More and more frequently lately I do “financial curbside consults” with doctors as I go about my clinical work. I think it's fun to “mix” my two vocations, although I confess it sometimes gets a little weird when they want to take a selfie with me to show their friends. I thought one of these more recent consults would make for an excellent blog post.
Doctor: I'm not really sure what to invest in. Do you think I should buy a rental property? I was thinking a townhome.
WCI: The likelihood that a rental townhome should be your first investment is so low that I think we can dismiss it offhand. Let's step back a minute. Do you have student loans?
Doctor: No, all paid off. I'm not really a big fan of debt so I've paid off my student loans and don't have any car loans or credit cards loans.
WCI: Well, that's great. That debt aversion is usually a good thing that gets you ahead of your peers. How much of your gross income do you save?
Doctor: I think about 50%.
WCI: Wow. That's really high. Where is all that money right now?
Doctor: It's pretty much just sitting in a savings account. I've thought about buying your book, but haven't gotten around to it.
WCI: Well, you should probably get around to it here pretty soon. Do you have any investments at all?
Doctor: No, not really.
WCI: What about your employer-provided retirement accounts? Don't you have a 401(k)? Are you maxing that out?
Doctor: Well, I put $19,000 in there each year and they put a few thousand in too.
WCI: You know that's an investment, right? What is the money actually invested in inside the 401(k)?
Doctor: I don't really know. I think I just picked the “moderate risk” option.
WCI: You probably ought to find out what you're putting tens of thousands of dollars into each year, don't you think? Now, why do you want to invest in real estate?
Doctor: Well, I thought it might be a good investment.
WCI: Why townhomes?
Doctor: I dunno, seemed easier. I didn't really grow up in the US so I didn't learn any of this 401(k) stuff growing up.
Doctor: Well, not really. But I do want my money to grow. But I don't want to lose any of it.
WCI: You know you actually do have to save 50% of your gross income a year for retirement if you aren't willing to put any of it at risk of loss. Once you understand how investing works, I bet you would be comfortable putting at least some of that money at risk of loss in order to earn higher returns.
Doctor: You're probably right. So how do I get started?
WCI: Well, as a general rule, you want to invest in accounts that are tax-protected in some way before you invest in accounts that are not. For example, lots of doctors who want to invest more than will fit in their 401(k) invest in a personal and spousal Backdoor Roth IRA.
Doctor: What's an IRA?
WCI: It stands for Individual Retirement Arrangement. It's basically a retirement account that you open on your own rather than going through your employer.
Doctor: Interesting. [Scribbles down IRA.]
WCI: Unfortunately, it gets a little complicated. A typical doctor with a retirement plan at work can't take a deduction for a traditional or tax-deferred IRA. Nor can she contribute directly to a Roth or post-tax IRA. So she has to do what is called a Backdoor Roth IRA, where you put $6K into a traditional IRA first, then move it to a Roth IRA afterward. Since you didn't get a tax deduction for the contribution, there is no tax cost for the second step, called a Roth conversion. But in the end, it's the same as if you just put $6K into a Roth IRA. You can do one for your spouse, another $6K, even if your spouse isn't working. There's a tutorial on my website that will walk you through it, or you can just read that book. Do you have a high deductible health plan or do any moonlighting anywhere else?
Doctor: No.
WCI: Because if you had a high deductible health plan, you could also contribute to and invest in a Health Savings Account. And if you had some 1099 income, you could open an individual 401(k) and put some more money in there. But once you've maxed out your employer-provided retirement plans and your individual retirement plans, everything else has to be invested in a non-qualified or taxable investing account.
Doctor: So where can I invest in those?
WCI: Well, my Roth IRAs and my taxable brokerage account are at Vanguard. I think that's a nice default place to start because it is a mutually owned mutual fund company, so the costs are generally lower and thus the returns are generally higher. But the general process of setting up an investment plan is to first set your goals, second decide which accounts you're going to invest in, third decide what your asset allocation or mix of investments is going to be and then finally select investments. Just picking out a townhome to buy is like skipping the first three steps and going straight to step four.
