Podcast #164 Show Notes: Why You Should Max Out Your Retirement Accounts

Maxing out your retirement accounts will make estate planning easier, give you better asset protection, and you’ll pay less in taxes all while your investments grow. A tax protected retirement account provides all this for you, whether it is a tax deferred account like a 401(k)s or tax free accounts like a Roth 401(k)s and Roth IRAs. Whichever one you choose to use, you are almost always better off than investing in a taxable account. We cover the downsides in this episode but they are not very big in comparison to the upsides of maxing out retirement accounts. These accounts are protected in case of bankruptcy. A 401(k) contribution gives you a tax break up front. You can rebalance within the account without a cost for buying and selling or a tax consequence. And you will almost surely take that money out of the account at a lower tax rate than you put it in. It is important to understand that a tax deferred retirement account is your biggest tax break. I discuss the different types of retirement accounts in this episode as well as the contributions you can make to them. I cannot stress the importance of maxing out your retirement accounts enough.

I also answer listener questions about tax benefits of private real estate funds, why I recommended an independent agent for disability insurance, collecting on both individual and group disability policies, how long you should continue your disability insurance policy, what to do with your money in residency, asset allocation, and adding small caps to your three fund portfolio.

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Quote of the Day

Our quote of the day today comes from author Robert Doroghazi, MD, who said,

“Considering the average physician income, all that is required to live comfortably and retire when you wish is a little fiscal discipline and the avoidance of stupid mistakes.”

I certainly agree with that.

Why You Should Max Out Your Retirement Accounts

We do a focused discussion on why you should max out your retirement accounts in this episode. Retirement accounts are awesome. If you talk to people, they’re all interested in some sort of an account that will give them easier estate planning, better asset protection, pay less in taxes, get their investments to grow better and facilitate rebalancing. But what they don’t realize is that they have this account available to them. It’s a tax protected retirement account. They come in a couple of different flavors. Obviously, you have 401(k)s which are tax deferred and you have Roth 401(k)s and Roth IRAs, which are tax free accounts. Meaning you put after tax money in there and then the earnings are never taxed again.

Those are the two main flavors of them, but whichever one you choose to use, you are almost always better off than investing in a taxable account. Now, a taxable account isn’t all bad. Most of my investments now are actually in a taxable account. That’s been a transition for us over the last three or four years, as we’ve gradually moved things out of our tax protected accounts into our taxable account, just because the proportion of our overall investments has grown. It’s not all bad. You get the lower capital gains rates on long-term capital gains. If you get qualified dividends out of there, those are also taxed at a lower rate. You can donate appreciated shares to charity instead of cash and flush those capital gains out of your portfolio. You can tax loss harvest as we’ve discussed.

But overall, these benefits pale in comparison to the benefits of using a retirement account for your investing. So, whenever you can use your retirement account, please do so. The downsides are not very big. For example, there’s the age 59 and a half rule, but honestly, there are so many exceptions to that rule, including using the S-E-P-P rule, Substantially Equal Periodic Payments rule, to get that money out penalty-free before age 59 and a half. You just have to basically take out the same percentage of it every year for at least five years and you’re allowed to do that. So even early retirement in that respect is an exception to the age 59 and a half rule. So really not many downsides all to use in these accounts.

Now granted, sometimes an employer offers a crappy account. It has crappy investments in it. The fees are super high, but even then, you’re still usually better off using it for the tax breaks. We are seeing fewer and fewer bad plans. I think employers are getting the picture that they are legally responsible to not have a crappy 401(k) plan. They can literally be sued by their employees because they have a fiduciary responsibility to them in that respect. So I think those accounts are actually getting better over time.

Benefits of Retirement Accounts

You need to understand, particularly for a typical doctor, why your 401(k) is so awesome. We are all worried about getting sued about policy limits. It rarely happens, but we’re all worried about it. Well, you can actually keep what is in your retirement accounts after declaring bankruptcy. So, say you get sued successfully. Chances for this to happen are super, super low. But say this happens and there’s a $10 million judgment brought against you. And what do you do? You declare bankruptcy and you get to keep what’s in your retirement accounts. So that’s a great reason to max them out.

But beyond that, a 401(k) gives you a tax break up front. If your marginal tax rate, meaning the rate at which your next dollar is taxed, is let’s say 40% between state and federal. If you put $10,000 into a tax deferred account, you just knocked $4,000 off your tax bill for that year. It’s a wonderful benefit.

Now the skeptics will say, “well, you’re just deferring those taxes”. But that’s not entirely true because you get a couple of other benefits in there. The first is that while that money grows, it is not taxed. As it spits off capital gains and dividends each year, like most investments do or spits out interest, you don’t pay taxes on that as it grows. So, the money actually grows faster inside the retirement account.

Another benefit is you can rebalance it and it costs you nothing to buy and sell in the account. There are no tax consequences of doing so. So, it’s easier to rebalance your portfolio as well or switch investments if you didn’t do a very good job selecting them, or if you just need to move things around. I mean, when I have to make changes in an account, I try to always do them in my tax deferred accounts.

But the last benefit is one that a lot of people don’t understand. That is the fact that you will almost surely, if you are a typical doctor, you will almost surely take that money out of the account at a lower tax rate than you put it in. And that is not a prediction of future tax rates. If tax rates go up, that doesn’t mean you’re taking that money out at a higher tax rate. The reason why is that taxes fill the brackets.

So, as you have taxable income in retirement, a certain amount, if you’re married, I think it’s $24,800 this year is the married standard deduction. So, if your only source of income in retirement is this tax deferred retirement account, your only source of taxable income anyway, obviously Roth IRAs and that sort of stuff doesn’t count. But if your source of taxable income is this traditional tax deferred retirement account, the first $24,000 plus comes out tax-free. So, if you saved 40%, when you put it in and you took it out at 0%, that is a huge arbitrage between those rates. And it’s a great benefit of that 401(k).

Now, beyond that, the next $19,000 or so, it comes out at 10%. The next $50,000 after that comes out at 12%. The next $75,000 after that comes out at 22%. So, all of this is coming out at a much lower tax rate than when you put the money in. So, this benefit of being able to fill the brackets is a huge benefit of being able to use a tax deferred retirement account, like a 401(k) or a cash balance plan, during your peak earnings years.

Now, there are some exceptions. They’re typically super savers that have multimillion-dollar IRAs and all this other income coming in from their side businesses and these side gigs they’ve got and a bunch of investment properties and that sort of stuff. It is possible to actually have a higher marginal tax rate when you pull this money out then when you put it in. But for the typical physician that saves up $2 million or $3 million portfolio to retire on. That is not going to be the case. You’re going to take that money out at a lower tax rate then when you put it in.

I think it’s important to understand that tax deferred retirement account is likely your biggest tax break. It is absolutely huge. If you’re in private practice with a set up like mine, my current setup at my partnership is I can put up to $57,000 into our 401(k) profit sharing plan. And right now, I can put another $17,500 into a defined benefit cash balance plan.

For most doctors, a deduction like that, being able to deduct $75,000 off your income is huge. That’s probably your biggest tax deduction. It’s bigger than your interest deduction,  your charitable contributions, and your mortgage interest deduction. It’s your biggest deduction. These days some doctors that are in business for themselves might have a substantial 199A deduction. This is the pass-through business deduction.

But those are basically the two biggest tax breaks out there. So, it’s important to understand if you’re looking to pay lower taxes, the best way you can lower them is saving more money for retirement in a tax deferred account.

