WCI Ambassador and podcast co-host Dr. Disha Spath joins us today, and we tackle a broad range of questions. We discuss the cold, hard truth that kids are just really, really expensive. Childcare is one of those things that can be complicated and expensive. We review some options for childcare and how to get a little cutback on the cost of that. We also discuss how much is reasonable to spend on an engagement ring, debate if second homes are worth purchasing, discuss the merits (or lack thereof) of robo-advisors, and review some of the ins and outs of Roth conversions.
In This Show:
The Cost of Childcare
“Hi Jim. I'm a general surgeon and my husband is a vascular surgeon. For obvious reasons, we have to have a full-time nanny. Currently, we use a company that takes care of W-2, paying employer taxes, deducting the nanny taxes, and actually paying the nanny.
However, they're upping their fees by over $1,000 this year. Is this something that you think that we could do on our own? Or do you have any resources for setting up a payroll? We will be doing this for many years, so these costs can add up.”
There are a lot of costs to having children, not least of which is childcare and the costs of complying with the tax requirements of childcare. Let me first tell you what not to do, then Disha can tell you what to do. What you should not do is what happened to my daughter this last summer. She was hired as a nanny and took care of a few kids for a local family for most of the summer. She made several thousand dollars. Then, when we started talking about taxes last month and I asked her how much she made, she said she didn't know. Did she get any tax forms from the employer? No, no tax forms from the employer. Basically, they were treating her like she was the Friday night babysitter. That works fine for the Friday night babysitter. It does not work fine for your full-time nanny. The IRS draws a line at $2,300 a year. If you are paying a household employee, which is what a nanny is, more than $2,300 in the year, you have to treat them like a real employee. You have to do I-9s, and you have to do W-2s, W-3s, W-4s.
You have to send them tax forms, because what happens is when they go to file their taxes, they're faced with the dilemma that my daughter has right now. The dilemma is, “Do I not report this income, or do I do what the IRS wants me to do?” which is to report the income. Don't put your nanny in that sort of a situation. Don't put any sort of household employee in that situation. Comply with the laws and do what you're supposed to do, and keep everybody out of trouble. Disha, do you want to talk to them a little bit about what they're supposed to do and some of the easy ways to do it?
“Absolutely. Yes, nannies are considered household employees, which are not independent contractors. Because you are basically employing this person for most of their time, you are now an employer. As an employer, you must pay the Social Security, Medicare, and federal and state unemployment taxes on the wages paid to that employee. Also remember that each state has their own rules, so there might be some state-level taxes.
If you're going to do this yourself, there are a few services that will help you with it. NannyChex charges $6.25 for a weekly paycheck, plus $80 per quarter for quarterly filings and $150 at the end of the year. Basically, that comes out to about $66 a month. Care.com does it for about $75 a month. We had a guest post by Dr. Astrid Moise on the White Coat Investor called Financial Cost of Childcare. If you want the details on that, she's got it all laid out for you. Basically you're going to be needing to pay all these taxes upfront, and then, like Jim said, provide them with tax forms at the end of the year, as well.
Another option is to consider maybe hiring an au pair. A lot of physician families with two physicians have good luck with au pairs because they're available to you at all times with changing schedules and with changing calls. Sometimes, scheduling those difficult hours with a nanny doesn't work out. Basically, an au pair is someone you sponsor to come live with you in your house for a year. Typically, you are also required to provide them with a car and accommodations. If you have an extra room in your house and you can get someone to come live with you, that would obviously be ideal—and actually turns out to be pretty cost-effective as well. The annual cost of having an au pair is about $19,000 plus the car and the accommodations. There are different companies out there that will help you find one that fits your family. That might be a good option for you. And of course, there are center-based daycares and in-home daycares, which are a little bit more expensive.”
I think most people are probably going to center-based childcare, but that doesn't work very well for doctors. When you get called into the hospital or you're working night shifts or evening shifts or weekend shifts, a lot of these places are closed. They're usually 8:00 to 5:00 operations, Monday through Friday. This was a huge issue I remember for one of my residency classmates. She was an ICU nurse. I think she worked nights. He was an emergency medicine resident, so no center-based daycare was going to work for them. They actually ended up paying my wife to watch their kid. Their child was about the age of our daughter, Whitney. The kids hung out together. They were good friends. But that was the only sort of a thing that would work for them. They could not have done anything that was standard banker’s hours.
“We're lucky because my husband works from home and then we moved close to his family so they could help out when one of us has to work or we both have to work and the daycare is closed because of COVID. Definitely childcare hours and center-based hours really restrict a lot of parents and make it quite impossible for dual physician couples. Nannies or au pairs would probably be a great option for those kinds of dual-physician families.”
Tax Breaks for Childcare Costs
Now, the government knows this is expensive stuff. I mean, imagine you're the average household making $55,000 or $60,000 a year, and you're looking at costs of $20,000-$30,000 to watch your kids. That doesn't work very well. The government has done a few things to kind of help with the cost. Do you want to talk a little bit about some of those tax breaks that come for childcare?
“There are two different options. And they've recently been really beefed up because of COVID, which is really awesome for families. The first option you have is a dependent care FSA. Of course, that's not guaranteed. Generally, that's employer-sponsored. If your employer has this option, it is a really good option for higher-income families. The other option is the child tax credit. The child tax credit was actually paid out in increments during COVID. The important thing to remember about that is the child tax credit is something that you opt into, but you can use the dependent care FSA money for the same stuff that you're getting the child tax credit for. You can't use both of them for the same amount of dollar expense. But thankfully, we all have so much childcare expense most of the time that we can utilize anything that we get.
The dependent care FSA basically lets you use pre-tax income and bypass Social Security and Medicare tax and pay for childcare expenses with your pre-tax income. It decreases your taxable income, which is awesome. And because of COVID, the American Rescue Plan actually increased the contribution that you can put into a dependent care FSA from a $5,000 max per year to $10,500 per year. They also made it so that it could roll over, whereas before in a dependent care FSA, it was a use-it-or-lose-it situation. But you can now roll over those funds. You can get almost $15,500 pre-tax for childcare this year. The child tax credit used to be a pretty bad deal for high earners because it maxed out at 20%. It's phased out many physicians because of AGI, your adjusted gross income. The higher your adjusted gross income, the less child tax credit you get. But because of the American Rescue Plan, it has increased the benefit from about $1,000 to you to up to $4,000 for one child and $8,000 for two or more children. These are really important tax benefits to be aware of, if you do have kids, and make sure you do utilize it. The important thing to know about a dependent care FSA is that you can have it even if you have an HSA. Oftentimes, you can't have HSA medical and a medical FSA, but you can have a medical HSA and a dependent care FSA together.”
That child tax credit was a bit of a change. It used to be almost no docs qualified for it. Now, many docs qualify for it. The phaseout starts, for head of household. If you're a single parent, you're probably filing head of household. It starts phasing out at $112,500 of income. So, most docs are going to be above that. But if you are married, it starts at $150,000. Married filing jointly starts at $150,000, but goes all the way to $400,000 before you're completely phased out of it. Likely the majority of docs can get their AGI below $400,000. I think the average physician income, not the average physician household, but the average physician income is $275,000 right now. Lots of docs are going to be under that $400,000 limit and be able to get some sort of a child tax credit. I know how much kids cost, and the tax credit doesn't come anywhere close to paying for them. But it helps, every little bit helps. If you qualify, make sure you're getting that when you file your taxes.
Mostly, though, it just costs a lot to pay for kids. The funny thing is everyone can't believe how expensive childcare is. Well, guess what? It doesn't get any better. They just keep becoming more and more expensive as time goes on. All of a sudden, you're paying for private school or you're paying for college or you're getting them a car or they start eating more. Have you ever fed teenage boys? They're not exactly skimpy on their portions. This expense doesn't really go away until they're out of college, to be honest with you. So, get used to it, I guess. Kids are expensive.
More information here:
Optimize Tax Savings from Dependent Care FSA and Child and Dependent Care Tax Credit
What to Spend on Engagement Rings
“Hey, Dr. Dahle. This is a pretty non-traditional question, but I'm currently a resident and I'm thinking about proposing to my girlfriend at some point. And I was wondering how much should someone in my position spend on a ring. Now tradition says that we should spend approximately three months of one's income on an engagement ring. And as a resident I bring in, let's say, $60,000 a year. So, three months of that would be $15,000. That's a lot of money, especially for someone on a resident's salary.
Now, obviously, I want to invest in the person I love. I want to get something that both she and us are proud of together. I'm just curious, do you have any guidance as to how much one in residency should spend on a ring, and also is the ring really even considered a financial investment? Obviously, it's something that is an investment into our future together, but since it is a financial podcast, is it something that we should consider as a financial investment, as well, since I would be potentially contributing a lot of money toward it? Thanks.”
Do you want to answer this one first, Disha?
“If I were buying a ring for someone, I would start with asking what they wanted rather than the dollar amount. I would take them to the store and get an idea of what they actually want. My husband bought me this awesome rock, several rocks, and he actually sold his motorcycle to do it. I mean, what a wonderful gesture, the fact that he lives longer, because he's not on a motorcycle anymore and he gives me a ring. But honestly when I saw it, I was like, ‘Oh, not my favorite ring, but that's OK because I love him and I'm going to accept it no matter what.' But generally, I would have preferred a really super-duper simple ring that was not that expensive, because honestly all these crevices in the ring make me nervous that there's bacteria in there that I'm carrying around from patient to patient. I'm pretty cognizant of all the germs, especially these days. So, I'm trying to wash this thing in peroxide several times a month. But it really stresses me out, honestly, to be wearing this much money and this much bacteria potential on my hand. I tend not to wear it. I just wear my wedding band. Again, I would talk to your potential spouse, your person, and just take her to a store. You know what else? Girls like a heads-up anyway. That's what I would recommend.”
You said three months’ salary. I've never heard that before. It used to be two months’ salary. I don't know when that changed, but that's just a guideline and keep in mind who that comes from. This isn't coming from some sort of sensible place. This is coming from the diamond industry, from the jewelers, that's who comes up with this stuff. This is not some sort of required purchase. You do not have to buy this. It's not an investment in the person. It's not, “I'm investing in this for some sort of return down the road.” That's not the way it works. It's a sign of commitment. It's a sign of love, but it's not some sort of investment you should expect a monetary return on. If you spend $30,000 on a ring, you're not somehow going to have a better marriage than if you spend $5,000 on a ring. That's just not the way it works. Let's not think of this as an investment, to start with.
“I totally agree. An investment is something that brings you cash into your pocket either now or later, but this is not going to do that. If the person likes you, they're going to marry you. It doesn't matter what kind of ring you give them. This is definitely a separate investment from cost. This is definitely an expense. That's OK. It's a great expense to have; just to be cognizant of your budget and make sure you know what they want.”
Lots of people borrow tons of money to have a wedding. I think that's a terrible way to start out a marriage, with all kinds of debt hanging over your head. Same thing with the ring. A lot of people borrow money to buy a ring. I think that's a terrible idea, to have a bunch of debt hanging over an engagement. I would say a lot of it depends on how much cash you have. If you have all kinds of cash, you're this attending physician with all your ducks in a row, you can spend all kinds of money on a ring.
If you were in the situation I was in when we got married, you probably shouldn't spend that much. I mean, I wasn't even graduated from college. I was donating plasma for grocery money. No, I was not going to go spend $15,000 on a ring. I think what I spent was probably $2,500. Granted it has been over two decades. So you have to apply some sort of inflation figure to that. It was a nice ring at the time, but it wasn't some huge rock that you would expect somebody to have that was marrying a doctor. But I did what Disha has suggested. This was not a surprise when I asked my wife to marry me. I mean maybe how I did it was a surprise. The fact that the question was coming was no surprise. We had been talking about marriage for months. She went with me when we went to the store and got to pick out what she liked and she still has it today. Up until the time she sprained that finger and can't actually get it over her knuckle, she wore it all the time. But that's kind of the way that wedding rings go. Try to inject some common sense into the situation. You don't necessarily want to cheap out on something like this. Typically, this is something that gets shown off to friends, and it's an important thing. You don't want to have some terrible ring, but at the same time, use some logic in the situation.
It's interesting, these days I keep hearing advertisements on the radio of trying to decide whether to use a mined diamond, which may have some ethical implications because people don't treat diamond mine workers very well in some parts of the world. Now you can grow diamonds in labs. I'm not sure which one's considered more valuable. I suspect the lab-grown one is cheaper and maybe even prettier but not as authentic. So, you've got that dilemma to sort out of the jewelers, too. But maybe that's a place you can save a few bucks and have a better-looking ring anyway. I don't know. That's about all the advice I've got for you on that subject—$15,000 seems like a lot for a resident to spend on a ring, though. I'll be honest. You can always get a nicer ring later. Don't feel like this only has to be a one-time purchase. Keep it reasonable. I'd say less than $10,000 if you're a resident. Good luck with your decision; it's your money. I would try to buy it with cash. Just the act of saving up for it or selling your motorcycle or something to get it, I think that reflects significant commitment to the marriage and to your partner.
What Does the Future Hold for WCI?
“Hi Dr. Dahle. Quick question I think you might enjoy answering. What do you see as the future of WCI? I know you've talked about having other speakers and other members joining your team as part of a way to keep it alive and make sure it doesn't die with you. But I'm also curious what other changes you envision might come to WCI in the next few years, the next few decades, and when you think you might start cutting back, and what your role will be going forward.”
I'll tell you what I've been telling people for the last decade. I don't know. I don't exactly know where it's going to go. I'm just along for the ride, and I couldn't have predicted where it is today five years ago. I couldn't have predicted where it was five years in from the beginning and who knows where it's going to be five years from now. Obviously, there are a lot more people depending on it now, though. So, we do need some longer projections and some longer plans and things to do.
