[Editor’s Note: This post by Physician on FIRE is a continuation of a post we published earlier this month that generated a lot of great discussion in the comments section. Today, Physician on FIRE assists this high earning doc to get his financial ducks in a row.]
To recap, in Part I, we met Dr. SW (a.k.a. Dr. Stealth Wealth), a physician earning $1,800,000 a year while spending about $70,000.We decided on a simple three fund portfolio for his investments, and toyed with the idea of a donor advised fund.
Today, we will expand upon that last idea, make a plan for his kids’ future, touch on insurance and asset protection, and last but not least, develop an investor policy statement.
Please keep in mind that I am not a financial advisor and the only letters behind my name are M.D. I am relying on the knowledge I’ve gained from a healthy dose of reading and personal experience, and on the collective wisdom of the Bogleheads, which is where this story originated. While I endorse the advice given here, the ideas were crowdsourced online.
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Holy Stealth Wealth Part II: Developing an Investor Policy Statement
The Donor Advised Fund
Regular readers know that I am a big fan of the donor advised fund (DAF). I give to ours regularly and have mine funded to the tune of $250,000 or about 10% of the nest egg I wanted to feel comfortably financially independent.
I mentioned the benefit of establishing one for Dr. SW as a way to make some capital gains disappear on his “winners” while allowing him to take some losses when he sells “losers” and liquidates his taxable account.
In the high-income tax bracket where he and his family live, every deduction counts. He’ll get the deduction for the full value of the appreciated assets he donates to the DAF he establishes, and will also be deducting the value of his losses when parts with stocks in the red.
The DAF can be thought of as a reservoir for monies to be donated at a later date. You get the immediate tax deduction, the money remains invested in an account you control, and it can be doled out to the charities of your choice at any time, present or future.
Dr. SW regularly gives to his church, is destined to have excessive wealth, and will without a doubt be happier donating a large chunk of his fortune than spending it on himself or leaving an obscene inheritance.
What Insurance Does the High Income Earner Need?
While his neighbors might not have a clue as to Dr. SW’s net worth, just being known as a doctor makes him a likelier target for a lawsuit of any kind. He would be wise to carry an umbrella policy to cover his current net worth of more than $3 Million.
For many other types of insurance, he can afford to self-insure. The umbrella policy will presumably require him to carry high limits on his home and auto policies. For the little stuff (cell phone, electronics, etc…) there’s simply no need to carry insurance.
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Regarding term life insurance and disability insurance, I’ve made the argument that it’s superfluous for someone in a position of financial independence. I also know that Dr. SW isn’t convinced he’s there yet; I believe he’s holding out for a grander state of financial freedom, which he will soon achieve, of course.
Nevertheless, Dr. SW would like to carry these, at least in the short-term. According to this thread at WCI, a $15,000 a month own-occupation disability policy with a laddered $4 million term life policy costs one 40-year old physician $730 a month. While the price will vary by age, gender, health, specialty, and location, Dr. SW can likely have similar coverage for under $1,000 a month.
To compare rates yourself, look to one of our recommended insurance agents or request online rates from Policygenius.
We won’t even discuss long-term care insurance except to state the obvious fact that Dr. SW doesn’t need it. He’ll be able to buy the whole nursing home, all its rooms, walkers, and bedside urinals, and hire the best caregivers money can buy.
Is a cash value life insurance policy a smart option for Dr. SW? Most of us in the personal finance realm avoid them like the plague, but for the extraordinarily high-income earner, there may be a place for one as an asset protection strategy. I would tread lightly here, and seek qualified, unbiased advice before strolling down this avenue.
Dr. SW will want to protect his assets. The umbrella insurance, maxing out retirement plans, and perhaps titling assets together as a couple as “tenancy by entirety” would be a good start. Beyond that, a complete asset protection plan is uniquely state and individual specific, and I would recommend a consultation with a local legal expert on the subject.
Planning for the Children’s Future
Currently, Dr. SW is investing in a Roth IRA for his children. How do they have earned income to qualify? Like GCC, Jr., his children are child models. I plan to start Roth IRAs for my own children now that they are 8 and 10 years old and earning true income caring for dogs via Rover.
As long as the work is well documented and justifiable, it may be reasonable to continue. The benefit is obvious. The salaries paid to them are a business expense for Dr. SW, and all earned income can be invested in the Roth IRA of the child as long as they each file a tax return showing earned income up to the amount of the Roth contribution.
PoF has kids too!
Dr. SW has invested in Roth accounts, but hasn’t started any 529 Plans. Why the Roth? According to Dr. SW, “I was told a Roth IRA could be used for any education expenses (even private school), buying their first home or medical emergency. I was then told by them holding the IRA in their name it will not affect any scholarships ”
While it’s true that Roth contributions can be withdrawn at any time for any purpose, money is fungible, and Roth money is the last money you want to touch. All of those potential expenses can be paid for with cash flow or the taxable account. Dr. SW is going to have far too much money to qualify for any need-based financial aid, so merit-based scholarships are the only option, anyway, so I fail to see the significance of the Roth money in this regard.