Different Types of Retirement Accounts

Now there are different types of retirement accounts for different types of people. If you’re an academic, chances are good you were offered some combination of accounts like a 403(b), which is very, very similar to a 401(k) as well as a 457(b), which is a little bit different. It’s actually deferred compensation. It’s technically your employer’s money, which has asset protection implications in that it’s protected from your creditors, but not your employer’s creditors. You might also have a 401(a). That is typically an account where it is only employer money going into it, or they have a mandatory contribution from you, but work similarly.

If you’re an academic, you really need to understand the accounts that are being offered to you, how they work and how you can maximize their benefits. If you’re in private practice, you probably have something more similar to what I have a 401(k) with a profit-sharing plan, plus or minus a defined benefit cash balance plan.

Remember if you’re in a partnership, you have to use the partnership plan. You can’t just go open your own plan. If you’re getting paid on a K1, you can’t go open a solo 401(k) with that, even if you incorporate your business.

If you have two types of income, for example, if you’re a W2 employee at a hospital and you also do some moonlighting, you can have more than one 401(k). You just need to make sure you stay within the rules. If they are completely unrelated employers, though, you can have a 401(k) for each one. But despite having multiple 401(k)s, you still only get one employee contribution. This year it is $19,500 for those under 50. However, you can make up the rest of that $57,000 per 401(k), per employer limit with employer contributions and also with after tax employee contributions if the plan allows it.

So, the way this typically works, if you have a couple of 401(k)s, is you put in your maximum employee contribution at the hospital 401(k), they give you some sort of match, a few thousand dollars, maybe $10,000 and that’s what goes in that 401(k). Then in your individual 401(k), it’s 100% employer contributions, which works out to be about 20% of the net earnings for your side business. If your side business made $50,000, you put about $10,000 into there. That is how you use more than one 401(k). Just keep those to contribution limits in mind. The first one is total for all the 401ks is your employee contribution. The second one is your employer 401(k) contribution. That’s the $57,000 limit.

I mentioned employee after tax contributions to 401(k)s. This is getting to be a more and more common feature in a 401(k). This is what we call the mega backdoor Roth IRA, because what you end up doing, assuming the plan allows it, is even above and beyond your $19,500 employee contribution, you can put in after tax money. And some plans allow you to convert that within the plan to a Roth 401(k). Obviously you didn’t get a deduction. So there is no tax cost to converting it to a Roth 401(k).

Some plans require you to and allow you to take the money out of that account. Put it in a Roth IRA and obviously do a Roth conversion. That again has no tax cost. Because that limit is so much higher than what you can typically put into an IRA they call it the mega backdoor Roth IRA. But that can be a good option for a number of people. There are a lot of complex uses of it, but the bottom line, if you’re trying to get more money into retirement accounts, that might be a good option for you.

There is always a backdoor Roth IRA for yourself and your spouse. If you’re under 50 is $6,000 a year for each of you, you put it into a traditional IRA. You then convert it to a Roth IRA with no tax costs because you weren’t allowed to take a deduction for the original contribution.

Then of course, one of my favorite retirement accounts, isn’t even labeled a retirement account. It’s the Health Savings Account or what I call the Stealth IRA, which is a wonderful account. It’s a triple tax-free account. You get a tax break when the money goes in, it grows tax protected. When you pull it out, it comes out tax free as long as you spend it on health care. If you take the money out and spend it on something else, you have to not only pay the taxes, but you have to pay a penalty. And that penalty lasts until age 65. After age 65 if you pull the money out and spend it on whatever you want, you just have to pay the taxes on it. So, in that respect is no worse than your 401(k). Thus, we call it a Stealth IRA. So, if you have access to an HSA because you use a high deductible health plan, be sure to use that as well.

As a general rule, the benefit of that money growing in a tax protected way is so advantageous that you don’t really want to take money out of a retirement account until you have to. Anyone telling you to pull money out of your retirement account, they’re usually going to cause you to make a mistake if you follow that advice. If you are worried about having a whole bunch of taxes down the road, the usual solution is not to pull the money out of the retirement account now. The solution is to do Roth conversion so that that money isn’t taxed when it comes out of the retirement accounts.

Reader and Listener Q&As

Benefits of Investing in Private Real Estate Funds

“I’ve recently been looking at real estate funds like CityVest, Alpha Investing, MLG and others. It seems like fund offerings come with many different structures on both the debt and equity side. I was wondering if you could speak to the tax advantages of choosing one fund to tape over another. For instance, CityVest just posted a house flipping fund, which seems to be taxed all through current income without allowing for any of the depreciation benefits. How do you account for the tax inefficiency when evaluating these types of funds? Additionally, I was thinking about setting up a Rocket Dollar self-directed IRA to use for backdoor Roth contributions. Do you still like their platform for self-directed Roth’s? And are there certain fund types that are better suited for Roth IRA than taxable accounts?”

Yes, there are some tax benefits. Some funds are very beneficial tax wise. For example, if it’s an equity fund that passes through the depreciation to you, especially if it’s bonus depreciation, that you kind of get a whole bunch of it up front, that can be used to offset other real estate income that you have. And it makes even more of your income be tax free. That is a huge benefit that generally comes with equity investments, whether it’s a single syndication, meaning a single apartment building that you bought with a bunch of other investors, or whether it is a fund that owns 10 or 15 different properties. Either way, if they’re passing through that depreciation, that’s a big tax benefit.

But there are other funds, for example, a typical debt fund, the loans money out to real estate developers. All of the income, all of the return from that is basically ordinary income. So, it comes out to you every year, you pay your ordinary income tax rates on it. It’s not very tax efficient. So, if you’re going to put one of those types of investments inside a retirement account, it would obviously be the debt fund. And you can put that into a self-directed IRA or a self-directed 401(k), if you would like, and it would be a much more tax efficient obviously.

He mentions the JKV fund which they are still raising money for that for another week. It is a fix and flip fund. It takes the money and buys houses from distressed sellers.  It fixes them up and then sell it within about six months for much higher price. The profit goes to you as an investor in the fund. Obviously, after any fees that you pay the people managing that fund to do.

That sort of investment no one has held long term. So there is really no significant depreciation that has passed through to you on that sort of an investment. It’s not tax efficient at all. If you were going to put again, a real estate investment into a retirement account, this would not be a bad one to do it with.

Rocket Dollar is one of our recommended self-directed 401k and IRA companies.

As far as how tax efficiency impacts my decision to invest. It mostly does not. I  try not to let the tax tail wag the investment dog. I’m also very limited on retirement account space and becoming more limited each month. Over the last three or four years as my taxable account or retirement account ratio has grown, I’ve gradually moved asset class after asset class to the taxable account. It is not that I’m moving money out of the retirement accounts. It’s simply that I have to start investing the money that’s in the retirement accounts and more into the investments that I’m leaving in those retirement accounts, because they’re not that tax efficient and buying the more tax efficient investments in the taxable account.

For example, I’ve transitioned out total international stock market fund. Most of my private real estate is out. My international small is now outside my retirement accounts. A significant portion of my bonds are now outside of retirement accounts. They’re invested in a municipal or a tax-free bond fund at Vanguard. And so, what gets left behind? The least tax efficient stuff, things like my tips fund is in there, things like that real estate investment trusts, that Vanguard REIT Index fund. That sort of stuff stays behind in the retirement accounts. I think I’ve got small value stocks inside the retirement accounts as well, but they’re probably the next thing to come out if that ratio continues to worsen, as I expect it will.