Doctor: That makes sense, but it all seems so complicated.
WCI: Why don't you finish reading the book, it'll only take you four hours, and then let's talk again. The truth is that you've already done all the hard stuff. You've become a doctor and now earn a high income. You're also very frugal and able to save a ton of money. The rest is actually pretty easy. It does take some work, but much less than what you have put in to learn your specialty.
Doctor: Thanks. I'll do that.
Hopefully more updates to come.
I’m having similar conversations with three of my friends right now.
Friend 1:
Has high income and I’ve just convinced them to open up a ROTH IRA. Next they’re going to roll over their after tax 401k contributions (which they’ve been maxing out) into that. But before they do that, I’ll have to explain if they have any taxable earnings on their after tax contributions, then they’ll have to get their 401k provider to roll that into an IRA. They’d heard of the backdoor roth though, so I’ll also have to warn them about the pro-rata rule. I feel like it’s an uphill task to explain everything, but they are interested and so far enthusiastic, if put off by the magnitude of the whole thing.
Friend 2:
Lost their job as their employer shut shop owing to the pandemic. Their 401k got rolled over into an IRA and “everything got invested in money market funds lol”. I offered to help them out with investing it, but they “just don’t have the time”. I think I’m going to shrug and let this one go.
Friend 3:
Keeps taking on debt. Has hundreds of thousands of dollars in student loans, but only makes the minimum payments on them. Recently took out Apple’s financing to buy a Macbook Pro and an iPad. So far, seems willing to clean up the mess, but not yet there where they want to take action. I guess I’ll gently remind them every now and then they were going to take action?
Ultimately I’ve found it’s only people who are interested in taking charge of their finances that will take charge of their finances. Everyone else, it’s just me suggesting things that eventually fall on deaf years, and I have to back off lest I spoil the friendship.
It’s the classic “when the student is ready, the teacher will appear.” Like was mentioned in a recent WCI post, there is an X factor of people who just kind of get it. Others it never quite clicks. But I love trying to help as many as I can following the WCI lead. Having these types of curbside consults has been a fun side benefit of becoming financially literate!
1. You can do a direct conversion–401(k) to Roth IRA. Obviously your friend will have to pay taxes on the earnings. This all assumes the 401(k) allows in service distributions or your friend has separated from the employer.
2. You can lead a horse to water…
3. Don’t be a nag. Just talk about how wonderful it is to have options in your life. When the student is ready, the teacher will appear.
For option 1, their employer allows in service distributions! And for option 3, I definitely don’t nag. We have rich conversations on so many other things, this is just passing comment.
I tried doing the rollover last year and had to pay tax on the money as a distribution. Found out that I have a rollover IRA. I do not think my 401 K allows rollover IRA to be rolled over in it. Now what do I do. I would have to slowly convert the IRA into Roth and would be stuck with taxes? I have found out that traditional IRA ‘s are useless in the high income bracket as the money is stuck till you are 60 and you have to pay taxes on the earnings. You might as well save on your own in a regular brokerage account.
Roth conversions are taxable events. They are also subject to the pro-rata rule, as discussed frequently when we talk about the Backdoor Roth IRA in posts like this one:
https://www.whitecoatinvestor.com/backdoor-roth-ira-tutorial/
https://www.whitecoatinvestor.com/17-ways-to-screw-up-a-backdoor-roth-ira/
It’s not clear to me exactly what is going on with you, but a Backdoor Roth IRA is way better than a taxable account. A non-deductible traditional IRA may not be however. Depends on need for asset protection, tax efficiency of the investment(s), length of time the money is in the account, who it will be left to at death etc.
sorry my comment the first line should read
I tried doing a roth conversion last year
dude I would check that your 401k doesn’t allow rollovers of outside IRA’s. would be strange- most brokerages /401k companies would love to have your business! If for some reason it doesn’t, then do a few surveys and make some 1099 income to open a solo401k, I recommend Fidelity, and roll the IRA into there like I have done. Vanguard is not an option as it’s solo 401k does not take IRA rollovers. the Vanguard solo 401k would be the only 401k plan that I know that would not accept rollovers, so please check with your current 401k plan.