The biggest risk to The White Coat Investor as a business is me. I'm the one most likely to screw it up. Something happening to me would be a significant issue, although much less significant now than it would've been a year or two ago. We're trying to make it so that it's a little bit more viable as a business and that it doesn't depend just on me. It wasn't that many years ago when I was the CEO and the chief technology officer in charge of everything basically. Then, we started hiring people. It gradually took over some of the things I was doing and then started doing some things that I wasn't even doing. That's when it's really grown by leaps and bounds.
What do we hope to do with it? Well, the mission statement is what we believe in. We truly want to help you get a fair shake on Wall Street. We want to help as many doctors become financially literate as we can. The longer we can do that, the more good we're going to do. Not only for those doctors and their families and their descendants but for their patients. We believe that doctors that have their financial ducks in a row are better doctors. We think that you can concentrate on your patients more, that you're less likely to do something maybe you shouldn't due to a financial conflict of interest. We want to keep that going for years and years and decades and who knows centuries maybe. That's our first mission.
Our second mission is to connect you to the good guys in the industry. The good news is connecting you to them means we can usually make some money. It makes it a viable business and allows us to pay people. The main focus for the last couple of years, as you've noticed, and the next few years going forward is going to be a process that involves removing me from the business. Not because I necessarily want to be out of the business, but because the business is better without me. By that, I mean, it's more of a business that can relate to more people and it's a business that can endure when I'm gone should something happen to me. Setting it up that way is good for the audience and it's good for the business. I'm not planning on going anywhere. I'm planning on doing this for a long time, but we want to be prepared for those sorts of things. As you may have noticed, my hobbies are not exactly the safest hobbies on the planet, and something could happen at any given moment. We want to be prepared for that.
One really big question is, can a business like this that was founded as Jim's blog outlive Jim? We don't really know. There's a certain percentage of you that are here listening, that are reading the blog, because you're personally connected to me. We understand that. I don't know what percentage of the audience that is, whether that's 10%, a third, or 90%. We don't really know. There is a certain number who are coming here to become financially educated. It's not that important that it's me behind the microphone or me behind the computer screen for some people. Obviously, removing me from the business, the latter people don't care all that much. The former care very much because they're just here to listen to me. We don't really know what that percentage is but we're certainly going to find out, because as people can tell, I'm not the only voice on this podcast.
Chances are, you won't be the last voice on this podcast either, Disha. Same thing on the blog. People have noticed we have a bunch of columnists and contributors. The idea is to have multiple voices on here and have multiple perspectives and to make it sustainable, because we think it does some really good things and we want to do that long term. I hope that answers your question of what we see long-term for the White Coat Investor. For the shorter term, we've got some books planned and some courses planned. We're going to keep doing the conference, and it gets better every year. We're continually making changes to the website and our communities to serve you better. That's where we're focused. We have a lot of people working hard on it now. It's a pretty fun mission and a pretty fun business to be part of.
“You know what I've found? It's a learning process being an entrepreneur and growing a company, but it's a lot of work and it takes a whole team. There are a lot of people behind the scenes of this podcast and the whole site. But what I found, with the Frugal Physician, was that I just wasn't willing to try to keep building that when there was already a platform that was reaching so many people here at The White Coat Investor. I thought the benefit to the community at large would be so much greater if we just joined forces and did this together. So that's why I'm here. I really hope that this company, this business that provides a really valuable service to our community of doctors, continues to keep going for years and years beyond us.”
Some people ask, “Why a business?” Why not a volunteer kind of organization or some sort of nonprofit or whatever. The truth is, I don't think we could do as much good if we weren't a business. It's the profit we make that allows us to hire people, that allows us to, again, reach more people, that allows us to connect you with the good guys in the industry. We think a business is the right format for this sort of an effort. That doesn't mean that money first is our mantra around here. It certainly is not. Do we make money? Yes. Do we want to take care of our employees and make payroll? Absolutely. But that is not necessarily the first and primary goal for the business. It does help me stay motivated sometimes when I'm not as motivated by the primary mission. Sometimes, I'm more motivated by money. Sometimes, I'm more motivated by the mission. I think it's good to have both those motivations working toward the success of this business.
More information here:
First Time Home Buyers Savings Accounts
“Hi, Dr. Dahle. Thank you for all that you do. My question is about the benefits of first-time home buyers savings accounts that are being put into legislation in several states now. Here in Mississippi, that would allow us to make state income tax deductible contributions of up to $5,000 a year, and any earnings the account generates are also gross state tax-free. Contributions past $5,000 each year are not tax-exempt, however. My wife is in the spring of her MS2 year, and our financial situation will allow us to start saving for a down payment on a home. The major caveat is the funds must be used here in the state of Mississippi. If her residency or attending position in the future put us into a different state, the funds would have to be withdrawn and would be subject to the 5% state income tax here in Mississippi, plus an additional 10% penalty. Is this too risky to have state tax exempt savings for a few years? Or am I overlooking anything? Thanks again.”
This is the first time Disha and I are hearing about these. Here's the deal. Doctors, as a general rule, do not spend a lot of time saving up a down payment. They either save it up very quickly, they already have the money, or they use a physician mortgage. If you are saving for a down payment of $5,000 at a time for many years, chances are very good you would've been better off financing more of the home and getting into it earlier. My guideline for buying a home has always been to buy when your personal situation is stable and your professional situation is stable. If you don't see any reason why your housing situation needs to change in the next five-plus years, I think you ought to buy a home. I don't necessarily think you have to have a 20% down payment. I also don't necessarily see this need for a huge long-term savings plan to come up with that down payment.
Now, there are obviously exceptions to that. If you're starting to save for a down payment early in a long residency and you're not buying during residency, then that can make sense to be saving for many years. Maybe if you're in the military and you're not planning to buy until you get out of the military, many years from now, that would make sense to be kind of a long-term saver in that direction. But I would almost rather see people just putting the money toward their retirement savings. Then, when they get closer to that date, maybe focus more on the home buying process. Five thousand dollars a year, which is the limit on lots of these state-specific plans, doesn't move the needle a lot for a doctor home. If you're buying a home in Mississippi that costs $80,000, then $5,000 goes a long way.
But the doctors I talk to are not buying $80,000 homes. Especially if you live somewhere that's not a low cost of living. The average home in Salt Lake now, we're not the Bay Area yet, but it's been going crazy in the last few years. The average home here is $400,000, and $5,000 a year doesn't go very far toward a $400,000 home. Especially when it's $800,000, by the time you actually buy it.
“These things are not made for doctors. These things are made for lower-earning people, the more average American earner. With the amount that we move, with the amount of uncertainty we have with Match Day and everything, it doesn't sound like a really good plan for a doctor.”
I don't think there's anything wrong with using it. If you want to use it, go ahead. I'm looking these accounts up online. They currently have them in Colorado, Iowa, Minnesota, Mississippi, Montana, Oregon, and Virginia. Keep in mind, there are other ways to save up. I think it'd be a terrible mistake to skip out on funding a Roth IRA in order to do this, for instance. Remember, you can take the contributions from a Roth IRA out and use them for a down payment. I would do a Roth IRA before I did this. This would be pretty far down my list of accounts to fund if I had a limited amount of money to put into something. If I didn't have a limited amount of money to put into something, if I had lots of money that I was saving, chances are I'm already in a home anyway, and I don't need this thing.
For some people, it's not a bad idea. Go ahead and use it. But a lot of these have a cap. I look at Colorado's, its cap is $50,000 total. It lets you put in $14,000 a year but no more than $50,000. Iowa, there's no cap. It's $100,000 in Minnesota for a joint account. No limits in Mississippi or Montana. It's $50,000 in Oregon and $50,000 in Virginia if you're single. Some of these haven't even passed yet. In Louisiana and Massachusetts and New Jersey and Pennsylvania, they're not even passed. They are just being talked about in the state legislature. Something to keep in mind, the government is trying to help people get into homes and be home buyers. This savings account is not a bad thing, but I just don't see this as being super useful for The White Coat Investor community.
More information here:
Is Renting Better Than Buying? Why We’re Financially Independent and Renting
Financing a Second Home
“Hi, Dr. Dahle. Thank you very much for all you do. I'm a physician in the Southeast. I have been listening to your podcast and reading your books since I was a fellow in 2018. I have a question that I got different answers to, and I need some guidance. I recently financed a house on a lake an hour from where I live as a second home. My family and I still want to use this house, but I also want to rent it out on Airbnb and I'm planning to give it out to a rental company for management.
My main concern is legal and tax protection. Someone advised me to create an LLC to put the house under, but when I did that, the bank threatened to have me forfeit the loan. So, I backed off. Now I'm not really sure what to do. Should I just rent it out and raise the insurance ceiling on it? Or should I try to refinance it under the LLC? Now, that would apply to any house I would buy in the future, I guess. Again, thank you very much for all you do. I'm looking forward to hearing from you.”
There is a lot to go into this question. The first thing is the concept of mixing business and pleasure. Many people want to do this. They want to have something they can use sometimes but somehow figure out a way for it to pay for itself. The dream is to have a second property that pays for itself so you can go up there whenever you want. But the truth is when we buy something for consumption reasons, we tend to look at it differently than when we buy something for investment reasons. When we're buying an investment, it's very much a cold, hard look at what the cash flow is. I don't think when we buy a house, we look at it quite the same way, and that includes second houses. When you're looking at that lake house, you think how it will be so fun to sit out on the deck and how it has a beautiful view. None of that goes into buying a rental property. When you're doing that, it's all about how much will this rent for? What will the expenses be? What will the purchase price be? What's the cap rate going to be? Let's evaluate this. Is it a good investment?
I think when you mix an investment property and a personal property, you get into trouble. You usually end up buying more for consumption reasons and just hoping it works out as a good investment. I think it's much less likely to. That is the first thing that pops to mind when I hear this question. What are you concerned about with this scheme, Disha?
“I would echo what you just said. Whenever you have a second home and you are trying to rent it out, it's good to know that, while you didn't buy it as an investment, it may help support some of the costs to have short-term renters in there. But it's probably not going to be a cash-flowing property. As long as you're OK with that, that's fine. The other thing is that whenever you try to put in an investment property or any property into an LLC, most mortgages have a due on sale clause. You can't transfer the property into someone else's name or a business's name without having to pay the mortgage like you encountered. That is something I haven't heard of actually happening to a lot of people, but I guess it did happen to you. It is a possibility in any closing disclosure or any loan document that you come across on a mortgage.
So then how do you protect yourself from liability in this kind of situation? While LLC is certainly one way to do it, the other way is just insurance. But then again, remember that if you bought it as a homeowner, you're going to need special renters or landlords’ insurance, if you're actually going to be renting this for a significant amount of time. You're going to need to have a lot of liability coverage, up to a million dollars usually, and make sure that you have the right policy that's going to cover short-term renters. It should also cover any kind of damage or harm that might come to the people that stay in your property, just because it's on the water or it has some other desirable thing that can also make it dangerous.”
Docks, boats, lakes, and running water are all things that add liability to the equation for sure. You often can have a mortgage on a property in an LLC. You probably shouldn't do it behind the bank's back, but I think if you were willing to continue to sign for it personally, I think they're usually OK with it. The other option is a non-recourse loan, basically where the loan is just to the LLC. But you know what? The bank is going to want a higher interest rate for that. Not only do you pay a higher interest rate when something is an investment property vs. something you're actually living in, but when the bank has no recourse on you personally, it's going to be an even higher interest rate.
It may be the bank balking at the fact that you have this sweet, personal loan for an owner-occupied house, and now you basically want to turn it into an investment property and put it into an LLC. I can't blame them for wanting to be paid more for covering that, because it's more risk to them. You just have to talk to the bank and talk to other banks and ask what the options are. Ask about signing for it personally and about a nonrecourse loan and refinancing into that. Ask what would happen if you just put more money into it so your loan-to-value is only 50% instead of 80%. They may be willing to work with you.
I totally agree with Disha about the insurance. Umbrella insurance is good. Everybody should have umbrella insurance on all their properties, but you're running a business now, too. You need business insurance. That's not an insignificant amount of liability. Keep in mind, too, with second homes, the rule of thumb is if you're not going to spend three months a year there, it probably doesn't pencil out. You're probably better off renting that space when you visit. Even if you're there for a month or two, you're probably better off renting it than you are buying it.
Keep that in mind when you're buying a ski condo or a lake house. How much are you really going to use it? I'm talking about beyond the first year. We all go up there all the time the first year. I'm talking about beyond that; how much are you really going to use it? If the truth is you're going to use it two weeks a year, this thing is not going to pencil out well for you as a second home. If it turns into this great investment property, that's one thing. But you ought to probably be looking at it as an investment property first in that situation. Then, maybe you can use it a little bit. Be aware that you can't buy it in an IRA and use it. If this is owned by your IRA, you cannot use it personally. That is an important thing to remember.
The other issue I see when I hear this question is the whole how leveraged should your life be question. Most of us as docs come out of school with a ton of student loans. We're trying to get into a practice, we're trying to get into a home. We have tons of debt. Our ratio of debt to our actual assets might be 40 times. We might have 40 times as much debt as we have assets. If you talk to experts on debt, on using debt, on using leverage to grow wealth, you'll see they recommend a much lower ratio of debt to assets. In fact, the numbers I have seen are 15%-35%. If you have a $1 million house and you have a $500,000 rental property and you have $500,000 in retirement accounts and you have $500,000 in other investments, that's $2.5 million in assets. They're suggesting how much debt you have on that is in the $350,000-$800,000 range. Not $2.5 million worth of debt when you've got a million dollars’ worth of assets. That's a very different scenario.
I think before you go financing a bunch of second homes, especially those that aren't actually a need for you, that you really should look at how leveraged your overall life is and decide how much leverage you actually want in your life. Because that not only introduces risk to your life, but it also impedes your cash flow, which in turn affects your ability to build wealth. Ask yourself: what is the plan for leveraging your life? When are you going to reduce it? How much do you want to have long-term? Keep that in mind when you're doing things like financing a second home that may or may not be a great investment property.