At some point, I may have the opportunity to move my debt real estate back into retirement accounts. But since it isn’t an available investment in two of our four 401(k)s and soon in all four of our 401(k)s, that basically just leaves our Roth IRAs, which are only about 5% of our portfolio and are dropping rapidly. So, I’d love to have them inside a tax protected account, but it’s not really a good option for us right now.

So, do I not invest in that asset class? No, I go ahead and still invest in it. Just realizing that that is part of the price of being a member of our society is you have to pay taxes and better to make the money and pay the taxes then not to make the money at all. So I try not to let the tax tail wag the investment dog. I try not to let the tax efficiency of the investments necessarily dictate my asset allocation.

If you’re interested in these sorts of private investments they’re totally optional, you don’t need these to become financially independent or to reach your financial goals. But if you’re interested in this sort of thing, you can learn about more of them by signing up for our real estate opportunities newsletter. You can find that a whitecoatinvestor.com/newsletter.

Why Use an Independent Insurance Agent?

“I’m wondering if there’s a reason you recommend buying the policy from an independent insurance agent? My residency program just started offering individual policies this year in addition to their typical group policies. The individual policy looks good on the surface to me, it’s Ameritas. So, big six. And includes an own occupation definition of disability, partial disability. It’s portable so I can bring it with me when I graduate residency. And it’s not cancelable. I’m wondering if there’s a big catch that I should be looking out for with a policy offered through my University residency program and that I should be definitely looking for an independent agent or if this policy through my program is reasonable.”

Why do I recommend independent agent? I think that’s where you’re going to get the best advice. Now, obviously, any advice you get from anyone who sells anything is going to be biased. So, the bias of an independent agent who isn’t going to be paid if you just stick with your residency policy, is to sell you a new policy. So, be aware of that. That is their bias.

But I think the best way to do this is to take the policy offered by your residency program, in this case, it sounds like maybe you have a halfway decent one, and compared to the ones you can buy from the big five or six companies. Have the agent point out the weaknesses in the policy. There probably are some. You know how the definition might be weaker, what riders aren’t there, how the price might go up, etc. so you understand. You may still make the decision to go with a weaker policy that costs you a lot less money and that’s okay. But at least you’re then making an informed decision.

I still think you need to go see an independent insurance agent, even if you don’t buy a policy from them. They understand that. They’re trying to do the right thing for you. If it’s one of these people on my list, they do so many hundreds of policies a year, losing a little bit of income is not going to change their life dramatically. They’re mostly focused on just doing the right thing for you.

Collecting on Two Disability Insurance Policies

“When I graduated from residency, I joined a private practice and I followed the advice and purchased a high-quality own occupation disability insurance policy. Since then I’ve changed jobs and I’m currently employed. I kept my original disability insurance policy, which I have always paid for with after tax dollars, because it was of such high quality and it was purchased when I was younger. My employer buys a disability insurance policy for me that is not as generous. My question is in the event I were to become disabled, are you aware of any reason I could not collect on both policies? Are there laws about this or fine print and some policies that would try to deny payment for dual coverage?”

Yes, you generally can collect on both an individual and group policy. You’re certainly not going to have any trouble collecting on a good individual policy that you bought from one of the big five or six companies. These are not cheap policies, but they’re very good policies and they’re going to pay out no matter what.

The group policy, you better read the fine print. You can go over that with your independent insurance agent when you buy or when you meet with them to have your options evaluated. But you have to be a little bit careful. Sometimes they do decrease the benefits based on what you’re getting on another policy. But most of the time, the way it works is the individual policy just will not sell you a whole bunch more insurance if you already have a group policy in place and they’ll both still pay out. So, I would say in general, you’re going to get the payout from both of them, but read the fine print on that group policy. Sometimes they might be limited.

How Long Should You Keep Your Disability Policy

Does it make sense for a healthy financially independent doctor to consider discontinuing his disability insurance? I guess the same question could be asked about term life insurance as well, though it is so much cheaper it is not as big a financial concern. I’ve already dropped my disability insurance. It’s not a cheap policy. If you have a good policy, it costs a lot of money, even if you buy it when you’re super young and healthy in residency. As you become financially independent, the idea is that you then drop it. You save the premiums, use them to buy something else you want or invest the money for your kids, or give it away to charity or whatever you want to do with the money. In general, you should drop it when you become financially independent. Maybe you keep it another year or two until you’re sure but mostly when you become financially independent, you don’t need disability insurance because disability is no longer a financial catastrophe in your life.

Another time you might want to consider dropping it is as you move into your 60s. Keep in mind how long these policies pay for. As a general rule, they will pay until you hit age 65 or 67 with some policies. So, if you get disabled at 35, you’re going to get 30 years of payments out of this sucker. But if you become disabled at 63, you’re only going to get two years out of it. And maybe it’s not worth paying the same premium for two years of benefit versus 30 years of benefit. And so even if you’re not totally financially independent by the time you’re getting into your 60s, you might consider dropping that disability insurance policy anyway. I’ll leave that in your hands. Some people feel less comfortable doing that than others.

Term-life, similar story. When you’re financially independent, you don’t actually need it, but it is a lot cheaper. I think a lot of people kind of do what I’ve done, where I dropped my disability and kept that term policy around. It would provide a little bit of liquidity in the event of my death.

Late Contribution for a Backdoor Roth IRA

“I am calling with a question about a late contribution for a backdoor Roth IRA that I ended up making. I realized that we are married filing separately for the first time this year, as I’m ending my residency year as a PGY-3, rolling into an attending salary for the second half of the year, and I will be going for PSLF. In  anticipation for that I wanted our income to look less. Given that we are in Washington and Washington is a community property state. I have a spouse who was not working last year. So, we thought this was going to be a luxury that splitting my resident salary between the two of us for our community property would make my income look less.

But the side effect is that when you file separately our Roth cap for income is 10k which is significantly below what the income was last year. So now having made a Roth recharacterization to a traditional IRA and now conversion back to a Roth in May, 2020 for the 2019 tax year, I’m now trying to figure out how to do a late conversion through TurboTax with the idea that I need to fill out this 2019 form 8606, but then I also need to fill out a 2020 form as well.”

She introduces a pretty cool technique, which for the right person, it can actually help. In a community property state, you are actually allowed to split your income between the two spouses. And if you do this right, it’s possible you can decrease your pay as you earn payments and thus increase the amount left to be forgiven under the public service loan forgiveness program. If you combine that community property aspect with filing married filing separately, that could be a way you can get a little bit more money forgiven under the public service loan forgiveness program. But in her case, the question is really about backdoor Roth IRAs and late contributions to a backdoor Roth IRA, especially when you already kind of screwed up your IRA contributions for the year and actually have to recharacterize them.

So yes, you need to recharacterize the Roth IRA to a traditional IRA. And then as soon as you’re allowed to reconvert it to a Roth IRA. But you can’t do a late conversion. The conversion is always reported on the tax form for the year in which it is actually done. So, if you do the conversion step in 2020, it gets reported on your 2020 taxes. But if the contribution is for the 2019 tax year, even if you do it in 2020, it still goes on your 2019 tax form that 8606 form that you report your backdoor Roth IRA contributions.