This one’s an instant classic! I do it often, too. We recently had a friend over for dinner. He’d gotten tired on not investing his money for years. So, he decided to start day-trading. Why? Because a surgeon he works with often, does it and “seems to be doing great”. Needless to say, it didn’t end well.
So I gave him the “You need a roadmap” talk. My easy Investment Policy Statement template was born out of that.
PS: IRA should read Individual Retirement Account.
PPS: Embrace your stardom, you’ve arrived!
It’s not very often I get to correct you, but IRA indeed does stand for Individual Retirement ARRANGEMENT.
https://www.irs.gov/retirement-plans/individual-retirement-arrangements-iras
https://www.irs.gov/pub/irs-pdf/p590a.pdf
https://en.wikipedia.org/wiki/Individual_retirement_account
Does it matter? Not really.
Wow, you are, of course, right! This is interesting… it’s almost universally (wrongly) referred to as …Account. Learn something every day. Thank you!
PFB
We are early in our retirement ages 39 & 44. I would like to check in to gain more perspective, wisdom and knowledge.
I am a veteran receiving ~40k a year with COLA adjustments and healthcare currently not working. My plan is to start working once our children are able to attend day care. My spouse makes ~200k a year currently. Assuming future raises with some rough math final pay would be ~240k at retirement. Our heath care will be supplemented in retirement. My spouse is pension eligible from two jobs, the highest paying job, we are considering 60% of her final pay to set a retirement date at age 60. That would yield us ~130k a year in retirement before taxes, health insurance etc. The second pension would bring ~6k a year. We will also have a rental property that will yield ~15k. To recap we will have 130k+40k+15k+6k=191k of guaranteed income in retirement.
Our primary mortgage will provide at least 1M in equity during retirement. We have no debt other than our mortgages.
My spouse is saving in a pre-tax account and we are both are saving in our Roth IRA’s. We are so far away from retirement it is impossible to say what these account balances will be. We have chosen to send our children to private school until they reach middle school age which prevents us from my spouse maxing out her pre-tax retirement account.
My first question is about SS. We are considering delaying SS until age 70. The research I have done predicts 48k a year pre-tax for my spouse. I did not factor my SS in at the moment because I still have earning years to gain. At age 70 with 191k in taxable income then brining in ~48k in SS.
I do not understand how SS works exactly. How much of the SS will we be gaining with it being taxed at 85%?
My second question is about withdrawal strategies. We will have pre-tax, taxable and Roth IRA’s. For simplicity let’s assume they are all equally funded. Being locked in a high tax bracket due to the pensions. Which accounts should we draw from first? Should we save the pre-tax accounts until age 72 (RMD) or is there a more tax efficient way to manage those accounts?
We are so far away from retirement I am hoping to avoid any pitfalls as early as possible. Wisdom is always welcomed.
Thank you for your time.
Best,
Too Early to Know
# 1 Rental property income is not guaranteed income.
# 2 The million bucks tied up in your home does not produce retirement income (although it eliminates the expense of rent/mortgage).
Re SS: As a general rule, the higher earning spouse should delay to 70 assuming good health. You can learn more about SS from Mike Piper’s excellent little book on the subject: https://amzn.to/36NX9Et (affiliate link)
85% of it is taxable income. The tax rate on it isn’t 85%. In your case, more like 20 something percent.
You should consider Roth conversions/contributions given your relatively high guaranteed income sources.
As a general rule, you spend pensions, SS, interest, RMDs first. After that, you generally spend high basis taxable assets. After that, tax-deferred assets up to the top of a tax bracket. Then Roth assets above that assuming you need/want more income.
Hope some of that helps.