Having an Airbnb is a second job. You're running a hotel business. You've either got to hire somebody to do those aspects of it, whether it's cleaning or turnover, the actual booking, that sort of stuff, or you have to do it yourself. As a doc, you have to ask yourself if this is a good use of your time. Or are you better off doing one more case or rounding on one more patient?
“Let me play the devil's advocate here. A lot of real estate investors love short-term rentals because it is active income that can offset your other active income. Especially if you can put in a significant amount of time into this property in the first year, you can claim REP status, and actually get all of the losses written off against your active income. But you have to be spending a considerable amount of time at this property. A lot of people leverage a short-term rental and then spend a lot of time in it in the first year, claim the REP status, and take the tax benefits of that. The next year they do the same thing with the next property. Then they outsource after the first year. That's a way to do it, but again, like Jim said, this is introducing a lot of different factors into your life to try to get tax benefits. But it's very difficult to be a full-time doctor and do this. You would have to be prepared to be a part-time doctor and a real estate professional.”
REP stands for Real Estate Professional. The requirement is 750 hours a year, and no more than that doing anything else. That means you cannot be practicing more than you are spending time on your real estate business. You're not going to come up with 750 hours a year on one rental. It's going to take more than that to get to your 750 hours. At a certain point, you have to ask, what do you want to do with your life? Do you want to be a practicing doctor? Do you want to go do real estate? If you want to go do real estate, I totally agree you should get real estate professional status and get those tax benefits. But if you actually went to medical school and residency because you want to practice medicine, this may not work out well for you—unless your spouse is the one who goes for real estate professional status.
We have somebody who works here at The White Coat Investor that has a short-term rental property that has seven units in it, managed primarily by his spouse. And guess what? She doesn't put in 750 hours a year. So, they don't get real estate professional status. That's with seven units. How many units are you going to be managing? It takes a certain number to really get to 750 hours. I'm sure lots of people fudge the numbers. It's a little bit of a grey area, but come on, it's got to be reasonable or it's not going to pass the audit.
More information here:
Should You Use Doctor Loans to Finance Investment Properties
Roth Conversions During Peak Earnings Years
“Hi, this is Anna. I imagine you're getting a lot of questions about Roth conversions. I was wondering if you could do a segment on them specifically regarding whether it is beneficial or not to do Roth conversions for high-income professionals during their standard working years. And also with the assumption, if you weren't doing Roth, but the tax savings you would get from tax-deferred was being used to go into investment accounts. Thanks for all you do.”
I’m always happy to talk more about Roth conversions. It's a popular topic. It's a frequent topic we address here. Part of the reason it keeps coming up is because it's complicated. It's not straightforward. There is no awesome rule of thumb. It's kind of the same, whether you're talking about doing Roth conversions, which is taking money that's in a tax-deferred account and moving it into a tax-free or Roth account. Or whether we're talking about making 401(k) contributions as Roth contributions or tax-deferred contributions.
It's a complicated question. The only rule of thumb I've got, which isn't really perfect, is that during your peak earnings years, most doctors should do tax-deferred contributions. In any other year, you should do tax-free contributions and consider Roth conversions. But even in that rule of thumb, there are tons of exceptions, too. What would you advise somebody who's asking a general question about Roth conversions, Disha? What should they be thinking about?
“What you should be thinking about is your tax rate now vs. your tax rate in retirement. If you're going to be paying more taxes, a higher percentage on your earned income right now, than you would be in retirement, then it would make sense to lower your taxable income now, when you're in a higher bracket and pay the taxes later when you're in a lower bracket. Also remember that you don't pay taxes on the first $40,000 or so that you actually get as income. When you're retired, you're likely not going to have a mortgage or as many expenses as you do now. You can typically live on less. It makes a lot of sense as a doctor when you're earning a lot right now to do pre-tax contributions now and then do Roth conversions later. But it does help to have a Roth bucket and a pre-tax bucket of money to play with in retirement. Many people in our community set this up by doing pre-tax contributions to the 401(k)s, but then also doing a Backdoor Roth. So, you have a little bit of Roth money that you can withdraw from to moderate the taxes when you're retired.”
I think that is as good as we get for a general rule. I see a lot of confusion on this. A lot of people don't understand the difference between a Roth conversion and a Backdoor Roth. They use the terms interchangeably, and these are specific terms with precise meetings. A Backdoor Roth IRA is a process. It's a two-step process. It involves a contribution to a traditional IRA that typically is not deductible because the person contributing is a high earner. Step 2 is to then do a Roth conversion of that money, to move it from the traditional IRA to the Roth IRA. Because you didn't get a tax deduction on it, there's no tax cost to doing the conversion. That's a Backdoor Roth IRA. That's not really what we're talking about with this question. Keep in mind that yes, there is a Roth conversion part of that step, but there's no tax cost to us.
When you start talking about the exceptions, the main exception is if you're just an awesome saver. If you just save tons and tons of money, you're going to work for a long time, you're going to have a huge IRA. You're going to have a serious required minimum distribution problem, which is a good problem to have. If you have all this money, all this income in retirement, that's when you start thinking, “Well, maybe Roth makes more sense now. Maybe I should do Roth conversions even during my peak earning years.”
It certainly does some cool things with estate planning. When something's inside a retirement account, because when you're paying the taxes on a conversion, you're essentially moving money from taxable into a tax-protected account. In that tax-protected account, money grows a little bit faster and money will also be able to be stretched once you die. Your heirs can stretch that money out, that tax protection out, for another 10 years. It's not as good as it used to be. They used to be able to stretch it over their entire life, but you can still stretch it for 10 years. That's a huge estate planning benefit. You can also name beneficiaries for it. There's none of this probate crap you have to go through with that money. Once it's in that retirement account, you just name a beneficiary. When you die, they show a death certificate and they've got the money right away without any hassle.
Then, of course, in most states, having money in any sort of retirement account provides substantial asset protection benefits. That's another advantage. Anytime you can move money from a taxable account into a tax-protected account, you're usually also moving it from a non-asset protected account to an asset protected account. That can be a good move as well. But you don't necessarily want to pay a whole bunch of extra taxes just to get those benefits. There's even more to it. A lot of it comes down to who is going to get the money. Who is going to spend this money? Are you actually going to spend it during your lifetime? What ends up happening is when a lot of people get into retirement, they spend their taxable account, then they spend their tax-deferred account, and then they die.
They never get to their Roth account, and they leave it to their heirs. That's great if their heirs are in a top bracket. If their heirs are in the 12% bracket or the 22% bracket and you did all these Roth conversions at 37%, that probably wasn't a great move. Same thing if you're leaving the money to charity. When a charity inherits a traditional IRA, they don't pay taxes on it. If you're going to leave anything behind to a charity, you ought to consider leaving behind your traditional IRA, or even better, your HSA is a great thing to leave behind to a charity. An HSA sucks to inherit if you're not a charity. You have to pay taxes on the whole thing in the year you inherit it and take it out of the account. But if the charity gets it, they don't have to pay taxes at all on it. Part of your consideration needs to be where is the money going to go when you die?
When you're 30, or 35, or 45 years old, you don't have all these answers. You don't know what tax rates are going to be in the future. You don't know how long you're going to work. You don't know how much you're going to save or how well your investments are going to do, or who you're going to leave your money to. It makes these decisions really, really hard. That's why we try to come up with rules of thumb, but they're just not perfect. If you're not sure what to do, split the difference. Do a little bit of a Roth conversion. Do a little bit of Roth contributions to your 401(k), and split the difference. At least that way, you'll minimize the regret of doing the wrong thing somewhat. I've tried to guess at every stage of my life if I should be doing Roth or tax-deferred contributions, and I've guessed wrong several times just because my life changed as I went along. It turned out what I thought was going to be the right move probably is not going to be the right move in the long run. You do the best you can.
More information here:
Should You Make Roth or Traditional 401(k) Contributions?
Robo-Advisors
“Hi, Dr. Dahle. My name is David, and I'm a practicing physician in Long Island, New York. I have a question for you today about robo-advisors. Right now, I am currently maxing out my 401(k) and my Backdoor Roth. And whatever money I have left over, I typically steer toward either a brokerage account or paying down my mortgage. And I kind of do a little bit of each with the extra. In terms of the brokerage account, I've chosen to go with Wealthfront, which seems to be a pretty highly reviewed and highly rated robo-advisor. In general, the costs are 0.25%. So it seems pretty low. And their benefits theoretically are that they perform tax-loss harvesting and direct tax indexing, where they buy the individual stocks of a mutual fund and can make changes based on those individual stocks as opposed to the mutual fund as a whole.
I guess my question is, do you think that it's risky putting all my extra money toward a robo-advisor? It just seems like for 0.25%, I probably would net more positive than the expense of 0.25% with these maneuvers. I know that these are things theoretically I could do on my own. But as the account grows larger, I would imagine they have better resources and better algorithms than I do. I'm just curious to hear what your thoughts are on this. And thank you again for everything that you do.”
This is one of those dilemmas. There's not necessarily a wrong answer here, but there's nothing here that I'm getting super excited about either. A robo-advisor that doesn't cost very much, doesn't cost very much. That's a good thing. The less you pay for advice, the more of your money you keep. Fees matter. You're right to be looking at that and asking yourself if you are getting the value out of this that you should be getting. My issue with the robo-advisor is that I think there's just a very narrow niche for them. If you need an advisor, you probably need an advisor on all of your accounts. A robo-advisor is not going to do all your accounts. They're going to do your taxable account and maybe your IRA, and you're going to be on your own for 401(k). If you can do it on your own, why do you have a robo-advisor for the taxable account? If you can’t do it on your own, why don't you have a real advisor that's advising and taking care of all of your money?
I think it's a pretty narrow niche of people that can actually use this. It's people with nothing more than a taxable account and a Roth IRA. What does that mean? That probably means a resident, as far as our audience goes. There are not a lot of people that don't end up having more accounts once they get out of residency. I think the niche for robo-advisors is just not very wide. It's a product that they're trying to sell to a larger audience. I think there is a place for it, for sure, in people that need an advisor and can just use a robo-advisor to manage their assets because all their assets are in a taxable account and an IRA. I think there's probably a niche there, but I don't think there are very many doctors in that niche.
They try to sell it by telling you they will tax-loss harvest. Well, that's great. Tax-loss harvesting is worth something, but is it worth 0.25% a year on a million-dollar portfolio? No way. You're not going to get that much tax benefit out of that. One percent a year on a million-dollar portfolio is $10,000, and 0.25% on a million a year is $2,500. What's the biggest tax benefit you're going to get out of tax-loss harvesting? Three thousand dollars a year against your ordinary income. So maybe that saves you $1,200 or $1,400 in taxes, and you're paying $2,500 for it. That doesn't pencil out. You're not going to get enough of a benefit out of that in order to pay for it.
The issue with direct indexing is fine, maybe there are a little bit of tax efficiency gains there. But what happens when you change your mind? You no longer want to use this strategy. You want out of Wealthfront. What do you own? You own a whole bunch of individual stocks, and you've got a mess on your hands to clean that up. You have to sell them, you have to hold them. You have to figure out which ones have losses and gains and try to offset them as you get out of that and into index funds. It's a lifelong commitment when you have a strategy like that in your taxable account. If you're not ready to make a lifelong commitment to Wealthfront to manage that taxable account for you, it is probably not worth it. I mean, they've only been around a few years. They may not be around in 60 years when you still need them to be managing that account. I'd be pretty careful adopting that sort of a strategy in a taxable account. What are your thoughts on robo-advisors, Disha?
“Jim, I would agree with you. Especially if you're a White Coat Investor, you've been listening to this podcast for a while, you most likely can do this on your own without the extra costs and really just very marginal gains by going with a robo-advisor. I don't have a hugely strong opinion against using robo-advisors, but I just don't see it being that useful for me or anyone else like me.”
I think that's the truth. When thinking about tax-loss harvesting, this is one of those things you do a few times in your mid-career, and then you will have so many tax losses that you're never going to use them all. Imagine you've got a $1 million taxable account and you hit a big bear market. Maybe you're able to tax-loss harvest $100,000 or $200,000. At $3,000 a year, how long did $200,000 in tax losses last? Six or seven decades. You've got enough. How many more tax losses do you need? Unless you've got some sort of tax loss, some capital gain coming up in your life that you need to offset. The only reason I keep grabbing tax losses is because, what if I sell the White Coat Investor someday? Maybe I could use some of these tax losses. I keep booking them when it's convenient and when I have a big tax loss, but I was way too excited about tax-loss harvesting early on in my investing career. Because then you come to the next bear market and you get so many tax losses, you're never going to need them again. Once that taxable account gets to a certain size, this is not a great use of your time or your fees to pay somebody else to do it for you. I hope that helps with your decision, whether to continue to use Wealthfront or not. I don't have anything against the company. They do what they do. You can read what they do. If you feel like that's adding value, you can try that. Just try to see the end from the beginning and decide if that's really something that you want long term.
Sponsor
Bob Bhayani is an independent provider of disability insurance planning solutions to the medical community in every state and a long-time White Coat Investor sponsor.
He specializes in working with residents and fellows early in their careers to set up sound financial and insurance strategies. If you need to review your disability insurance coverage or if you just need to get this critical insurance in place, contact Bob at drdisabilityquotes.com today. You can email [email protected] or call (973) 771-9100.
Quote of the Day
Henry David Thoreau said,
“Wealth is the ability to fully experience life.”
White Coat Investors Guide to Asset Protection
The latest WCI book has officially been released. The White Coat Investors Guide to Asset Protection is for anyone interested in protecting your assets. It's a relatively short book, and close to half of it is the most comprehensive list of state-specific asset protection laws that I know about. The asset protection laws are always state-specific. It is important to know what the laws are in your state and in the states where you may do business or have assets. If you're worried about losing everything to a lawsuit, if you just want to make sure you've done the basics of asset protection, if you want to learn more about advanced asset protection techniques, if you're thinking about going to see an asset protection lawyer, or if you've been named in a lawsuit, we recommend you pick up The White Coat Investors Guide to Asset Protection.