But a recharacterization is basically going back and tell the IRS that I didn’t really do a Roth IRA contribution. I really did a traditional IRA contribution. So, it’s reported on your taxes exactly the same as if it were just a simple IRA contribution in the first place. So, it’s not really a big deal there.

If you need help with these subjects, take a look at my backdoor Roth IRA tutorial or the post about late contributions to the backdoor Roth IRA, which will walk you through what you need to put on the tax forms if you do your contribution for the previous year in the next year. So, if you’re making contributions for 2019 in May of 2020, then you’ll want to fill that out according to that late contribution to the backdoor Roth IRA tutorial.

If you need help with TurboTax, one of my favorite backdoor Roth IRA TurboTax tutorials is done by the finance buff Harry Sit. If you’re still stuck, we have a bunch of recommended tax folks.

Best Way to Allocate Income as a Resident

What should you do with your money in residency? Well, if they’re going to give you 457 money, obviously take that. If they’re going to give you a match, make sure you’re putting enough in the 403(b) to get the match. That is basically part of your salary. You don’t want to leave part of your salary on the table. So, make sure you get that match.

It’s generally great to roll your old 403(b) into your new 403(b), unless you have the money to convert it to a Roth IRA. That can be a great move as well, especially when you’re in a low tax year, like you often are in during residency. Bear in mind though that a Roth conversion will increase your income and thus your income driven repayment program payments. And possibly decrease any subsidy you might get under the repay program and any future forgiveness you might get such as that available through public service loan forgiveness. But in general, low income year is a great time to do a Roth conversion.

Asset Allocation

“With my total asset allocation, since I’m in my 30s, I decided not to go with bonds until I’m in my 40s, but I wanted to do  80% stock, which is split up between 50% total VTSAX, or equivalent, 15% small value and 15% international. And then eventually 20% into real estate with half being REITs and half being syndications once I’m an accredited investor. A couple of questions for you. Does that seem like a reasonable plan? And second question with the REITs, would you recommend putting those into the Roth IRA, given their tax drag?”

He is planning to add bonds in his 40s. I think that’s reasonable. I think you really need to watch your own risk tolerance to make sure you’re not going to panic sell, but certainly, if you don’t need money for 30 years, it’s not crazy to have none of it in bonds. But as you get into your 40s, I think it’s wise to probably start adding some bonds or at least some less risky investments to the mix. He’s talking about going 80% stock and 20% real estate for now. I think that’s a reasonable mix. You could probably reverse those numbers and I would still think it was a reasonable mix, 80% real estate and 20% bonds if you’re really into real estate. The key is to pick something reasonable and stick with it so that whenever that investment has its day in the sun, you’re still invested in it. But it sounds like his desired asset allocation, at least until he adds bonds, is 50% in total stock market, 15% in small value, 15% in international, 10% in REITs and 10% in private investments. Is it reasonable? Sure. Sure, it’s a reasonable asset allocation.

It’s a pretty good tilt though. So, you really need to make sure you are committed to both holding small value stocks and REITs in the long run. Remember, over the last decade, a decision to do that has not paid off. You would have been better off in large growth stocks because large growth stocks have outperformed small value stocks over the last decade. But in the long run, the data suggests that the riskier small and the riskier value stocks do pay a premium. You earn more money in them in the long run, but bear in mind that this isn’t physics, it’s finance, and there’s not nearly as much data in finance as there is in physics.

Your international tilt is fairly small in my opinion. I wonder if some of that is performance chasing. For instance, Vanguard is trying to look into their crystal ball and predict returns for the next decade. And they’re suggesting that they think international stocks are gonna make 9.5% to 6.5% for U.S. stocks. And that’s worth about what you paid for it. Obviously, they don’t know any more than you do what’s going to do well in the future.

But there is this idea that the pendulum swings back and forth between these two and domestic stocks have certainly outperformed international stocks over the last 10 years. It would not surprise me one bit to see international stocks now outperformed domestic stocks over the next 10 years. So, I don’t know, it feels like a 15% tilt to international is pretty small to me. I might bump that up a little bit, but otherwise, I think it’s a reasonable asset allocation.

You’re asking where should your REITs go. They should probably go in the Roth IRA. You may not have a taxable account and they’re not a very tax efficient asset class anyway, so what does that leave? That leaves the Roth IRA. And that’s where my REITs are. They’re still in my Vanguard Roth IRA. They’ve been there for 15 years. I just haven’t had any other place that I really could put them.

Another question about asset allocation was whether you should add small caps to your three fund portfolio. It certainly hasn’t been a problem lately to not have small caps in your portfolio. Large cap stocks are big stocks that have outperformed small stocks over the last decade or so. But yes, you could certainly add a small cap tilt by swapping some total stock market for a small cap index fund. That would achieve your goal.

Historically, there has been a premium for small stocks, meaning you got paid more, they earn more over the long run. But of the factor premiums out there like values, size momentum or the size of the company is generally recognized as the weakest or the smallest of the premiums. It’s the worst of the factors. Yes, it’s still a factor, but it has the smallest benefit. The academics would tell you if you’re only going to add one tilt, add a value tilt to your portfolio. You can get both a small and a value tilt with just the addition of one more fund to your portfolio. You just add a small value fund instead of a straightforward small cap index fund.

State Tax Credits

“I recently sold my practice and moved from South Carolina after practicing for 30 years. I did a large real estate deal prior to leaving and received a large state and federal historic preservation tax credit. My question is how to sell my greater than $160,000 state tax credit as I will no longer be earning any income in this state.”

“A lot of you may not be aware, but there are tax credits out there, both state and federal, primarily state that can actually be bought and sold. These are transferable tax credits. And so, there’s a few brokers out there who for a fee we’ll sell these sorts of things. At a discount of course. That discount is about 10 cents on the dollar to willing buyers. So, I don’t have a recommended broker for this. I just haven’t had enough White Coat Investors ask me for this particular service.  But if you do a quick Google search of tax credit brokers, you’ll bring up some names. I’d call up two or three of them and go with the one that seems the least slimy. You get into this field and sometimes things can be a little bit interesting.

It’s a little bit like the conservation credits that you’ve been seeing go around from time to time where people are using this technique of buying a property, deciding it’s worth more than what they paid for it, transferring it to a charity basically, or dedicating it to conservation, and then ending up with a tax credit that’s bigger than your cost of buying the property in the first place. And there’s a lot of gray there. You need to really make sure you’re working with someone reputable and not being crazy on how large of a tax credit you’re taking for it.

Ending

Make sure you max out your retirement accounts.

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Full Transcription

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. Here’s your host, Dr. Jim Dahle.

Dr. Jim Dahle:

This is White Coat Investor podcast number 164 – Why you should max out your retirement accounts? Our sponsor today is Pattern. Shopping for disability insurance is complicated enough. Wondering if you were getting the right coverage, unbiased advice along with the best prices and discounts can make the process even more overwhelming.

Dr. Jim Dahle:
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Dr. Jim Dahle:
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Dr. Jim Dahle:
All right, our quote of the day today comes from author Robert Doroghazi, MD who said, “Considering the average physician income, all that is required to live comfortably and retire when you wish is a little fiscal discipline and the avoidance of stupid mistakes”. I certainly agree with that.
Dr. Jim Dahle:
Thank you very much for what you do. These are difficult times. There are difficult times in hospitals. Some of you are fighting the pandemic pretty hard. Some of you are out of work. Some of you are struggling with lower volumes than usual, and trying to rebuild your businesses. It’s not easy. I appreciate what you’re doing.
Dr. Jim Dahle:
We have a number of courses available at the White Coat Investor. We’ll be talking a little bit about these in upcoming podcasts, but be sure to check them out. If you go to the whitecoatinvestor.com, we have an entire dropdown menu at the top entitled courses. And many of you have had your conferences that you are planning on using your CME dollars for canceled due to the pandemic.