A 529 Plan is a great way to save money for a child’s education. It’s funded with post-tax money, grows tax-free, and when withdrawn to pay for education-related expenses, withdrawals are tax-free. It’s essentially a Roth IRA for education, but the limits on contributions are much higher.
A high-income earner like Dr. SW can “Superfund” a 529 Plan for each child. The limit is 5 years’ worth of the $14,000 gift tax exclusion amount per parent, or $140,000 in a lump sum.
They could afford to start two of them this year, and perhaps a third next year when the next bundle of joy arrives. It could be started prior to his or her birth, but we might want to spread this $420,000 expense out just a tad. Alternatively, he could start with a lower amount, but my understanding is that you’re only allowed to exceed $28,000 as a couple once every five years without altering your potential estate tax. I recommend going all in with the big bucks or “starting small” with $28,000 apiece.
Creating the Investor Policy Statement
When I created mine, I called it an Investor Policy Statement (IPS). The White Coat Investor calls his an Investing Policy Statement. The BigLaw Investor and most of the rest of the world seems to prefer the term Investment Policy Statement. I still think mine makes the most sense, so I’m sticking with it.
An IPS is a document that defines your investing goals and philosophy, with specifics as to asset allocation, tax strategies, and a drawdown or capital preservation plan. The bullet points are principles that should guide your personal finance decisions. It is a living document, and can be revised when appropriate, but only after careful consideration, and certainly not too often.
Let’s get to it:
Objectives:
- Build wealth to easily support a relatively early retirement
- Invest in a simple, reproducible, low cost manner
- Residual money available for charity and/or a legacy
Philosophy:
- Invest in a three-fund Vanguard portfolio, or similar variant
- Accept market returns; rebalance with new additions
- With a very low and safe withdrawal rate, risk tolerance is high to maximize potential returns
Asset Allocation:
- 60% US Stocks. VTSAX or similar
- 20% International Stocks. VTIAX or similar
- 20% Bonds and Fixed Income. VBTLX or similar
- Asset allocation will be calculated across all accounts, rather than within each account.
Additional Considerations:
- Front-load tax-deferred investments in January to the extent possible
- Backdoor Roth contributions for both spouses in January
- After initial funding, revisit further 529 investments in 2022 / 2023
- Invest in taxable account monthly
- Set Cost basis in taxable account to “Specific ID” and monitor for losses for potential tax loss harvesting monthly when making a new investment
- Partners for VTSAX: VFIAX, VLCAX
- Partners for VTIAX: VFWAX, VTMGX
- Most expenses can be covered with cash flow, but keep a few months’ expenses in a readily available account as an emergency fund
- Avoid rampant lifestyle inflation. Continue to spend intentionally.
- Continue to build Donor Advised Fund balance. Consider modeling PoF plan of maintaining a balance equal to 10% of invested assets. Give from DAF annually rather than writing a check to charitable organizations
Pre-Retirement Considerations:
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- Explore part-time possibilities. Hiring locums may be a viable option
- Research family health insurance options
- Review estate plan with attorney
- Maintain licensure and skills to allow for medical mission work
- Develop hobbies and interests prior to dropping out completely
- Explore opportunities to sell practice
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That’s it! In my own IPS, I’ve got a drawdown strategy defined, but for Dr. SW, it should be really straightforward. Draw from the defined benefit cash balance plan and live off a portion of the dividends from a ginormous taxable account. Have fun, and give generously.
Further Considerations
Now that we’ve established a basic IPS, I think we would be remiss not to address a few items that are only peripherally related to personal finance.
Dr. SW stated:
“I finished residency and literally work all the time. Not sure if I can work this hard for the next fifteen years so at some point probably cutting back.”
I’m not sure he can work that hard for the next five years with three little ones at home. We can comfortably say they don’t need the money, but I can also understand the allure of the high-paying job. Once you get into money-making mode, a day off is many dollars lost. Breaking free from that mindset might do wonders for his psyche and his family.
Adding employees, sub-contractors, and locums physicians may be one way to maintain the practice and literally buy time without a huge hit to the bottom line as a business owner.
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I’m not a business owner, but my net worth is similar to Dr. SW’s. It also took me four times longer to obtain it, but I’m at a point where I value my time as much or more than additional money beyond that which I needed to feel comfortably financially independent.
In the fall of 2017, I downgraded my income and upgraded my lifestyle with a part-time position where my initials only appear on the schedule seven days per month.
Finally, I simply want to say Bravo!
It takes intelligence, an impeccable work ethic, and a keen business acumen to arrive at the place you have positioned yourself. What I find equally impressive is the manner in which you humbly go about your life living a bit better than a resident simply because it suits you. Good for you, Dr. Stealth Wealth.
Now that you’ve read Part I and Part II, how did we do? What additional feedback or suggestions do you have for Dr. SW?
Still can’t get over how absurd his income is. I did the math to see how I could get to his income range. To get even in the ballpark, I’d have to work 7 days a week and see patients for 36 hours a day.