Milestones to Millionaire
#65 — Family Doc Achieves $0 Net Worth
This Canadian family doc and her social worker partner applied to be a guest on the show when they achieved $0 net worth. But since applying, they paid off all their student loans. They’ve had a savings rate of 60%-70%! Tracking their lifestyle inflation percentage, concrete spending/savings goals, and monthly financial meetings together have catapulted them to their goals.
Sponsor: LocumStory
Full Transcript
Intro:
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 262 – Cost of raising a child, questions on homes, rings, and robo-advisors.
Dr. Jim Dahle:
This podcast is sponsored by Bob Bhayani at drdisabilityquotes.com. He is an independent provider of disability insurance planning solutions to the medical community in every state and a long-time White Coat Investor sponsor.
Dr. Jim Dahle:
He specializes in working with residents and fellows early in their careers to set up sound financial and insurance strategies. If you need to review your disability insurance coverage, or if you just need to get this critical insurance in place, contact Bob at drdisabilityquotes.com today. You can email [email protected] or you can call (973) 771-9100.
Dr. Jim Dahle:
Let's see, we're recording this, it's March 28th. This actually isn't going to run until May 12th. You know what that means when there's six weeks between the time of recording and the time it's going to run. It means I'm about to go have a whole bunch of fun.
Dr. Jim Dahle:
But today we are together. I am here with Dr. Disha Spath, my co-host here on the White Coat Investor podcast, and we have got a great episode planned for you today. What have you been up to lately, Disha?
Dr. Disha Spath:
Oh gosh. Just the usual kids and work and nothing too special recently. How about you?
Dr. Jim Dahle:
Well, I'm actually recording this between two trips. I'm in town for, let's see, 28 hours between a trip to Phoenix and a trip to Costa Rica. And I've got a shift in that time period. So, I've got a whole bunch of work this morning, and packing bags in between the work.
Dr. Jim Dahle:
And so, it's a pretty quick turnaround, but we're going to get this recorded. Cindy tells me we have to record this episode today because I'm apparently going to be out of town three or four weeks in April, and she's going to be out of town the other week. So here we are recording six weeks in advance. If anything in this episode seems really out of touch with what's going on in the world, don't blame us. It's recorded quite a bit in advance.
Dr. Disha Spath:
It's because Jim's a rockstar.
Dr. Jim Dahle:
Well, I don't know if I'm a rockstar, but I mean the pandemic's not over, I guess, it may never be over. It depends on how you define “over”, but we're definitely traveling again. And we kind of take this perspective that since we're financially independent, we don't want to miss out on anything. We still like work, but we don't want to miss out on anything.
Dr. Jim Dahle:
And so, we're trying to live this hybrid life where we're going on all these trips and do whatever we want to do, but also have meaningful work and it ends up getting really busy sometimes. And I don't know, maybe we'll figure that out one of these days, but so far, we have not yet.
Dr. Disha Spath:
Yeah. There's definitely like a bunch of rebound travel that's happening.
Dr. Jim Dahle:
Yeah, for sure. There's a lot of rebound travel out there. All right. I got to tell you about something I've been working on. I'm actually done with it at this point that we're recording this, but it hasn't launched yet. By the time you hear this episode, it will be launched and it's called the White Coat Investors Guide to Asset Protection. This is a book I've written over the winter. It's all about asset protection, a single subject.
Dr. Jim Dahle:
We're all out there worried we're going to get our pants suit off us, from making one mistake at work and losing everything we've ever earned. Everything we have, that our whole life we're going to be destitute because of one malpractice suit. And that fear is probably completely overwrought for most of us, but the chances are not zero of that happening.
Dr. Jim Dahle:
The book goes into both, what I call basic and more advanced asset protection strategies, but perhaps the most important part of the book is it details all of the relevant asset protection laws.
Dr. Jim Dahle:
And this was a big deal compiling all these because asset protection law is state-specific. Every state has its own asset protection laws, whether they protect IRAs, whether there is a homestead exemption, whether they protect whole life insurance, what has to be done when they sue you. All these laws are unique in state by state. And so without knowing your state's laws, you can't really come up with any sort of a reasonable asset protection plan.
Dr. Jim Dahle:
A big chunk of the book, more than a third of the book is just a listing of the state asset protection laws. And you can use that to look up your own state, state of anywhere you do business, states you're considering moving to after your training, etc. And so, it's going to be a pretty useful book to have on your bookshelf, not just to read once, but to actually have as a reference.
Dr. Jim Dahle:
So, check that out. It's available at Amazon like usual. You go to whitecoatinvestor.com/assetprotectionbook, and it'll take you right there. But I hope you enjoy that. It represents a lot of work and the staff's done a great job doing the layout. Emily, primarily is our staff member who's worked on that as well as getting it uploaded onto Amazon. So, thank you Emily for that help. Check out the book if you are interested.
Dr. Disha Spath:
Jim, I can't wait to read it.
Dr. Jim Dahle:
Yeah, it's going to be good. We'll get a copy out to you. If you got a big audience, you got some huge Facebook group or you're a blogger or you're a podcast, or you don't have a copy yet, shoot us an email. We'll send you a copy. Tell your audience about it. We'd be super grateful. That would be awesome.
Dr. Jim Dahle:
All right, let's talk about childcare. Why don't we kick this off with a question off the Speak Pipe? We got a great question from Megan. Let's listen to her question and then we're going to rant a little bit about the cost of raising children because they're not insignificant. All right, let's take a listen to this one.
Megan:
Hi Jim. I'm a general surgeon and my husband is a vascular surgeon. For obvious reasons, we have to have a full-time nanny. Currently, we use a company that takes care of W2 paying employer taxes, deducting the nanny taxes, and actually paying the nanny.
Megan:
However, they're upping their fees by over a thousand dollars this year. Is this something that you think that we could do on our own? Or do you have any resources for setting up a payroll? We will be doing this for many years, so these costs can add up.
Dr. Jim Dahle:
That's a great question, Megan. Thanks for leaving that. There are a lot of costs of having children, not least of which is childcare and the costs of complying with the tax requirements of childcare.
Dr. Jim Dahle:
Let me first tell you what not to do, then Disha can tell you what to do. What you should not do is what happened to my daughter this last summer. She was hired as a nanny and took care of a few kids for a local family for most of the summer. She made several thousand dollars.
Dr. Jim Dahle:
And then we start talking about taxes last month and I ask her how much she made. She doesn't know how much she made. Did she get any tax forms from the employer? No, no tax forms from the employer. Basically, they were treating her like she was the Friday night babysitter.
Dr. Jim Dahle:
Well, that works fine for the Friday night babysitter. It does not work fine for your full-time nanny. The IRS draws a line at $2,300 a year. If you are paying a household employee, which is what a nanny is, more than $2,300 in the year, you got to treat them like a real employee. You got to do I-9s, you got to do W2s, W3s, W4s.
Dr. Jim Dahle:
You got to send them tax forms, because what happens is when they go to file their taxes, they're faced with the dilemma that my daughter has right now. The dilemma is “Do I not report this income, or do I do what the IRS wants me to do?” which is report the income. Say, “I didn't get a W2 I should have gotten and throw you under the bus for not paying applicable payroll taxes.”
Dr. Jim Dahle:
So don't put your nanny in that sort of a situation. Don't put any sort of household employee in that situation. Actually, comply with the laws and do what you're supposed to do, and keep everybody out of trouble. Disha, do you want to talk to them a little bit about what they're supposed to do and some of the easy ways to do it?
Dr. Disha Spath:
Absolutely. Yeah. Nannies are considered household employees, which are not independent contractors. Because you are basically employing this person for most of their time, you are now an employer. And as an employer, you must pay the social security, Medicare, and federal and state unemployment taxes on the wages paid to that employee. And also remember that each state has their own rule. So, there might be some state-level taxes.
Dr. Disha Spath:
If you're going to do this yourself, there are a few services that will help you with it. NannyChex does it for $6, for a weekly paycheck, they charge $6.25 plus $80 per quarter for quarterly filings and $150 at the end of the year. Basically, that comes out to about $66 a month.
Dr. Disha Spath:
Care.com does it for about $75 a month. We had a guest post by Dr. Astrid Moise on the White Coat Investor called Financial Cost of Childcare. And if you want the details on that, she's got it all laid out for you. Basically you're going to be needing to pay all these taxes up front, and then like Jim said, providing them with tax forms at the end of the year as well.
Dr. Disha Spath:
That's one way to do it. NannyChex or Care.com sounds like a good option. Of course, you could also consider maybe hiring an aupair. A lot of physician families with two physicians have good luck with aupairs because they're available to you at all times with changing schedules, with changing calls, sometimes nanny schedules don't work out, but aupair is basically you sponsor someone to come live with you in your house for a year. Usually, you are also required to provide them with a car and accommodations.
Dr. Disha Spath:
So, if you have an extra room in your house, and you can get someone to come live with you, that would obviously be ideal and actually turns out to be pretty cost-effective as well. The annual cost of having apairs is about $19,000 plus the car and the accommodations. And there are different companies out there that will do that for you. That might be a good option for you. And of course, there's center-based and day-cares and in-home day-cares, which are a little bit more expensive.
Dr. Jim Dahle:
Yeah, I think most people are probably going to center-based childcare, but that doesn't work very well for doctors. When you get called into the hospital or you're working night shifts or evening shifts or weekend shifts, a lot of these places are closed. They're like 8:00 to 5:00 operations, Monday through Friday.
Dr. Jim Dahle:
This was a huge issue I remember for one of my residency classmates. She was an ICU nurse. I think she worked nights. He was an emergency medicine resident, no center-based daycare was going to work for them. And so, they actually ended up paying my wife to watch their kid, and it was good. She was about the age of Whitney. And so, they hung out together. They were good friends. But that was the only sort of a thing that would work for them. They could not have done anything that was standard, for standard employees who work banker’s hours.
Dr. Disha Spath:
Right. Yeah. We're lucky because my husband works from home and then we moved close to his family so they could help out when one of us has to work or we both have to work and the daycare's closed because of COVID and all this stuff. Definitely childcare hours and center-based hours really restrict a lot of parents and make it quite impossible for dual physician couples. So yeah, nannies or aupairs would probably be a great option for those kinds of dual physician families.
Dr. Jim Dahle:
Now, the government knows this is expensive stuff. I mean, imagine you're the average household making $55,000 or $60,000 a year, and you're looking at costs of $20,000, $30,000, $33,000 to watch your kids. That doesn't work very well. So, the government has done a few things to kind of help with the cost. Do you want to talk a little bit about some of those tax breaks that come for childcare?
Dr. Disha Spath:
Yes. There are two different options. And they've recently been really beefed up because of COVID, which is really awesome for families. The first option you have is a dependent care FSA. Of course, that's not guaranteed. Generally, that's employer-sponsored. If your employer has this option, this is a really good option for higher-income families.
Dr. Disha Spath:
The other option is child tax credit. The child tax credit was actually paid out in increments during COVID. The important thing to remember about that is that child tax credit is something that you opt into, but you can use the dependent care FSA money for the same stuff that you're getting the child tax credit for. So, you can't use both of them for the same amount of dollar expense. But thankfully, we all have so much child care expense most of the time that we can utilize anything that we get.
Dr. Disha Spath:
The dependent care FSA basically lets you use pre-tax income and bypass social security and Medicare tax and pay for child expenses with your pre-tax income. So it decreases your taxable income, which is awesome. And because of COVID, the American Rescue Plan actually increased the contribution that you can put into a dependent care FSA from a $5,000 max per year to $10,500 per year.
Dr. Disha Spath:
And they actually made it so that it could rollover. Whereas before in a dependent care FSA, it was either use it or lose it situation. Because of COVID you can roll over those funds. You can almost get $15,500 pre-tax for childcare this year. And the child tax credit, which used to be a pretty bad deal for high earners because it maxed out at 20%.
Dr. Disha Spath:
So, it's phased out because of AGI, your adjusted gross income. The higher adjusted gross income, the less child tax credit you get. But because of the American Rescue Plan, it has increased the benefit from about $1,000 to you to up to $4,000 per child, for one child and $8,000 for two or more children.
Dr. Disha Spath:
These are really important tax benefits to be aware of, if you do have kids and make sure you do utilize it. The important thing to know about a dependent care FSA is that you can have it even if you have an HSA. A lot of the time you can't have HSA medical and medical FSA, but you can have a medical HSA and a dependent care FSA together.
Dr. Jim Dahle:
Yeah. That child tax credit was a bit of a change. It used to be almost no docs qualified for it. Now many docs qualify for it. The phase-out starts for head of household, which if you're a single parent, you're probably filing head of household. It starts phasing out at $112,500 of income. All right. So, most docs are going to be above that.
Dr. Jim Dahle:
But if you are married, it starts at $150,000. Married filing jointly starts at $150,000, but goes all the way to $400,000 before you're completely phased out of it. So, lots of docs can get their AGI below $400,000, probably the majority of docs. I think the average physician income, not the average physician household, but the average physician income is $275,000 right now.
Dr. Jim Dahle:
So, lots of docs are going to be under that $400,000 limit and be able to get some sort of a child tax credit, which I know how much kids cost and the tax credit doesn't come anywhere close to paying for them, but it helps, every little bit helps. And so, if you qualify for that, make sure you're getting that when you file your taxes.
Dr. Jim Dahle:
But mostly, it just costs a lot to pay for kids. And the funny thing is everyone thinks, “Oh, it's crazy. It's paying for childcare. I can't believe how expensive childcare is.” Well, guess what? It doesn't get any better. They just keep becoming more and more expensive as time goes on. All of a sudden now you're paying for private school or you're paying for college or you're getting them a car or they start eating more. Have you ever fed teenage boys? They're not exactly skimpy on their portions. This expense doesn't really go away until they're out of college, to be honest with you. So, get used to it I guess. Kids are expensive.