Dr. Jim Dahle:
And so, if you have CME money that you need to use and you don’t want it to go to waste, we have one course offering currently and hope to have more soon, that offers CME. And it is the 2020 Continuing Financial Education course. This consists mostly of presentations from our conference back in March, but also has up to six hours in additional material, but it’s eligible for CME. So, you can purchase it with your CME dollars. So be sure to check that out, if you are interested.
Dr. Jim Dahle:
Speaking of interesting stuff, I saw an article in the Wall Street Journal recently. It demonstrated that over 30% of investors over 65 sold out of all of their equities at some point between February and May. If you look at all investors, not just the older ones, that was about 18%. So, a number of people that basically completely liquidated their stocks in that time period.

Dr. Jim Dahle:
In case this needs to be said, stocks are not instruments for short-term investments or speculation. Okay? None of the money that you need in the next five years should be in stocks. So, if the stock market drops 20% or 30%, that is not a reason to sell your stocks. If anything, it’s a reason to buy more. But most importantly, those are the times for which you need a written financial plan to help you and to help you stay the course in those time periods.
Dr. Jim Dahle:
Now, another benefit of having a written financial plan is the act of putting it together. Not only points out where your deficiencies and knowledge are, but it also helps you and your partner get on the same page. And so, there is not one of you saying, “Let’s sell when stocks go down” and the other one’s saying, “No, let’s buy more”. You’ve already decided in advance what you’re going to do.
Dr. Jim Dahle:
If you need help doing that, we have a list of recommended financial advisors that can help you. We also have the “Fire Your Financial Advisor” online course, which is obviously less expensive than a financial advisor, and can help you learn to put that plan in place.

Dr. Jim Dahle:
I’d be most interested to know what percentage of those who got out of the market, what percentage of them ended up buying back in at a lower price. What percentage bought back in at a higher price than what they sold that and what percentage may never buy in. That data unfortunately, it was not in the article.
Dr. Jim Dahle:
Now from time to time, I get feedback about the podcast. For example, this came in by email recently asking us to do dedicated podcast to a subject area. “Perhaps once a quarter or once every other month, you can do a deep dive into an area like whole life insurance or Backdoor Roth, IRAs, or disability insurance, or asset allocation or rebalancing. Maybe it could be 20 minutes of didactics followed by answering questions. And maybe even announced ahead of time, the topic in order to collect questions from listeners”.
Dr. Jim Dahle:
Well, we did that recently with our disability insurance podcast. I hope you enjoyed that. And we do plan to do this sort of a thing from time to time going forward. It’s always a question of whether you guys would rather hear kind of a dedicated podcast, dedicated to a certain subject, or whether I just let your questions and your interest drive the podcast.
Dr. Jim Dahle:
Certainly, on the blog, we tend to do a lot of dedicated subjects. So, if there is something that you want to learn a lot about one subject, 457 plans or Backdoor Roth IRAs, or the 199A Deduction or something like that, the blog is far more focused in that respect. Whereas the podcast tends to be a potpourri of your questions and what you’re interested in.
Dr. Jim Dahle:
Now obviously if you guys all ask the same questions over and over again, there’s some repetition on the podcast. I hope that’s useful. As you go along, listening to them, I’m hoping that as you hear these questions, you are more able to give the answer yourself, because these are the same questions you’re going to get from your colleagues, your peers, your trainees in the hospitals and in your clinics.
Dr. Jim Dahle:
And so, I hope that you’ll be able to help answer their questions because you’ve heard the question so many times on the podcast. The truth is there’s probably only 50 or 100 questions out there that White Coat Investors ask over and over again. We’re not as unique as we think we are. We all kind of have the same questions.

Dr. Jim Dahle:
At any rate, we’ve debated back and forth for years what format to do the show in. As those who’ve listened to the first few episodes now in the beginning, we did a lot of episodes dedicated to a single subject, but kind of transitioned away from that for the most part to interviews about half the time and answering your questions almost all off the Speak Pipe now. In fact, I’m not even able to get to all of them on the Speak Pipe lately.
Dr. Jim Dahle:
So, I appreciate the feedback, keep it coming. If you want more questions, let us know. If you prefer a more focused episode, let us know. But barring some overwhelming response from you will probably continue mostly through the questions and then from time to time, we’ll throw in a more dedicated episode or portion of an episode.

 

Dr. Jim Dahle:
Before we get to questions today, I thought we’d do a little bit more of a focused discussion about why you should max out your retirement accounts. Retirement accounts are awesome. If you talk to people, they’re all interested in some sort of an account that will give them easier estate planning, better asset protection, pay less in taxes, get their investments to grow better and facilitate rebalancing.
Dr. Jim Dahle:
But what they don’t realize they’re to have this account available to them. It’s a tax protected retirement account and they come in a couple of different flavors, right? Obviously, you have 401(k)s which are tax deferred and you have Roth 401(k)s and Roth IRAs, which are tax free accounts. Meaning you put after tax money in there and then the earnings are never taxed again.
Dr. Jim Dahle:
Those are the two main flavors of them, but whichever one you choose to use either way, you are almost always better off than investing in a taxable account. Now, a taxable account isn’t all bad. Most of my investments now are actually in a taxable account. That’s been a transition for us over the last three or four years, as we’ve gradually moved things out of our tax protected accounts into our taxable account, just because it’s proportion of our overall investments has grown.
Dr. Jim Dahle:
It’s not all bad, right? You get the lower capital gains rates on long-term capital gains. If you get qualified dividends out of there, those are also taxed at a lower rate. You can donate appreciated shares to charity instead of cash and flush those capital gains out of your portfolio. You can tax loss harvest as we’ve discussed.

Dr. Jim Dahle:
But overall, these benefits pale in comparison to the benefits of using a retirement account for your investing. So, whenever you can use your retirement account, please do so. The downsides are not very big. For example, there’s the age 59 and a half rule, but honestly, there are so many exceptions to that rule, including using the SEPP. S-E-P-P rule. Substantially Equal Periodic Payments rule to get that money out penalty free before age 59 and a half. You just have to basically take out the same percentage of it every year for at least five years and you’re allowed to do that. So even early retirement in that respect is an exception to the age 59 and a half rule. So really not many downsides all to use in these accounts.
Dr. Jim Dahle:
Now granted, sometimes an employer offers a crappy account. It’s got crappy investments in it. The fees are super high, but even then, you’re still usually better off using it for the tax breaks. And so, we’re seeing fewer and fewer of those. I think people are getting the picture. The employers are getting the picture that they are legally responsible to not have a crappy 401(k) plan. That literally they can be sued by their employees because they have a fiduciary responsibility to them in that respect. And so, I think those accounts are actually getting better over time.
Dr. Jim Dahle:
But you need to understand particularly for a typical doctor, why your 401(k) is so awesome. We’re all worried about getting sued about policy limits. It rarely happens, but we’re all worried about it. Well, you can actually keep what’s in your retirement accounts after declaring bankruptcy. So, say you get sued successfully. Chances for this to happen are super, super low. But say this happens and there’s a $10 million judgment brought against you. And what do you do? You declare bankruptcy and you get to keep what’s in your retirement accounts. So that’s a great reason to max them out.
Dr. Jim Dahle:
But beyond that, a 401(k) gives you a tax break up front. If your marginal tax rate meaning the rate at which your next dollar is taxed is let’s say 40% between state and federal. If you put $10,000 into a tax deferred account, you just knocked $4,000 off your tax bill for that year. It’s a wonderful benefit.
Dr. Jim Dahle:
Now the skeptics will say, “Well, you’re just deferring those taxes”. But that’s not entirely true because you get a couple of other benefits in there. The first is that while that money grows, it is not taxed. As it spits off capital gains and dividends each year, like most investments do or spits out interest, you don’t pay taxes on that as it grows. So, the money actually grows faster inside the retirement account.

