. I don’t think it necessarily makes sense to go looking for a cash balance plan.

[00:20:32] All right next question, I thought that if you were to convert retirement account money into a Roth that you had to convert the whole account. Is it possible to convert variable sums each year as you wish. Yes you only have to convert as much as you want. You can spend 10 years converting one IRA to a Roth IRA if you want. And a lot of people do that in those years between retirement or when they cut back and when they start taking Social Security to move money into a Roth IRA. So they don’t have to pay required minimum distributions on it. And to give them some tax diversification in retirement. You certainly do not have to convert the whole account.

[00:21:06] Next question. I’m a child psychiatrist. When you’re out of fellowship with 350,000 thousand dollars in student loans and I’ve been planning on applying for public service loan forgiveness when I qualify. I’m five and a half years in. My husband is another Doc with slightly less loans refinanced at two and a half percent that will pay off in about five years. I am deeply deeply unhappy in my nonprofit job. I’ve looked endlessly at other nonprofit jobs and I can’t find anything better. I’ve even looked into nonprofit, nonclinical opportunities but they pay significantly less than I make now around two hundred thousand dollars. I’ve been toying with the idea of going for profit at least temporarily to see if private practice is a better fit for me. I don’t want to keep the loans pending such a high interest rate but I am afraid to refinance if I am unhappy in the private sector as well. What would you do? Wait it out in the nonprofit? Try for profit and potentially lose out on some public service loan forgiveness years ago? Go for profit and never look back?

[00:21:59] I’m so sorry you’re in this situation. It sucks to have a job you don’t like and feel like you’re stuck there with the handcuffs on because you really need the public service loan forgiveness. But you only make two hundred thousand dollars a year and you owe three hundred fifty thousand dollars. In student loans. That’s a lot of money and you have the possibility of getting that all forgiven in just four and a half more years of working there. It reminds me of the job I had when I came out of residency. I would see up to six patients an hour. I did little of what I was trained to do. I worked the equivalent of one point five full time equivalents for 120,000 dollars per year nights, weekends, holidays, and evenings. My employer dictated I live in a state I didn’t want to live in. My employer sent me for up to five months at a time to a country where people were trying to kill me, didn’t let me off a half mile by half mile compound, and forced me to do exercise, dumb training, and wear a camouflage uniform. When I came home my second child didn’t know who I was. Deeply unhappy described how I and most of my colleagues felt about that job a great percentage at the time. But at the end of my four years my student loans were forgiven. So when I look at 350,000 dollars as a child psychiatrist. I think it may just be worth sucking it up and stay in an job you don’t like for another four years. Would I get out as soon as I had that public service loan forgiveness. I probably would. And I’d go try a private sector job I’d go try something else and see if I can find something else that’s going to make me happy. You do have the benefit of having a husband that’s a physician. I think an anesthesiologist who makes pretty good money and is going to wipe out his student loans and certainly you ought to be looking at all your money together you know. It’s our money once you get married, it’s our loans, it’s our income and maybe it’s not that big a deal given that other income to pay off that 350,000 dollars in student loans. But I think in this sort of a situation I try to stick with it and stick with the plan and try to get those loans paid off. It is just a lot of money. Of course keep in mind you could also check with some other options for a public service loan forgiveness eligible jobs, military jobs, those kind of contract positions are usually also eligible as long as you’re directly employed by them. I wouldn’t do something I was unhappy doing for 20 years but I might do it for four. Especially if they were basically giving me the equivalent of six years of pay. I mean think about as you’re making 200000 dollars a year you know for four years and they’re going to Forgive 350000 dollars in loans because of it. That’s like a pretty significant boost to your pay. It’s a pretty good raise. So you know it’s a difficult situation you’re in. I empathize with you a great deal but I think in my case I’d really be considering sticking it out especially since there’s a decent chance that you’re not going to like it any better in the private sector.

[00:25:02] This episode was sponsored by Adam Grossman of Mayport Wealth Management. Adam is a Boston based adviser who works with physicians across the country. Unlike most other advisers Adam Opper straightforward flat fees for both standalone financial planning and investment management whatever stage you are on your career Adam can help you get organized with a personalized financial plan and can help you implement it with a low cost index fund portfolio. Adam is a CFA Charter old who received his MBA from MIT but more importantly you’ll benefit from Adam’s own personal experience with many of the same financial obstacles and opportunities that face physicians. To learn more visit Adam’s website Mayport dot com slash Whitecoat to download a free eBook especially for physicians.

[00:25:42] Head up shoulders back. You’ve got this. We can help. We’ll see you next time on the White Coat investor podcast.

[00:25:47] My dad your host Dr. Dahle is a practicing emergency physician, blogger, author, and podcaster. He is not a licensed accountant, attorney, or financial advisor. So this podcast is for your entertainment and information only and should not be considered official, personalized financial advice.