Dr. Disha Spath:
Yeah. I feel like it just shifts.
Dr. Jim Dahle:
Yeah, exactly.
Dr. Disha Spath:
At least with the day-care expenses, it is somewhat subsidized by the government with these tax benefits. So, you might as well use them while you can.
Dr. Jim Dahle:
Yeah, let's go onto our next question on the Speak Pipe here. This one is about engagement rings. And we had a good time discussing this, but let's take a listen to the question.
Speaker:
Hey, Dr. Dahle. This is a pretty non-traditional question, but I'm currently a resident and I'm thinking about proposing to my girlfriend at some point. And I was wondering how much should someone in my position spend on a ring. Now tradition says that we should spend approximately three months of one's income on an engagement ring. And as a resident I reck in, let's say, $60,000 a year. So three months of that would be $15,000. That's a lot of money especially for someone on a residence salary.
Speaker:
Now, obviously, I want to invest in the person I love. I want to get something that both she and us are proud of together. I'm just curious, do you have any guidance as to how much one in residence position should spend on a ring, and also is the ring really even considered a financial investment? Obviously, it's something that is an investment into our future together, but since it is a financial podcast, is it something that we should consider as a financial investment as well since I would be potentially contributing a lot of money towards it? Thanks.
Dr. Jim Dahle:
All right. Great question. Do you want to answer this one first, Disha?
Dr. Disha Spath:
Yeah. I would definitely, if I were buying a ring for someone, I would start with what they wanted rather than the dollar amount. I would take them to the store, kind of get an idea of what they actually want. It's like a funny story. My husband bought me this awesome rock right here, several rocks, and he actually sold his motorcycle to do it. I mean, what a wonderful gesture, the fact that he lives longer, because he's not on a motorcycle anymore and he gives me a ring.
Dr. Disha Spath:
But honestly when I saw it, I was like, “Oh, not my favorite ring, but that's okay because I love him and I'm going to accept it no matter what.” But I generally would've preferred a really super-duper simple ring, not that expensive ring because honestly all these crevices in the ring make me nervous that there's bacteria in there that I'm carrying around from patient to patient.
Dr. Disha Spath:
I'm pretty cognizant of all the germs, especially these days. So, I'm trying to wash this thing in peroxide several times a month. But it really stresses me out honestly, to be wearing this much money and this much bacteria potential on my hand. So I tend not to wear it. I just wear my wedding ring. But yes, I would talk to your potential spouse, your person, and just take her to a store and you know what? Girls like heads up anyway. That's what I would recommend.
Dr. Jim Dahle:
You say three months’ salary. I've never heard that before. It used to be two months’ salary. I don't know when that changed, but that's a guideline and keep in mind who that comes from, right? This isn't coming from some sort of sensible place. This is coming from the diamond industry, from the jewelers, that's who comes up with this stuff. This is not some sort of required purchase. You do not have to buy this. And it's not an investment in the person. It's not, “I'm investing in this for some sort of return down the road.”
Dr. Jim Dahle:
That's not the way it works. It's a sign of commitment. It's a sign of love, but it's not some sort of investment you should expect a monetary return on. That if you spend $30,000 on a ring, you're somehow going to have a better marriage than if you spend $5,000 on a ring. That's just not the way it works. So, let's not think of this as an investment to start with.
Dr. Disha Spath:
I totally agree. An investment is something that brings you cash into your pocket either now or later, but this is not going to do that. If the person likes you, they're going to marry you. It doesn't matter what kind of ring you give them, but it would be great. I'm sure that if they had some sort of a clue as to what they were going to be wearing on their hand for the rest of their life. Yeah, that's definitely a separate investment from cost. This is definitely an expense. That's okay. It's a great expense to have just to be cognizant of your budget and make sure you know what they want.
Dr. Jim Dahle:
Yeah, for sure. I mean, it's like anything. Lots of people borrow tons of money to have a wedding. I think that's a terrible way to start out a marriage with all kinds of debt hanging over your head.
Dr. Disha Spath:
Absolutely.
Dr. Jim Dahle:
Same thing, lots of people borrow money to buy a ring. I think that's a terrible idea to have a bunch of debt hanging over an engagement. I would say a lot of it depends on how much cash you have. If you got all kinds of cash, you're this attending physician with all your ducks in a row, you can spend all kinds of money on a ring.
Dr. Jim Dahle:
If you were in the situation I was in when we got married, you probably shouldn't spend that much. I mean, I wasn't even graduated yet from college. Here I am donating plasma for grocery money. No, I'm not going to go spend $15,000 on a ring. I think what I spent was probably $2,500. Now, granted it has been over two decades. So you got to apply some sort of inflation figure to that. It was a nice ring at the time, but it wasn't some huge rock that you would expect somebody to have. That was marrying a doctor for instance.
Dr. Jim Dahle:
But I did what Disha has suggested. This was not a surprise when I asked my wife to marry me. I mean maybe how I did it, it was a surprise. It ended up being on the ice between periods of a college hockey game. But that's a story for another day. But the fact that the question was coming was no surprise, we've been talking about marriage for months.
Dr. Jim Dahle:
We've been talking about everything you can imagine about marriage to try to be prepared for it. And so it wasn't a surprise that the question was coming. And so, she went with me when we went to the store. And she got to pick out what she liked and still has it today. And up until the time she sprained that finger and can't actually get it over her knuckle, she wore it all the time. But that's kind of the way that wedding rings go.
Dr. Jim Dahle:
And so, try to inject some common sense into the situation. You don't necessarily want to cheap out on something like this. Typically, this is something that gets shown off to friends and it's an important thing. So, you don't want to have some terrible ring, but at the same time, use some logic in the situation.
Dr. Jim Dahle:
It's interesting, these days, I keep hearing these advertisements on the radio of trying to decide whether to use a mined diamond, which may have some ethical implications, apparently, because people don't treat diamond mine workers very well in some parts of the world, versus I guess they're growing them now in labs. And so, I'm not sure which one's considered more valuable. I suspect the lab grown one is cheaper and maybe even prettier, but not as authentic. So, you've got that dilemma to sort out of the jewelers too.
Dr. Jim Dahle:
But maybe that's a place you can save a few bucks and have a better-looking ring anyway. I don't know. That's about all the advice I've got for you on that subject. $15,000 seems like a lot for a resident to spend on a ring though. I'll be honest.
Dr. Disha Spath:
That's crazy. I think most people spend about $3,000 if you're looking for like a number. But funny story, actually, Josh and I are going to go shop for a simpler ring for me this year because it's our 10 years.
Dr. Jim Dahle:
Very cool. There's always the opportunity to upgrade this thing. I don't know what they call it, an anniversary ring or something. You can always get a nicer ring later. Don't feel like this only has to be a one-time purchase. Keep it reasonable. I don't know that I'd say $3,000. That feels like maybe not all that much these days, but I'd say less than $10,000 if you're a resident anyway. That seems like a lot to spend more than that to me.
Dr. Jim Dahle:
But good luck with your decision, it's your money. And I would try to buy it with cash. Just the act of saving up for it or selling your motorcycle or something to get it, I think reflects significant commitment to the marriage and to your partner. And so, I like that idea.
Dr. Jim Dahle:
All right, let's do our quote of the day. I love this quote. This one's from Henry David Thoreau. He said, “Wealth is the ability to fully experience life.” And I think there's a lot of truth to that. When you can really not have to miss out on any opportunities because you have the money to pay for them.
Dr. Jim Dahle:
All right. Let's take another question. This one is from Randall.
Randall:
Hi Dr. Dahle. Quick question I think you might enjoy answering. What do you see as the future of WCI? I know you've talked about having other speakers and other members joining your team as part of a way to keep it alive and make sure it doesn't die with you. But I'm also curious what other changes you envision might come to WCI in the next few years, next few decades and when you think you might start cutting back and what your role will be going forward.
Dr. Jim Dahle:
All right. The future of WCI. Yeah. I'll tell you what I've been telling people for the last decade. I don't know. I don't exactly know where it's going to go. I'm just along for the ride and I couldn't have predicted where it is today five years ago. I couldn't have predicted where it was five years in from beginning and who knows where it's going to be five years from now. Obviously, there's a lot more people depending on it now though. So, we do need some longer projections and some longer plans and things to do.
Dr. Jim Dahle:
The biggest risk to what the White Coat Investor as a business is me. I'm the one most likely to screw it up. Something happening to me would be a significant issue, although much less significant now than it would've been a year or two ago. We're trying to make it so that it's a little bit more viable as a business and that it doesn't depend just on me.
Dr. Jim Dahle:
It wasn't that many years ago when I was the CEO, the chief technology officer in charge of everything basically. And then we started hiring people. It gradually took over some of the things I was doing and then started doing some things that I wasn't even doing. And so, that's when it's really grown by leaps and bounds.
Dr. Jim Dahle:
What do we hope to do with it? Well, the mission statement is what we believe in. We truly want to help you get a fair shake on Wall Street. We want to help as many doctors become financially literate as we can. And the longer we can do that for, the more good we're going to do. Not only for those doctors and their families and their descendants, but for their patients, because we believe that doctors that have their financial ducks in a row are better doctors.
Dr. Jim Dahle:
We think that you can concentrate on your patients more. That you're less likely to do something maybe you shouldn't due to a financial conflict of interest. And so we want to keep that going for years and years and decades and who knows centuries maybe, who knows. And so, that's our first mission.
Dr. Jim Dahle:
Our second one is to connect you to the good guys in the industry. And the good news is connecting you to them, we can usually make some money. And so, it makes it a viable business and allows us to pay people.
Dr. Jim Dahle:
But the main focus for the last couple of years as you've noticed, and the next few years is going to be a process that involves removing me from the business. Not because I necessarily want to be out of the business, but because the business is better without me.
Dr. Jim Dahle:
And by that, I mean, it's more of a business that can relate to more people and it's a business that can endure when I'm gone or should something happen to me. But just setting it up that way is good for the audience, it's good for the business, etc.
Dr. Jim Dahle:
And no, I'm not planning on going anywhere. I'm planning on doing this for a long time, but we want to be prepared for those sorts of things. As you may have noticed, my hobbies are not exactly the safest hobbies on the planet and something could happen at any given moment. And so, we want to be prepared for that.
Dr. Disha Spath:
Oh, Jim don't be a Debbie downer, we'd miss you so much. We’ll all miss you.
Dr. Jim Dahle:
It's true. The founder, especially if something like this is going to be a big part of it. But it's really a big question. Can a business like this that was founded as Jim's blog outlive Jim? And we don't really know. There's a certain percentage of you that are here listening, that are reading the blog because you're personally connected to me. And we understand that. I don't know what percentage of the audience that is, whether that's 10%, or a third, or 90%. We don't really know.
Dr. Jim Dahle:
But there's a certain number who are coming here to become financially educated. And it's not that important that it's me behind the microphone or me behind the computer screen. And so, obviously removing me from the business, the latter people don't care all that much. The former care very much because they're just here to listen to me.
Dr. Jim Dahle:
And so, we don't really know what that percentage is but we're certainly going to find out, because as people can tell, I'm not the only voice on this podcast. And chances are, you won't be the last voice on this podcast either, Disha. And same thing on the blog. People have noticed we have a bunch of columnists and contributors.
Dr. Disha Spath:
You mean you're not handing the empire to me.
Dr. Jim Dahle:
I know. I know it's weird. It's weird, isn't it? But the idea is to have multiple voices on here and have multiple perspectives and to make it sustainable because we think it does some really good things and we want to do that long term.
Dr. Jim Dahle:
So, I hope that answers your question of what we see long term for the White Coat Investor. More shorter term, we've got some books planned, some courses planned. We're going to keep doing the conference and it gets better every year. And we're continually making changes to the website and our communities to serve you better. That's where we're focused. And we got a lot of people working hard on it now. So it's a pretty fun mission and pretty fun business to be part of.
Dr. Disha Spath:
You know what I've found? It's a learning process being an entrepreneur and growing a company, but it's a lot of work and it takes a whole team. There are a lot of people behind the scenes of this podcast and the whole site. But what I found, with the Frugal Physician, was that I just wasn't willing to try to keep building that when there was already a platform that was reaching so many people here at the White Coat Investor.
Dr. Disha Spath:
I thought the benefit to the community at large would be so much greater if we just joined forces and did this together. So that's why I'm here. And I really hope that this company, this business that provides a really valuable service to our community of doctors continues to keep going for years and years beyond us.
Dr. Jim Dahle:
Yeah. Some people ask “Why a business?” Why not a volunteer kind of organization or some sort of non-profit or whatever. And the truth is, I don't think we could do as much good if we weren't a business. It's the profit we make that allows us to hire people, that allows us to, again, reach more people, that allows us to connect you with the good guys in the industry.
Dr. Jim Dahle:
We think a business is the right format for this sort of an effort. But that doesn't mean that money first is our mantra around here. It certainly is not. Do we make money? Yes. Do we want to take care of our employees and make payroll? Absolutely. But, that's not necessarily the first and primary goal for the business.
Dr. Jim Dahle:
It does help me stay motivated sometimes when I'm not as motivated by the primary mission. Sometimes I'm more motivated by money. Sometimes I'm more motivated by the mission. And I think it's good to have both those motivations working toward the success of this business.
Dr. Jim Dahle:
All right, enough about WCI. Let's talk about you. This podcast is not supposed to be about me. It's not supposed to be about WCI. It's supposed to be about you and your dilemmas and your struggles with money. So let's talk about the benefit of first-time home buyers' savings accounts. This is a question from Jaylen. So let's take a listen.
Jaylen:
Hi, Dr. Dahle. Thank you for all that you do. My question is about the benefits of first-time home buyers savings accounts that are being put into legislation in several states now. Here in Mississippi, that would allow us to make state income tax deductible contributions of up to $5,000 a year, and any earnings the account generates are also gross state tax-free. Contributions past $5,000 each year are not tax-exempt however.