But no hate here. It’s hard for me to see how that level of income is even possible for a doctor but I respect the hustle. An interesting case scenario of an extreme outlier in more ways than one.
For most docs, it involves owning a business and having a lot of clinicians working for you and getting a piece of their action.
“He would be wise to carry an umbrella policy to cover his current net worth of more than $3 Million.”
My job includes figuring out the insurance we need to buy for a multinational corporation. This is not how you determine the amount of insurance you need. This is the equivalent of saying that you need to increase your disability insurance at the end of your career because your income has increased, even after you have become financially independent. You need to insure against the risk, not your assets, because the size of the risk has no relationship with your assets. (The likelihood of getting sued might, but the liability does not.). You need to talk to your insurance agent about how much a claim usually costs, including the legal fees, and remember that the agent makes more when you buy more when you decide.
To put this another way, you owe the person you hurt what they lost, not what you have. Having insurance will not let you keep your assets or future income. If the person you hurt lost more than you insured for, they can get your insurance proceeds, your assets and your future income. You need adequate insurance to cover the amount of a claim so that the person you hurt will agree to cap their damages at the amount of your insurance or you kicking in a small amount. When I was young I needed lots of insurance because I had lots of young friends with long lucrative careers ahead of them that would be expensive to replace if I disable them. Now that I am older and have more assets I have dropped half of my insurance because my friends are getting close to retirement and have less future income to lose so it would be cheaper to replace their lost income.
Thank you Caro for putting it so succinctly. We have often had this discussion here re: amount of umbrella coverage and while not everyone espoused the need to have umbrella coverage = net worth, there was no solid reasoning why. Appreciate the explanation!
What does it have to do with your friends? I’m far more worried about the random people sharing the roads with me. 80% of umbrella policy claims are auto-related.
I presume it’s because passengers are potential victims of a collision and friends=passengers.
My friends matter because the question I’m trying to answer to decide how much insurance to carry isn’t just “how do people get hurt?”, it’s “how am I likely to hurt people, and how much will it cost?”
For me, the answers to the first question is car accidents and mishaps around the house.
My friends matter because they are more likely to be with me when I cause a catastrophic accident and get hurt by me, and they are more expensive to hurt than the average Joe when they are young and high future income professionals. Your readers are likely to be in the same situation.
If the random guy on the road causes an accident, then it sucks but it doesn’t cost me money, it’s his liability not mine. If I am the random guy on the road causing an accident, then I could injure some random person outside my car, or a non-random person inside my car (aka my “friend”).
My friends were a lot more expensive to hurt than the average Joe because they were at the start of a high income career, and also more likely to be with me when I screwed up and get hurt by me.
I calculated out their lifetime income and I carried enough insurance to cover two of them losing their income for life if I screwed up. I also considered likely medical costs etc.
Nowadays twenty plus years later, my friends have fewer working years left so it gets cheaper every year to replace their remaining future income streams and I dropped the insurance I carry to something more like an average catastrophic claim.
Looking at house mishaps, I don’t have a pool, trampoline or other high risk features, so my friends aren’t likely to get hurt by me here. The main house risk is for people working, cleaning gutters, etc etc. Most of my risk management around the house is focused on reducing the risk that I would be found liable in the first place, by keeping the place in good repair, warning of known risks, hiring contractors instead of employees, and requiring in writing that my contractors carry workers compensation insurance.
Got it.
Caro – How does an individual quantify that risk? If an umbrella policy covers risk that supercedes your current policy limits, how do you determine that upper limit? Couldn’t you theoretically get in an accident with someone driving a Bugatti?
Couldn’t the amount you’re sued for be almost limitless depending on the incident in question?
Yes, but at least now you’re thinking about the true risks you’re taking! Obviously they have nothing to do with your net worth.
Yep it is literally impossible to insure away all of your risk. But it’s not the car you hit that you have to worry about. Cars are cheap. That $2M Bugatti driven off the lot with 30% immediate depreciation is a lot of money but probably independently insured and unlikely to be attempting to get full coverage from you as the person who hit it and totalled it.
What’s expensive is people. A lifetime of lost income (say $2 million net present value for a middle class income) + catastrophic medical bills (say a million bucks initially) + a lifetime of 24 hour care attendants for a quadriplegic (millions) + a victim with a choice between suing you or starving?
But fortunately that kind of catastrophic injury is rare.
So what do we do as people with substantial assets? Talk to insurance brokers about what they recommend and the size of an average claim in your area. Think about whether you have any factors that make your life more dangerous (pool, trampoline, bad driver). Think about anything that makes a claim more expensive (lots of high income people around you). And settle on a number that lets you feel comfortable.
An excellent approach. I completely agree.
Makes perfect sense, thanks for the breakdown
I disagree with the asset allocation. I see no good reason for the bond position. Once you have gone far past having enough money (which Dr StealthWealth will fairly shortly), the bond position offers protection against nothing. It just decreases long term returns.
Technically, most people should “disagree with” every asset allocation but their own.
“Technically, most people should “disagree with” every asset allocation but their own.”
An excellent response!