Dr. Jim Dahle:
And the second benefit, well, there’s another benefit. I mean, you can rebalance it and it costs you nothing to buy and sell in the account, right? There are no tax consequences of doing so. So, it’s easier to rebalance your portfolio as well or switch investments if you didn’t do a very good job selecting them, or if you just need to move things around. I mean, when I have to make changes in an account, I try to always do them in my tax deferred accounts.
Dr. Jim Dahle:
But the last benefit is one that a lot of people don’t understand. And that’s the fact that you will almost surely, if you are a typical doctor, you will almost surely take that money out of the account at a lower tax rate than you put it in. And that is not a prediction of future tax rates, right? If tax rates go up, that doesn’t mean you’re taking that money out at a higher tax rate. And the reason why is that taxes fill the brackets.
Dr. Jim Dahle:
So, as you have taxable income in retirement, a certain amount, if you’re married, I think it’s $24,800 or $24,600 this year is the married standard deduction. So, if your only source of income in retirement is this tax deferred retirement account, your only source of taxable income anyway, obviously Roth IRAs and that sort of stuff doesn’t count. But if your source of taxable income is this traditional tax deferred retirement account, the first $24,000 plus comes out tax-free. So, if you saved 40%, when you put it in and you took it out at 0%, that is a huge arbitrage between those rates. And it’s a great benefit of that 401(k).

Dr. Jim Dahle:
Now, beyond that, the next $19,000 or so, it comes out at 10%. The next $50,000 after that comes out at 12%. The next $75,000 after that comes out at 22%. So, all of this is coming out at a much lower tax rate than when you put the money in. So, this benefit of being able to fill the brackets is a huge benefit of being able to use a tax deferred retirement account, like a 401(k) or a cash balance plan during your peak earnings years.
Dr. Jim Dahle:
Now, there are some exceptions. They’re typically super savers that have multimillion-dollar IRAs and all this other income coming in from their side businesses and these side gigs they’ve got and a bunch of investment properties and that sort of stuff. It is possible to actually have a higher marginal tax rate when you pull this money out then when you put it in. But for the typical physician that saves up $2 million or $3 million portfolio to retire on. That is not going to be the case. You’re going to take that money out at a lower tax rate then when you put it in.
Dr. Jim Dahle:
I think it’s important to understand that that tax deferred retirement account is likely your biggest tax break. It is absolutely huge. If you’re in private practice and you’ve got, you know, a setup like mine, for instance. My current setup at my partnership is I can put up to $57,000 into our 401(k) profit sharing plan. And right now, I can put another $17,500 into a defined benefit cash balance plan.
Dr. Jim Dahle:
For most doctors, a deduction like that, being able to deduct $70,000 or more, $75,000 off your income is huge. That’s probably your biggest tax deduction. It’s bigger than your interest deduction, it’s bigger than your charitable contributions. It’s bigger than your mortgage interest deduction. It’s your biggest deduction. These days some docs that are in business for themselves might have a substantial 199A deduction. This is the pass-through business deduction.
Dr. Jim Dahle:
But those are basically the two biggest tax breaks out there. So, it’s important to understand if you’re looking for to pay lower taxes, the best way you can lower them is saving more money for retirement and doing so in a tax deferred account.
Dr. Jim Dahle:
Now there are different types of retirement accounts for different types of people. If you’re an academic, chances are good you were offered some combination of accounts like a 403(b), which is very, very similar to a 401(k) as well as a 457(b), which is a little bit different. It’s actually deferred compensation. It’s technically your employer’s money, which has asset protection implications and that it’s protected from your creditors, but not your employer’s creditors. You might also have a 401(a). That’s typically an account where it is only employer money going into it, or they have a mandatory contribution from you, but work similarly.
Dr. Jim Dahle:
And so, if you’re an academic, you really need to understand the accounts that are being offered to you, how they work and how you can maximize their benefits. If you’re in private practice, you probably have something more similar to what I have a 401(k) with a profit-sharing plan, plus minus a defined benefit cash balance plan.
Dr. Jim Dahle:
Remember if you’re in a partnership, you have to use the partnership plan. You can’t just go open your own plan. If you’re getting paid on a K1, you can’t go open a solo 401(k) with that. Even if you incorporate your business, right? Even the partner is actually your corporation, you can’t just go open your own solo 401(k).

Dr. Jim Dahle:
Which is kind of interesting because the way this recent PPP loan, this forgivable loan that they were given out in response to the pandemic, that actually didn’t work that way. If you had your own corporation, you could actually apply for your own, which was separate from the partnership plan. Remember that a true independent contractor, right? You’re paid on a 1099. You can use an individual 401(k), which takes a lot of the hassle and expense out of running a 401(k) program. You can go to E-Trade or Vanguard or Fidelity or whoever you want and open those up. You can even get self-directed ones.
Dr. Jim Dahle:
If you have two types of income, for example, if you’re a W2 employee at a hospital and you also do some moonlighting, you can have more than one 401(k). You just need to make sure you stay within the rules, right? If they are completely unrelated employers, though, you can have a 401(k) for each one. But despite having multiple 401(k)s, you still only get one employee contribution. This year it’s $19,500 for those under 50, there’s a catchup contribution for those who are 50 plus. However, you can make up the rest of that $57,000 per 401(k), per employer limit with employer contributions and also with after tax employee contributions if the plan allows it.
Dr. Jim Dahle:
So, the way this typically works, if you have a couple of 401(k)s is you put in your maximum employee contribution at the hospital 401(k), they give you some sort of match, a few thousand dollars, maybe $10,000 and that’s what goes in that 401(k). And then in your individual 401(k), it’s 100% employer contributions, which works out to be about 20% of the net earnings for your side business. If your side business made $50,000, you put about $10,000 into there. And that’s how you use more than one 401(k). Just keep those to contribution limits in mind. The first one is total for all the 401ks is your employee contribution. The second one is your per 401(k) contribution. That’s the $57,000 limit.
Dr. Jim Dahle:
I mentioned employee after tax contributions to 401(k)s. And this is getting to be a more and more common feature in a 401(k). This is what we call the mega backdoor Roth IRA, because what you end up doing, assuming the plan allows it is even at above and beyond your $19,500 employee contribution, you can put in after tax money. And some plans allow you to convert that within the plan to a Roth 401(k). And obviously you didn’t get a deduction. So there’s no tax cost to converting it to a Roth 401(k).