Jaylen:
My wife is in the spring of her MS2 year and our financial situation will allow us to start saving for a down payment on a home. The major caveat is the funds must be used here in the state of Mississippi. If her residency, or attending position in the future put us into a different state, the funds would have to be withdrawn and would be subject to the 5% state income tax here in Mississippi, plus an additional 10% penalty. Is this too risky to have state tax exempt savings for a few years? Or am I overlooking anything? Thanks again.
Dr. Jim Dahle:
Well, this is my first-time hearing about these. Have you heard about these before, Disha?
Dr. Disha Spath:
I haven't. It sounds like a good deal for someone who's going to be stable in one state.
Dr. Jim Dahle:
Yeah. Here's the deal. Doctors as a general rule, do not spend a lot of time saving up a down payment. They either save it up very quickly. They already have the money, or they use a physician mortgage. If you are saving for a down payment of $5,000 at a time for many years, chances are very good you would've been better off financing more of the home and getting into it earlier.
Dr. Jim Dahle:
My guideline for buying a home has always been buy when your personal situation is stable and your professional situation is stable. If you don't see any reason why your housing situation needs to change in the next five-plus years, I think you ought to buy a home. I don't necessarily think you have to have a down payment, a classic 20% down payment. And so, I don't necessarily see this need for a huge long-term savings plan to come up with that down payment.
Dr. Jim Dahle:
Now, there's obviously exceptions to that. If you're starting to save for a down payment early in a long residency, and you're not buying during residency, then, okay, that can make sense to be saving for many years. Maybe if you're in the military and you're not planning to buy until you get out of the military, many years from now, that would make sense to be kind of a long-term saver in that direction.
Dr. Jim Dahle:
But I would almost rather see people just putting the money toward their retirement savings. And then when they get closer to that date, maybe focus more on the home buying process. So, that's part of it. And the other part is $5,000 a year, which is the limit on lots of these state-specific plans, doesn't move the needle a lot for a doctor home. If you're buying a home in Mississippi that costs $80,000, yeah, $5,000 goes a long way.
Dr. Jim Dahle:
But the doctors I talk to are not buying $80,000 homes. Especially if you live somewhere that's not a low cost of living. The average home in Salt Lake now, we're not the Bay Area yet, but it's been going crazy in the last few years. The average home here is $400,000. $5,000 a year doesn't go very far toward a $400,000 home. And especially when it's $800,000, by the time you actually buy it.
Dr. Disha Spath:
Yeah. These things are made not for doctors. These things are made for lower-earning people, the more average American earner. But yeah, with the amount that we move, with the amount of uncertainty we have with match day and everything, it doesn't sound like a really good plan for a doctor.
Dr. Jim Dahle:
Yeah. I don't think there's anything wrong with using it. If you want to use it, go ahead. I'm looking through this internet site. They've got them in Colorado, Iowa, Minnesota, Mississippi, Montana, Oregon, and Virginia.
Dr. Jim Dahle:
Keep in mind, there's other ways to save up. I think it'd be a terrible mistake to skip out on funding a Roth IRA in order to do this, for instance. Because remember, you can take the contributions from a Roth IRA out and use them for this. I would do a Roth IRA before I did this. This would be pretty far down my list of accounts to fund if I had a limited amount of money to put into something. And if I didn't have a limited amount of money to put into something, if I had lots of money that I was saving, chances are I'm already in a home anyway, and I don't need this thing.
Dr. Jim Dahle:
But for some people, it's not a bad idea. Go ahead and use it. But a lot of these have a cap. I look at Colorado's, its cap is $50,000 total, it lets you put in $14,000 a year, but no more than $50,000. Iowa, there's no cap. It's $100,000 in Minnesota for a joint account. No limits in Mississippi or Montana. $50,000 in Oregon. $50,000 in Virginia, if you're single. And some of these haven't even passed yet. Like, in Louisiana and Massachusetts and New Jersey, and Pennsylvania, they're not even passed. They're just being talked about in the state legislature.
Dr. Jim Dahle:
Something to keep in mind, the government's trying to help us people get into homes and be home buyers. So, it's not a bad thing, but I just don't see this as being super useful for the White Coat Investor community.
Dr. Jim Dahle:
Okay. Another question about financing. This one comes from Abdul. Let's take a listen to this.
Abdul:
Hi, Dr. Dahle. Thank you very much for all you do. I'm a physician in the Southeast, I have been listening to your podcast and reading your books since I was a fellow in 2018. I have a question that I got different answers to, and I need some guidance. I recently financed a house on a lake an hour from where I live as a second home. My family and I still want to use this house, but I also want to rent it out on Airbnb and I'm planning to give it out to a rental company for management.
Abdul:
My main concern is legal and tax protection. Someone advised me to create an LLC to put the house under, but when I did that, the bank threatened to have me forfeit the loan. So I backed off. Now I'm not really sure what to do. Should I just rent it out and raise the insurance ceiling on it? Or should I try to refinance it under the LLC? Now, that would apply to any house I would buy in the future, I guess. Again, thank you very much for all you do. I'm looking forward to hearing from you.
Dr. Jim Dahle:
All right. Good question. Lots to go into that question. It seems so simple sometimes, but there's actually a lot to discuss about your question. The first thing is the concept of mixing business and pleasure. Lots of people want to do this. They want to have something they can use sometimes, but somehow figure out a way for it to pay for itself. This is the dream is to have a second property that pays for itself so you can go up there whenever you want.
Dr. Jim Dahle:
But the truth is we buy something for consumption reasons, we tend to look at it differently than when we buy something for investment reasons. When we're buying an investment, it's very much a cold, hard look at what the cash flow is. And I don't think when we buy a house, we look at it quite the same way and that includes second houses.
Dr. Jim Dahle:
When you're looking at that lake house, you're like, “Oh, this would be so fun to sit out on the deck. And it's a beautiful view. And I like the neighbors.” And none of that goes into buying a rental property. When you're doing that, it's all about how much will this rent for? What will the expenses be? What will the purchase price be? What's the cap rate going to be? Let's evaluate this. Is it a good investment?
Dr. Jim Dahle:
And I think mixing those two, you get into trouble. You usually end up buying more for consumption reasons and just hoping it works out as a good investment. And I think it's much less likely to. So that's the first thing that pops to mind when I hear this question. What are you concerned about this scheme, Disha?
Dr. Disha Spath:
Yeah, I would echo what you just said. Whenever you have a second home, and you are trying to rent it out, it's good to know that when you didn't buy it as an investment, it may help support some of the costs to have short term renters in there, but it's probably not going to be a cash flowing property. As long as you're okay with that, that's fine.
Dr. Disha Spath:
The other thing is that whenever you try to put in an investment property or any property into an LLC, most mortgages have a due on sale clause. So you can't transfer the property into someone else's name or a business's name without having to pay the mortgage like you encountered. That is something I haven't heard of it actually happening to a lot of people, but I guess it did happen to you. And it is a possibility in any closing disclosure or any loan document that you come across on a mortgage.
Dr. Disha Spath:
So then how do you protect yourself from liability in this kind of situation? While LLC is certainly one way to do it. The other way is just insurance. But then again, remember that if you bought it as a homeowner, you're going to need special renters or landlords’ insurance, if you're actually going to be renting this for a significant amount of time.
Dr. Disha Spath:
So, you're going to need to have a lot of liability coverage, up to a million dollars usually, and make sure that you have the right policy that's going to cover short term renters. And also cover any kind of damage or harm that might come to the people that stay in your property, just because it's on the water or it has some other desirable thing that also kind of makes it dangerous.
Dr. Jim Dahle:
Yeah, for sure. Docks, boats, lakes, running water. All that stuff adds liability to the equation for sure. You often can have a mortgage on a property in an LLC. You probably shouldn't do it behind the bank's back, but typically I think if you were willing to continue to sign for it personally, I think they're usually okay with it.
Dr. Jim Dahle:
The other option is a non-recourse loan, basically where the loan is just to the LLC. But you know what? The bank is going to want a higher interest rate for that. Not only do you pay a higher interest rate when something is an investment property versus something you're actually living in, but when the bank has no recourse on you personally, it's even going to be an even higher interest rate.
Dr. Jim Dahle:
And so, it may be the bank balking at the fact that you got this sweet, personal loan for an owner-occupied house, and now you basically want to turn it into an investment property and put it into an LLC. I can't blame them for wanting to be paid more for covering that because it's more risk to them. And so, I think that's obviously something to consider.
Dr. Jim Dahle:
And so, you just got to talk to the bank, talk to other banks, say, “What are the options? What if I signed for it personally? What if we just go with a nonrecourse loan and refinance into that? What if I put some more money into it?” So now your loan to value is only 50% instead of 80%. Then maybe they'll be a little bit more willing to work with you.
Dr. Jim Dahle:
And I totally agree with you about the insurance. Umbrella insurance is good. Everybody should have umbrella insurance on all their properties, but you're running a business now too. You need business insurance. And that's not an insignificant amount of liability.
Dr. Jim Dahle:
Keep in mind too, second homes, the number that most people come up with, the rule of thumb, is if you're not going to spend three months a year there, it probably doesn't pencil out. You're probably better off renting that space when you go. Even if you're there for a month or two, you're probably better off renting it than you are buying it.
Dr. Jim Dahle:
And so, keep that in mind when you're buying a ski condo, when you're buying a lake house, how much are you really going to use it? And I'm talking about beyond the first year. We all go up there all the time the first year. I'm talking about beyond that, how much are you really going to use it? And if the truth is you're going to use it two weeks a year, this thing is not going to pencil out well for you as a second home.
Dr. Jim Dahle:
If it turns into this great investment property, that's one thing. But you ought to probably be looking at it as an investment property first in that situation. And then maybe you can use it a little bit. Be aware that you can't buy it in an IRA and use it. If this is owned by your IRA, you cannot use it personally. So that's an important thing to keep in mind.
Dr. Jim Dahle:
The other issue I see when I hear this question is the whole “How leveraged should your life be?” question. And most of us as docs, we come out of school, we owe a ton of student loans. We're trying to get into a practice, we're trying to get into a home. We've got tons of debt. Our ratio of debt to our actual assets might be 40 times, it might have 40 times as much debt as we have assets.
Dr. Jim Dahle:
And if you talk to experts on debt, on using debt, on using leverage to grow wealth, you'll see they recommend a much lower ratio of debt to assets. In fact, the numbers I have seen are 15% to 35%.
Dr. Jim Dahle:
So, if you got a million-dollar house and you got a $500,000 rental property, and you got $500,000 in retirement accounts and you got $500,000 in other investments. That's $2.5 million in assets. They're suggesting how much debt you have on that is in the $350,000 to $800,000 range. Not $2.5 million worth of debt when you've got a million dollars’ worth of assets. So that's a very different scenario.
Dr. Jim Dahle:
I think before you go financing a bunch of second homes, especially those that aren't actually a need for you, that you really look at how leveraged your overall life is and decide how much leverage you actually want in your life. Because that not only introduces risk to your life, nobody ever went bankrupt without having a bunch of debt, but it also impedes your cash flow, which in turn affects your ability to build wealth.
Dr. Jim Dahle:
And so, ask yourself, what is the plan for leveraging your life? When are you going to reduce it? How much do you want to have long-term? Etc. And keep that in mind when you're doing things like financing a second home that may or may not be a great investment property.
Dr. Disha Spath:
Great. Yeah, that's a great discussion.
Dr. Jim Dahle:
And I guess we could talk about Airbnbs too.
Dr. Disha Spath:
Yeah.
Dr. Jim Dahle:
Airbnb is a second job. You're running a hotel business. So, you've either got to hire somebody to do those aspects of it, whether it's cleaning or turnover, the actual booking, that sort of stuff, or you got to do it yourself. And as a doc, you got to ask yourself, “Is this a good use of my time? Or am I better off doing one more case or rounding on one more patient?” Or whatever it is that you do as a doc.
Dr. Disha Spath:
Let me play the devil's advocate here. A lot of real estate investors love short term rentals because now it's active income that can offset your other active income. And especially if you can put in a significant amount of time into this property in the first year, you can claim REP status, and actually get all of the losses written off against your active income. But you have to be spending a considerable amount of time at this property.
Dr. Disha Spath:
So, a lot of people leverage a short-term rental and then spend a lot of time in it in the first year, claim the REP status and take the tax benefits of that. And the next year do the same thing with the next property. And then an outsource after the first year. That's a way to do it. That's a way to do it, but again, like Jim said, this is introducing a lot of different factors into your life to try to get tax benefits, but it's very difficult to be a full-time doctor and do this. So, you'd have to be prepared to be a part-time doctor and a real estate professional.
Dr. Jim Dahle:
Yeah, exactly. REP stands for Real Estate Professional. The requirement is 750 hours a year, and no more than that doing anything else. That means you cannot be practicing more than you're spending time on your real estate business. And you're not going to come up with 750 hours a year on one rental. It's going to take more than that to get to your 750 hours.
Dr. Jim Dahle:
And at a certain point you got to ask, what do you want to do with your life? Do you want to be a practicing doctor? Do you want to go do real estate? And if you want to go do real estate, I totally agree you should get real estate professional status and get those tax benefits. But if you actually went to medical school and residency because you want to practice medicine, this may not work out well for you, unless your spouse is the one who goes for real estate professional status.
Dr. Jim Dahle:
We have somebody who works here at the White Coat Investor that has a short-term rental property that's got seven units in it, managed primarily by his spouse. And guess what? She doesn't put in 750 hours a year. So they don't get real estate professional status. And that's with seven units. How many units are you going to be managing? It takes a certain number to really get to 750 hours. I'm sure lots of people fudge the numbers. It's a little bit of a grey area, but come on, it's got to be reasonable or it's not going to pass the audit.
Dr. Jim Dahle:
All right. Enough about the second home for Airbnb. Let's talk about Roth conversions. Here's a question from Anna.