Dr. Jim Dahle:
Some plans require you to and allow you to take the money out of that account. Put it in a Roth IRA and obviously do a Roth conversion. That again has no tax cost because that limit is so much higher than what you can typically put into an IRA here. They call it the mega backdoor Roth IRA. But that can be a good option for a number of people. There are a lot of complex uses of it, but the bottom line, if you’re trying to get more money into retirement accounts, that might be a good option for you.
Dr. Jim Dahle:
There’s always a backdoor Roth IRA for yourself and your spouse. If you’re under 50 is $6,000 a year for each of you, you put it into a traditional IRA. You then convert it to a Roth IRA with no tax costs because you weren’t allowed to take a deduction for the original contribution.
Dr. Jim Dahle:
And then of course, one of my favorite retirement accounts, isn’t even labeled a retirement account. It’s the Health Savings Account or what I call the Stealth IRA, which is a wonderful account. It’s a triple tax-free account. You get a tax break when the money goes in, it grows tax protected. When you pull it out, it comes out tax free as long as you spend it on health care. If you take the money out and spend it on something else, you have to not only pay the taxes, but you have to pay a penalty. And that penalty lasts until age 65. After age 65 if you pull the money out and spend it on whatever you want, you just have to pay the taxes on it. So, in that respect is no worse than your 401(k). Thus, we call it a Stealth IRA. So, if you have access to an HSA because you use a high deductible health plan, be sure to use that as well.
Dr. Jim Dahle:
As a general rule, that benefit of that money growing in a tax protected way is so advantageous that you don’t really want to take money out of a retirement account until you have to.

Dr. Jim Dahle:
So, anybody that’s telling you to pull money out of your retirement account, they’re usually going to cause you to make a mistake if you follow that advice. Usually, if the answer is you’re worried about having a whole bunch of taxes down the road, the usual solution to that is not to pull the money out of the retirement account now so that doesn’t happen. The solution is to do Roth conversion so that that money isn’t taxed when it comes out of the retirement accounts.
Dr. Jim Dahle:
So, I hope that’s all very helpful to you. I hope that was kind of a deep dive into retirement accounts. I hope you’re using it. I hope you see the benefits of maxing them out.

Dr. Jim Dahle:
All right, let’s take some questions from you guys. I’ve got 10 questions lined up here, off the Speak Pipe. It wasn’t as many as we’ve got. I had to leave some in reserve and I’m not sure we’re even going to get to all 10 of these with the time we have, but let’s give it a try. Our first one comes from Matt. Let’s take a listen.
Matt:
Hey Jim, my name is Matt and I’m an ENT in Portland, Oregon. I’ve recently been looking at real estate funds like CityVest, Alpha Investing, MLG and others. It seems like fund offerings come with many different structures on both the debt and equity side. I was wondering if you could speak to the tax advantages of choosing one fund to tape over another. For instance, CityVest just posted a house flipping fund, which seems to be taxed all through current income without allowing for any of the depreciation benefits. How do you account for the tax inefficiency when evaluating these types of funds? Additionally, I was thinking about setting up a Rocket Dollar self-directed IRA to use for backdoor Roth contributions. Do you still like their platform for self-directed Roth’s? And are there certain fund types that are better suited for Roth IRA than taxable accounts? Thanks again for all that you do.

Dr. Jim Dahle:
All right. First of all, Matt, thanks for plugging all of our sponsors. I’m sure they really appreciate that. Can I talk about the various tax benefits of private real estate funds? Well, yes, there are some tax benefits. Some funds are very beneficial tax wise. For example, if it’s an equity fund that passes through the depreciation to you, especially if it’s bonus depreciation, that you kind of get a whole bunch of it up front, that can be used to offset other real estate income that you have. And it makes even more of your income be tax free.
Dr. Jim Dahle:
And so that’s a huge benefit. And that generally comes with equity investments, whether it’s a single syndication, meaning a single apartment building that you bought with a bunch of other investors, or whether it is a fund that owns 10 or 15 different apartment buildings or retail buildings or whatever, 15 different properties. Either way, if they’re passing through that depreciation, that’s a big tax benefit.
Dr. Jim Dahle:
But there are other funds, for example, a typical debt fund, the loans money out to real estate developers. All of the income, all of the return from that is basically ordinary income. So, it comes out to you every year, you pay your ordinary income tax rates on it. It’s not very tax efficient. So, if you’re going to put one of those types of investments inside a retirement account, it would obviously be the debt fund. And you can put that into a self-directed IRA or a self-directed 401(k), if you would like, and it would be a much more tax efficient obviously.
Dr. Jim Dahle:
You mentioned the JKV fund. I think when you guys hear this podcast, they’re actually still raising money for that for another week. You can contact CityVest about that, but that’s a fix and flip fund. So, what that fund is, is it takes the money, it buys houses from distressed sellers. People that need to go out of their house. They can’t make the mortgage payment, whatever, and they don’t want to lose everything. They want to get this thing sold.
Dr. Jim Dahle:
So, it buys houses from people like that. It fixes them up. Because obviously these people can’t make the mortgage payment. They’re not maintaining the house. So, they fix it up and then sell it within about six months for a much higher price. And the profit goes to you as an investor in the fund. Obviously, after any fees that you pay, the people managing that fund to do.
Dr. Jim Dahle:
That sort of investment nobody’s held this thing long term. So, there’s really no significant depreciation that has passed through to you on that sort of an investment. It’s not tax efficient at all. If you were going to put again, a real estate investment into a retirement account, this would not be a bad one to do it with.
Dr. Jim Dahle:
You mentioned Rocket Dollar. Rocket Dollar is one of our recommended self-directed IRA companies. You can find all of those recommended companies at whitecoatinvestor.com under the retirement accounts recommended list. So that’s a place where you can find that sort of thing.
Dr. Jim Dahle:
As far as how tax efficiency impacts my decision to invest. It mostly does not. I mostly try not to let the tax tail wag the investment dog. I’m also very limited on retirement account space and becoming more limited each month. Over the last three or four years, I mentioned earlier in the podcast as my taxable account or retirement account ratio has grown, I’ve gradually moved asset classes after asset class to the taxable account. And it’s not that I’m moving money out of the retirement accounts. It’s simply that I have to start investing the money that’s in the retirement accounts and more into the investments that I’m leaving in those retirement accounts, because they’re not that tax efficient and buying the more tax efficient investments in the taxable account.