Anna:
Hi, this is Anna. I imagine you're getting a lot of questions about Roth conversions and I was wondering if you could do a segment on them specifically regarding whether it is beneficial or not to do Roth conversions for high-income professionals during their standard working years. And also with the assumption, if you weren't doing Roth, but the tax savings you would get from tax-deferred was being used to go into investment accounts. Thanks for all you do.
Dr. Jim Dahle:
All right. I’m always happy to talk more about Roth conversions. It's a popular topic. It's a frequent topic we address here. And part of the reason it keeps coming up is because it's complicated. It's not straightforward. There is no awesome rule of thumb. And it's kind of the same, whether you're talking about doing Roth conversions, which is taking money that's in a tax deferred account and moving it into a tax-free or Roth account. Or whether we're talking about making 401(k) contributions as Roth contributions or tax deferred contributions.
Dr. Jim Dahle:
It's a complicated question. The only rule of thumb I've got, which isn't really perfect, is that during your peak earnings years, most doctors should do tax-deferred contributions. And in any other year, you should do tax free contributions and consider Roth conversions. But even in that rule of thumb, there are tons of exceptions too. What would you advise somebody who's asking a general question about Roth conversions, Disha? What should they be thinking about?
Dr. Disha Spath:
What you should be thinking about is your tax rate now versus your tax rate in retirement. If you're going to be paying more taxes, higher percentage on your earned income right now, then you would be in retirement. Then it would make sense to lower your taxable income now, when you're in a higher bracket and pay the taxes later when you're in a lower bracket.
Dr. Disha Spath:
Also remember that you don't pay taxes in the first $40,000 or so thousand dollars that you actually get as income. When you're retired, and also, you're not going to most likely have a mortgage, or as many expenses. When you're retired, your expenses and the amount that you need to live on is going to be lower than what you're earning right now.
Dr. Disha Spath:
So, it makes a lot of sense as a doctor when you're earning a lot right now to do pre-tax contributions now, and then do Roth conversions later. But it does help to have a Roth bucket and a pre-tax bucket of money to play with in retirement. And a lot of people in our community set this up by doing pre-tax contributions to the 401(k)s, but then also doing a backdoor Roth. So, you have a little bit of Roth money that you can withdraw from to moderate the taxes when you're retired.
Dr. Jim Dahle:
Yeah. I think that is as good as we get for a general rule. I see a lot of confusion on this. A lot of people don't understand the difference between a Roth conversion and a backdoor Roth. They use the terms interchangeably, and these are specific terms with precise meetings.
Dr. Jim Dahle:
A backdoor Roth IRA is a process. It's a two-step process. It involves a contribution to a traditional IRA that typically is not deductible because the person contributing is a high earner. And then step two is to then do a Roth conversion of that money, to move it from the traditional IRA to the Roth IRA. Because you didn't get a tax deduction on it, there's no tax cost to doing the conversion. That's a backdoor Roth IRA.
Dr. Jim Dahle:
That's not really what we're talking about with this question. So, keep that in mind that yes, there is a Roth conversion part of that step, but there's no tax cost to us. That's really not what we're talking about here. We're talking about when you actually got to pay taxes on the conversion or on the money that you contribute to a Roth 401(k), etc.
Dr. Jim Dahle:
When you start talking about the exceptions, the main exception is if you're just an awesome saver. If you just save tons and tons of money, you're going to work for a long time, you're going to have a huge IRA. You're going to have a serious required minimum distribution problem, which is a good problem to have. That you have all this money, all this income in retirement. That's when you start thinking, “Well, maybe Roth makes more sense now. Maybe I should do Roth conversions even during my peak earnings years. Maybe I should do Roth contributions even during my peak earnings years.”
Dr. Jim Dahle:
It certainly does some cool things with estate planning. When something's inside a retirement account, because when you're paying the taxes on a conversion, you're essentially moving money from taxable into a tax-protected account. And in that tax-protected account, money grows a little bit faster and money will also be able to be stretched once you die.
Dr. Jim Dahle:
Your heirs can stretch that money out, that tax protection out for another 10 years. It's not as good as it used to be. They used to be able to stretch it over their entire life, but you can still stretch it for 10 years. And that's a huge estate planning benefit.
Dr. Jim Dahle:
You can also name beneficiaries for it. There's none of this probate crap you got to go through with that money. Once it's in that retirement account, you just name a beneficiary. When you die, they show a death certificate and they've got the money right away without any hassle.
Dr. Jim Dahle:
And then of course in most states, having money in any sort of retirement account provides substantial asset protection benefits. And so, that's another advantage. Anytime you can move money from a taxable account into a tax protected account, you're usually also moving it from a non-asset protected account to an asset protected account. And that can be a good move as well. But you don't necessarily want to pay a whole bunch of extra taxes just to get those benefits.
Dr. Jim Dahle:
But there's even more to it. I mean, a lot of it comes down to, “Well, who's going to get this money. Who's going to spend this money? Are you actually going to spend it during your lifetime?” Because what ends up happening is when a lot of people get into retirement, they spend their taxable account, then they spend their tax deferred account and then they die.
Dr. Jim Dahle:
They never get to their Roth account and they leave it to their heirs. Well, that's great if their heirs are in a top bracket, but if their heirs are in the 15% bracket or I guess we don't have a 15% bracket right now, if they're in the 12% bracket or the 22% bracket, and you did all these Roth conversions at 37%, and then you gave the money to them. That probably wasn't a great move.
Dr. Jim Dahle:
Same thing if you're leaving the money to charity. When a charity inherits a traditional IRA they don't pay taxes on it. So if you're going to leave anything behind to a charity, you ought to consider leaving behind your traditional IRA or even better, your HSA is a great thing to leave behind to a charity.
Dr. Jim Dahle:
HSA sucks to inherit if you're not a charity. You got to pay taxes on the whole thing in the year you inherit it and take it out of the account. But if the charity gets it, they don't have to pay taxes at all on it. So, part of it is where's the money going to go when you die?
Dr. Jim Dahle:
And when you're 30, you're 35 or 45 years old, you don't have all these answers. You don't know what tax rates are going to be in the future. You don't know how long you're going to work. You don't know how much you're going to save or how well your investments are going to do, or who you're going to leave your money to. And so it makes these decisions really, really hard. And that's why we try to come up with rules of thumb, but they're just not perfect.
Dr. Jim Dahle:
So, if you're not sure what to do, split the difference. Do a little bit of a Roth conversion. Do a little bit of Roth contributions to your 401(k), and split the difference. And at least that way, you'll minimize the regret of doing the wrong thing somewhat.
Dr. Jim Dahle:
I've tried to guess at every stage of my life, what I should be doing Roth or tax-deferred contributions, and I've guessed wrong several times just because my life changed as I went along. And it turned out what I thought was going to be the right move, probably is not going to be the right move in the long run. So, you do the best you can.
Dr. Jim Dahle:
All right, let's take a question from David on robo-advisors. Good times.
David:
Hi, Dr. Dahle. My name is David and I'm a practicing physician in Long Island, New York. I have a question for you today about robo-advisors. Right now, I am currently maxing out my 401(k) and my backdoor Roth. And whatever money I have left over, I typically steer towards either a brokerage account or paying down my mortgage. And I kind of do a little bit of each with the extra.
David:
In terms of the brokerage account, I've chosen to go with Wealthfront, which seems to be a pretty highly reviewed and highly rated robo-advisor. In general, the costs are 0.25%. So it seems pretty low. And their benefits theoretically are that they perform tax loss harvesting, and direct tax indexing, where they buy the individual stocks of a mutual fund and can make changes based on those individual stocks as opposed to the mutual fund as a whole.
David:
I guess my question is, do you think that it's risky putting all my extra money towards a robo-advisor? It just seems like for 0.25%, I probably would net more positive than the expense of 0.25% with these maneuvers. I know that these are things theoretically I could do on my own. But as the account grows larger, I would imagine they have better resources and better algorithms than I do. So I'm just curious to hear what your thoughts are on this. And thank you again for everything that you do.
Dr. Jim Dahle:
This is one of those dilemmas. Because there's not necessarily a wrong answer here, but there's nothing here that I'm getting super excited about either. A robo-advisor that doesn't cost very much, doesn't cost very much. And that's a good thing. The less you pay for advice, the more of your money you keep. Fees matter. And so, you're right to be looking at that and asking yourself, “Am I getting the value out of this that I should be getting?”
Dr. Jim Dahle:
My issue with the robo-advisor is that I think there's just a very narrow niche for them. If you need an advisor, you probably need an advisor on all of your accounts. And with a robo-advisor, they're not going to do all your accounts. They're going to do your taxable account and maybe your IRA, and you're going to be on your own for 401(k).
Dr. Jim Dahle:
If you can do it on your own, why do you have a robo-advisor for the taxable account? If you can’t do it on your own, why don't you have a real advisor that's advising and taking care of all of your money?
Dr. Jim Dahle:
And so, I think it's a pretty narrow niche of people that can actually use this. It's people with nothing more than a taxable account and a Roth IRA. What does that mean? That probably means a resident. As far as our audience goes. There's not a lot of people that don't end up having more accounts once they get out of residency.
Dr. Jim Dahle:
So, I think the niche for robo-advisors is just not very wide. And it's a product that they're trying to sell to a larger audience. And I think there is a place for it, for sure, in people that need an advisor and can just use a robo-advisor to manage their assets because all their assets are in a taxable account and an IRA.
Dr. Jim Dahle:
I think there's probably a niche there, but I don't think there's very many doctors in that niche. And so, I don't know that it really works for the people that listen to this podcast very well. They try to sell it with, “We'll tax-loss harvest.” Well, that's great. Tax-loss harvesting is worth something, but is it worth 0.25% a year on a million-dollar portfolio? No way, no way. You're not going to get that much tax benefit out of that.
Dr. Jim Dahle:
1% a year on a million-dollar portfolio is $10,000. 0.25% on a million a year is $2,500. What's the biggest tax benefit you're going to get out of tax loss harvesting? Well, $3,000 a year against your ordinary income. So maybe that saves you $1,200, $1,400 in taxes. And you're paying $2,500 for it. That doesn't pencil out. You're not going to get enough of a benefit out of that in order to pay for it.
Dr. Jim Dahle:
And the issue with direct indexing is fine, maybe there's a little bit of tax efficiency gains there. But what happens when you change your mind? You change your mind. You no longer want to use this strategy. You want out of Wealthfront. What do you own? You own a whole bunch of individual stocks, and you've got a mess on your hands to clean that up. You got to sell them, you got to hold them. You got to figure out which ones have losses and gains and try to offset them as you get out of that and into index funds.
Dr. Jim Dahle:
It's a lifelong commitment when you have a strategy like that in your taxable account. And if you're not ready to make a lifelong commitment to Wealthfront to manage that tax account for you, I mean, they've only been around a few years. They may not be around in 60 years when you still need them to be managing that account. And so, I'd be pretty careful adopting that sort of a strategy in a taxable account. What are your thoughts on robo-advisors, Disha?
Dr. Disha Spath:
Yeah, Jim, I would agree with you. Especially if you're a White Coat Investor, you've been listening to this podcast for a while, you most likely can do this on your own without the extra costs and really just very marginal gains by going with a robo-advisor. I don't have a hugely strong opinion against using robo-advisors, but I just don't see it being that useful for me or anyone else like me.
Dr. Jim Dahle:
Yeah. I think that's the truth. I mean, tax-loss harvesting, right? This is one of those things you do a few times in your mid-career, and then you've got so many tax losses that you're never going to use them all.
Dr. Jim Dahle:
Imagine you've got a million-dollar taxable account and you hit a big bear mark. And maybe you're able to tax loss harvest $100,000, $200,000. At $3,000 a year, how long did $200,000 in tax losses last? Six, seven decades. You've got enough. How many more tax losses do you need? Unless you've got some sort of tax loss, some capital gain coming up in your life that you need to offset. That's the only reason I keep grabbing tax losses is because, well, what if I sell the White Coat Investor someday? Maybe I could use some of these tax losses.
Dr. Jim Dahle:
And so, I keep booking them when it's convenient and when I have a big tax loss, but I was way too excited about tax-loss harvesting early on in my investing career. Because then you come to the next bear market and you get so many tax losses, you're never going to need them again. Just from doing like two trades, two round trips with the tax losses. And all of a sudden you have tons of tax losses and you don't need anymore. Once that taxable account gets to a certain size, this is not a great use of your time or your fees to pay somebody else to do it for you.
Dr. Jim Dahle:
All right. I hope that helps David with your decision, whether to continue to use Wealthfront or not. I don't have anything against the company. They do what they do. You can read what they do. And if you feel like that's adding value, you can try that. Just try to see the end from the beginning and decide if that's really something that you want long term.
Dr. Jim Dahle:
All right. Anything else we ought to cover today, Disha, the audience needs to hear?
Dr. Disha Spath:
I need to hear where you're going in Costa Rica.
Dr. Jim Dahle:
Yeah. This is going to be a fun trip in Costa Rica. By the time you hear this, I'll hopefully be back and it'll be a distant memory. But it's a canyoneering trip. Flying into San Jose, driving up into the mountains and we're exploring some waterfalls and canyons that were just recently explored for the first time. And then we're going to do a little bit of pack grafting, and we'll be back in six days. So it's a pretty whirlwind trip. But it should be a lot of fun going with a friend and brother-in-law. We found a canyoneer down there that we're going to team up with to do some canyons. So, it should be a lot of fun.
Dr. Disha Spath:
Sounds amazing. I hope you have a great trip.
Dr. Jim Dahle:
Yeah. Thanks. Well, one thing that we ought to mention, I don't know which way it's going to go. Right now it's March 28th. By the time you hear this, it's going to be mid-May. But remember May 1st is when the student loan holiday is supposed to end.
Dr. Disha Spath:
Right.
Dr. Jim Dahle:
And so, keep in mind if the student loan holiday has ended by the time you hear this, you may need to refinance your student loans. So, go to the recommended tab under whitecoatinvestor.com, find those recommended student loan deals. You get cashback. We're throwing in our flagship Fire Your Financial Advisor course for anybody who refinances through those links, and check that out.
Dr. Jim Dahle:
If they do extend it, which wouldn't surprise me at all in this election year, then again, pay attention to when your federal student loans stop being at 0%. Eventually, you'd think they will stop doing that, but you never know. Maybe they'll come through and forgive them all or something. Who knows what the Congress is going to do. But if you have federal student loans, make sure you're keeping up to date on that. And as soon as we know what's going on, we'll announce it to you on the podcast.
Dr. Disha Spath:
Absolutely. Another deadline I'd like to remind people of is the October 31st deadline to consolidate your student loans if you are looking towards getting the PSLF waiver forgiveness, which is the broader forgiveness that a lot of people are eligible for now. So make sure you look at that as well.
Dr. Jim Dahle:
Yeah. This is the emergency program put in place because of the pandemic. President Biden was able to put this program in place on an emergency basis, basically, people who made payments under programs that didn't use to count for PSLF or they made late payments. Or they made payments that were a dollar short. Those payments all didn't used to count. Now they do count, but only through October 31st. And so, make sure you file the paperwork you need to for that.
Dr. Jim Dahle:
All right. Let me remind you of our sponsor for this podcast, Bob Bhayani at drdisabilityquotes.com. He's been a long-time sponsor at the White Coat Investor. One listener sent us this review, “Bob and his team were organized, patient, unerringly professional, and honest. I was completely disarmed by his time and care. I'm indebted to Bob's advocacy on my behalf and on behalf of other physicians and to you for recommending him.”
Dr. Jim Dahle:
Contact Bob. The website is drdisabilityquotes.com. The email is [email protected] and the phone is (973) 771-9100. If you don't have disability insurance, get disability insurance.
Dr. Jim Dahle:
Don't forget that our book is out. This is the asset protection book. The White Coat Investors Guide to Asset Protection. You can pick that up on Amazon now. It is not expensive. That's even cheaper if you get it on Kindle. And it'll give you the information you need about asset protection.
Dr. Jim Dahle:
All right, let's go over our latest review. Disha, do you want to tell us about this one?
Dr. Disha Spath:
All right. “The real deal. This guy knows what he’s talking about. No hyperbole, no scams, just a common sense, evidence based, and rational guide to personal finance and investing. I’ve been listening for 2 years. It would have saved me literally six figures had I discovered him earlier. Oh well, better late than never. Definitely geared toward high income earners, but anyone will be wiser and smarter with their money by listening to this one.” Awesome. Thank you so much for that.
Dr. Jim Dahle:
Yeah, we really appreciate those five-star reviews. They help us to spread the word about the White Coat Investor. Well, we've come to the end of this podcast. Keep your head up, your shoulders back. You've got this and we can help. We'll see you next time on the White Coat Investor podcast.
Dr. Disha Spath:
See you later.
Disclaimer:
The host of the White Coat Investor podcast 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.
With the three main “buckets” of retirement savings, you mention a traditional strategy of spending the taxable account, then the tax-deferred, then leaving the Roth for your heirs. Does this still make sense after the SECURE Act, with inherited IRAs needing to be withdrawn in 10 years? If there is money left in the second bucket when you die it seems like your heirs would be much better off with the taxable account (especially if the step up in basis is still around).
I don’t follow your reasoning. There’s nothing keeping heirs from taking IRA money out after 10 years and reinvesting it in taxable. They would still be ahead of a taxable first strategy.
But as far as what’s best to inherit, the Roth comes first and then probably the taxable account since it is post-tax and gets a step-up in basis at death. 10 years of tax protected growth probably doesn’t make up for having to pay tax on the entire amount when withdrawn. Tax-deferred money is the best thing to leave to charity though if you have charitable inclinations.
As far as what to spend first, it’s generally true that you should spend taxable before tax-protected accounts, but it is not always true that you should spend tax-deferred before tax-free. What if you’re in the top bracket and your heir is in the lowest one for instance?
You have to take RMDs from your tax deferred accounts. You do not have the option to choose to spend taxable money instead. After tax, the money that comes out of TD accounts will be in your taxable accounts at that point. If, after tax, your RMDs cover your spending, then the taxable accounts will accumulate as you reinvest dividends and interest.
Heirs will get stepped up basis.
The question is not what to spend first. You are forced to draw down your TD accounts no matter what.
You are clearly better off leaving Roth money to grow.
So their is not much deciding to do unless you plan to spend more than after tax RMDs.
I think we’re all talking about money above and beyond the RMDs here. You obviously are going to first spend all money you have to pay taxes on:
Pension
SS payments
Dividends and interest and capital gains distributions in taxable accounts
Rents
RMDs
You are absolutely NOT clearly better off leaving Roth money to grow as I explained above. If your heirs are in a much lower bracket than you, or if you’re leaving money to charity instead of heirs, you are going to be better off spending Roth before tax-deferred.
I don’t get it. The money in a Roth goes to heirs tax free, so why does their tax bracket relative to yours matter? You will not pay tax on it if you take it out while alive and they will not pay tax on it if you leave it to them.
If you leave it to them they get an extra period of tax free growth before they have yo take it out?
If they are paying zero federal taxes, then they do not benefit from its tax free nature. But how would they benefit by you spending down the Roth and leaving them taxable or tax deferred money?
Are you saying that taking more than RMDs from tax deferred whittles down the estate and saves on estate taxes???
You’re JUST thinking about the heir. Think about the total tax burden.
Let’s say for simplicity sake that somebody has a $159K IRA and a $100K Roth IRA. They will spend $100K and then die. Which one should they spend? Let’s assume this person is in the 37% bracket and the heir is in the 12% bracket.
Option 1: Spend the Traditional IRA. In this case, you pull out $100K to spend and $59K to pay the taxes and leave the Roth IRA to the heir. The heir gets a $100K Roth IRA. You got to spend $100K and the heir got to spend $100K so $200K total was spent.
Option 2: Spend the Roth IRA. In this case, you pull out $100K to spend and leave the traditional IRA to the heir. The heir gets to spend $140K and pays $19K in taxes so $240K total was spent.
Does that help?
For a very large estate, doing Roth conversions can reduce the size of the estate and thus the estate taxes due. I guess spending tax-deferred before Roth would have some effect on lowering the size of the estate, but only because you’re paying a bunch of income taxes.
OK. I was still assuming one did not need any money past RMDs, which I gather is common for readers of this site. Then it becomes literally a question of spending from the Roth vs spending from the TD account beyond RMDs.
Under those conditions, any spending above RMDs from tax deferred and any spending at all from Roth would deplete assets faster than necessary.
Under the condition where one has decided to spend more than RMDs, pension and SS, then the relative tax brackets of older generation and heirs becomes important.
It is not necessarily the case that heirs are in a lower tax bracket, particularly if they are single and parents are married.
Agreed.
The dependent care FSA limits bit is a little ambiguously phrased. Everything on Google says 2022 limits are back to 5k. You could only get 15k in 2022 if you maxed your DCFSA in 2021 to the higher temporary limit, didn’t use any, rolled it over to 2022, and maxed your 2022 DCFSA on top.
I’m seeing the same thing. Dependent care FSA max at $5k for 2022. Bummed I didn’t know about the one time increase last year!
“The child tax credit was actually paid out in increments during COVID. The important thing to remember about that is the child tax credit is something that you opt into, but you can use the dependent care FSA money for the same stuff that you’re getting the child tax credit for. You can’t use both of them for the same amount of dollar expense. ”
I also found this confusing – is this conflating the child tax credit and the child and dependent care tax credit? The child tax credit was paid out in increments last year, but I’m not sure what “opt into” means – do you mean that you could opt out of receiving the monthly payments? You’re not getting the child tax credit for anything specific to childcare costs, but you say both “you CAN use the dependent care FSA money for the same stuff that you’re getting the child tax credit for” and “you CAN’T use both of them for the same amount of dollar expense.”
Thanks for clarification.
To the first couple with the nanny – we used Poppins Payroll a few years ago with good results. According to their website their fees are currently $45/mo ($540/year) which sounds like it would be a much better value over what you currently have. They dealt with payroll & taxes and they were really helpful when I had questions. (not an ad, just a happy customer).
It would be great to get a guest post about how to DIY your household employer taxes. I’m amazed how expensive the payroll companies are, especially if you’re just hiring someone part-time. I can see why so many people pay under the table for something like the summer babysitting job; if you’re paying $2500, it’s hard to stomach paying $500 for payroll services. How hard is it to do it yourself?
It’s not impossible. I’ve done it before (not for household employees, but for WCI employees). But I wouldn’t recommend it. Surprisingly easy to make mistakes and the software makes it SOOO much easier.
But you can use something like Quickbooks instead of “a company.” Quickbooks is $35 a month plus $4 an employee but 50% off right now for the first three months. I saw a competitor that was $20 a month plus $4 an employee. What’s your time worth?
Schedule H isn’t a big deal.
https://www.irs.gov/pub/irs-pdf/f1040sh.pdf
Check out nanny pay.com. It’s $200 for the year and does all the calculations and issues a W2 and Schedule H at the end of the year. Most of the other companies make you think they’re helping by filing quarterly taxes for you, but for a Household Employee, you are not required to file quarterly taxes (ie 941.) You’ll still have to do the state taxes yourself but it’s usually not that difficult.
Why not just pay the nanny 1099?
Is the nanny running her own nannying business or is she your employee? If your kid is the only one a nanny watches it might be hard to call her an independent contractor.
I use https://simplenannypayroll.com — $29 a year (not a month), generates the taxes due and paystubs etc. Still need to pay the nanny (check or Venmo etc) & the government, but those are easy enough.
Thanks for sharing. Great resource.
To get the REPS status, does one have to take a course …..is it an official license one applies for? Or do you just say you are REPs on your tax paperwork?
As far as the engagement ring goes….knowing what I know now, I wouldn’t care about giving or receiving one. If it’s an important symbol to you or your partner, a silicone ring or tungsten is what I’d recommend. If my partner cared about the value of the ring I’d probably take a long pause. Again,
Learned by experience.
Please not Tungsten. Have you ever tried to cut those off?
Haha I know you’d say something about that. Tungsten is supposed To be good because it’s supposed not to deform during a crash injury and instead it Just snaps. Of course it has to be tungsten and not some cheap tungsten alloy
I couldn’t agree more. Waste of money (my spouse agrees). We opted for no rings and have been happily married for over 20 years without them!
Here is a small adaptation. Consider getting a silicone wedding ring and engagement ring to stand in for your valuable one when you are working, exercising, etc. Lots of colors, styles and at $25 you won’t be overconcerned when it is scratched or when they cut it off because your fingers are injured. Doesn’t conduct electricity either.
We did get an engagement ring. Closer to costume jewelry than some expensive piece. Way under $300. Has held up for a long time. Never considered buying something more expensive now that we could. I could not imagine paying $1,000 for a ring. $15,000 is science fiction. Rings like that do exist. No reason to buy one. Put the extra $14,700 into shares of VTI.
$15,000 for a ring is insane, but not as insane as signing a legal contract to promise half your assets and possibly years to decades of financial support in the very likely event of divorce.
I suppose it depends on the meaning of “very likely”. There was a big study that found physician divorce rates to be ~24%, well under average for the population.
And the risk of losing half your money depends on the laws of your state, your circumstances and whether you have a prenup. Your odds could be low enough to be clearly below very likely.
I have known some people to spend more time thinking about rings and weddings than they do thinking about whether they should marry. Not only is the ring not a requirement, neither is marriage. If kids are imminent, then I see the point in making sure that a non-working parent is fairly treated. But outside of that context, I don’t understand why so many people put their finances and futures at such high risk. Anyway, $15,000 is too much for a ring. But more importantly, the contract you sign afterwards could lose you $1,500,000.
Brian, couldn’t agree more. Reality is that in most states you have nothing to gain and a lot to lose being the spouse who makes more money. And if you are a man, well, equality is quickly forgotten outside of where it is convenient for the other side.
No rings, and wedding cost us less than 5k for a crowd of 150 family and friends. Definitely a dangerous spot for many to start their financial journey.
Surely the vast majority of the people that read this blog are here for the content (and not simply because of a personal connection to you). I suspect your challenge, as you transfer ownership, is finding other people that will create content that matches the quality and style of what you provide. You have a genuine and pragmatic style that difficult to just recreate. And in general, some of your writer have been fine, while others do not seem to resonate. But overall, people are here for your special style of thinking/writing. And to me it seems obvious. I mean, if it weren’t special… WCI would be just like any other no-name blog that never gains enough followers to turn a profit.
Well, I hope you’re wrong but fear you could be right. I guess we’ll find out in the coming years because I certainly am not immortal.
To the nanny caller, ask your tax person if they can give you a subscription to Quickbooks. That’s what my tax guy did for our nanny (subscription is free, it cost like $179 for the software but you can use it for three years before updating) and it’s very simple to use.
Jim, Good news bad news. Love reading all your stuff. We’ll written and insightful. Occasionally a POF article is good but maybe 25-50%. Maybe 10% of guest posts are useful and usually I can’t get to the end of them. And honestly the content person who writes on Sunday isn’t great. I’m not complaining because I don’t have to read what’s not interesting or helpful. And I get you needing to make the business less dependent on you to monetize it for an exit. Unfortunately I would guess a huge chunk of readers are like me and keep reading because of your stuff specifically. But maybe that won’t matter since whoever buys it might not realize that.
Maybe you’re right that the business cannot exist without me. I guess we’ll find out eventually because I’m not immortal. In the meantime, recognize that I’m still personally producing just as much content as I ever have. There are two podcasts a week. 2-3 of the blog posts a week are written by me. I write the newsletters. It’s me on the Youtube channel etc. So you can’t complain that I’m doing anything less. All you can complain of is that we’re giving you more free stuff to do with as you please.
Fair. Thanks for all you do.