Dr. Jim Dahle:
So, for example, I’ve transitioned out total international stock market fund. The total stock market fund. Most of my private real estate is out there. My international small is now outside my retirement accounts. A significant portion of my bonds are now outside of retirement accounts. They’re invested in a municipal or a tax-free bond fund at Vanguard. And so, what gets left behind while the least tax efficient stuff, things like my tips fund is in there, things like that real estate investment trusts, that Vanguard REIT Index fund. That sort of stuff stays behind in the retirement accounts. I think I’ve got small value stocks inside the retirement accounts as well, but they’re probably the next thing to come out if that ratio continues to worsen, as I expect it will.
Dr. Jim Dahle:
At some point, I may have the opportunity to move my debt real estate back into retirement accounts. But since it isn’t an available investment in two of our four 401(k)s and soon in all four of our 401(k)s, that basically just leaves our Roth IRAs, which are only about 5% of our portfolio and are dropping rapidly. So, I’d love to have them inside a tax protected account, but it’s not really a good option for us right now. It doesn’t look like it will be.
Dr. Jim Dahle:
So, do I not invest in that asset class? No, I go ahead and still invest in it. Just realizing that that is part of the price of being a member of our society is you got to pay taxes and better to make the money and pay the taxes then not to make the money at all. So I try not to let the tax tail wag the investment dog. I try not to let the tax efficiency of the investments necessarily dictate my asset allocation.
Dr. Jim Dahle:
If you’re interested in these sorts of private investments and they’re totally optional, right? You don’t need these to become financially independent or to reach your financial goals. But if you’re interested in this sort of thing, you can learn about more of them by signing up for our real estate opportunities newsletter. You can find that a whitecoatinvestor.com/newsletter.
Dr. Jim Dahle:
Let’s take our next question. This one comes from Daphne.
Daphne:
Hi, Jim. I’m a mid-career physician who’s doing very well financially. But I have decided that I’d like to start formally keeping a budget. My question is this. Recommended savings rates that are commonly suggested by you and others are in the approximately 20% range. Where do entrepreneurial endeavors and alternative investments fit within this framework? Here are some examples. Say I invest $25,000 into a real estate syndication. Does that fall into the 20% savings/investment category? It’s outgoing money. And while I anticipate seeing a return on the investment down the road, there is also the possibility that I could lose it all.
Daphne:
Another example would be personal seed money invested in a startup or a side business or personal capital that is used to fund an LLC for real estate investment purposes, rehabs or repairs. These are all investments that I hope will succeed, but they could also fail. For budgeting purposes, how would you categorize these various things? Are they expenditures only, or are they part of the 20% savings/investment category when the success or failure of such ventures will not be known until some point in the future? Thank you for your thoughts on this.

Dr. Jim Dahle:
Okay. I think this is a pretty easy question. I mean, you want a formerly budget, where do your investments in alternative investments fit? Well, they fit into your savings rate. That’s where they go. They are savings. Just because they’re higher risk or you’re not sure exactly what’s going to happen with them, it’s not money you saved and invested for your future. So that would all go toward my 20% savings rate.
Dr. Jim Dahle:
All right, let’s take our next question. This one comes from Bina. I hope I’m pronouncing that right. Let’s take a listen.

Bina:
Hi, White Coat Investor. I recently read your book and I found that really helpful. I also recently started listening to the podcast, which is also great. My uncle started residency in a few weeks and I’m looking into getting disability insurance. I’m wondering if there’s a reason you recommend buying the policy from an independent insurance agent? My residency program just started offering individual policies this year in addition to their typical group policies. The individual policy looks good on the surface to me, it’s Ameritas. So, big six. And includes an own occupation definition of disability, partial disability. It’s portable so I can bring it with me when I graduate residency. And it’s not cancelable. I’m wondering if there’s a big catch that I should be looking out for with a policy offered through my University residency program and that I should be definitely looking for an independent agent or if this policy through my program is reasonable. Thanks for your help.

Dr. Jim Dahle:
Okay. This and our next couple of questions are on disability insurance. I don’t think they came in in time for us to include them in our disability insurance discussion a couple of weeks ago. But this one is “Why do I recommend independent agent?” Well, I think that’s where you’re going to get the best advice. Now, obviously, any advice you get from anybody who sells anything is going to be biased. So, the bias of an independent agent who isn’t going to be paid, if you just stick with your residency policy is to sell you a new policy. So, be aware of that. That is their bias.
Dr. Jim Dahle:
But I think the best way to do this is to take the policy offered by your residency program. And in this case, it sounds like maybe you have a halfway decent one. That’s an individual policy. You can even take with you when you go. And have it be compared to the ones you can buy from the big five or six companies. Have the agent point out the weaknesses in the policy. And there probably are some. You know how the definition might be weaker, what riders aren’t there, how the price might go up, etc. so you understand. And you may still make the decision to go with a weaker policy that costs you a lot less money and that’s okay. But at least you’re then making an informed decision.
Dr. Jim Dahle:
So, I still think you need to go see an independent insurance agent, even if you don’t buy a policy from them. And they understand that. They’re trying to do the right thing for you. If it’s one of these people on my list, they do so many hundreds of policies a year, losing a little bit of income is not going to change their life dramatically. And they’re mostly focused on just doing the right thing for you.
Dr. Jim Dahle:
Our next question comes in from Josh. Let’s take a listen.

Josh:
Hi Jim. I have a simple question that I’ve always wanted to know the answer for, but I’ve never asked. When I graduated from residency in 2012, I joined a private practice and I followed the advice of a very new physician, personal finance blog at that time and purchased a high-quality own occupation disability insurance policy. Since then I’ve changed jobs and I’m currently employed. I kept my original disability insurance policy, which I have always paid for with after tax dollars, because it was of such high quality and it was purchased when I was younger. My employer buys a disability insurance policy for me that is not as generous. My question is in the event I become disabled, are you aware of any reason I could not collect on both policies? Are there laws about this or fine print and some policies that would try to deny payment for dual coverage? I’m just curious.

Dr. Jim Dahle:
Okay. So basically, Josh is asking, “Can I collect on both my individual and group policy if I get disabled?” And yes, you generally can. You’re certainly not going to have any trouble collecting on a good individual policy that you bought from one of the big five or six companies. These are not cheap policies, but they’re very good policies and they’re going to pay out no matter what.
Dr. Jim Dahle:
The group policy, you better read the fine print. And you can go over that with your independent insurance agent when you buy or when you meet with them, when you have your options evaluated. But you got to be a little bit careful. Sometimes they do decrease the benefits based on what you’re getting on another policy. But most of the time, the way it works is the individual policy just will not sell you a whole bunch more insurance if you already have a group policy in place and they’ll both still pay out. So, I would say in general, you’re going to get the payout from both of them, but read the fine print on that group policy. Sometimes they might be limited.
Dr. Jim Dahle:
Okay. Our next question comes from Jay.

Jay:
Hi Jim. Thanks for all you do. You’re a great help to doctors and medical professionals. I have a question about disability insurance. I’m a mid-career sports doc in the Southeast. I’ve had disability insurance since finishing residency almost 15 years ago. I pay about $200 a month for $9,000 own occupation policy. I’ve been fortunate with good health and I’m pretty close to financial independence. I do have three children and a non-working spouse. My oldest child is starting college in fall. My question is, how long should I continue my disability policy? It’s not breaking the bank, but it is pretty expensive. Does it make sense for a healthy financially independent doctor to consider discontinuing his disability insurance? I guess the same question could be asked about term life insurance as well though. It’s so much cheaper that it’s not as big a financial concern. Thank you for all that you do.

Dr. Jim Dahle:
All right, Jay. Well, congratulations number one. If you’re getting that close to FI that you’re starting to think about dropping your disability insurance, you are winning the game. So, I’ve already dropped my disability insurance. It’s not a cheap policy. This stuff’s really expensive. If you have a good policy, it costs a lot of money. Even if you buy it when you’re super young and healthy in residency. And so, as you become financially independent, the idea is that you then drop it. You save the premiums, you use them to buy something else you want or invest the money for your kids, or give it away to charity or whatever you want to do with the money. And so, in general, you should drop it when you become financially independent. Maybe you keep it another year or two until you’re sure or whatever. But mostly when you become financially independent, you don’t need disability insurance because disability is no longer a financial catastrophe in your life.

Dr. Jim Dahle:
Another time you might want to consider dropping it is as you move toward and into your 60s. Because keep in mind how long these policies pay for. As a general rule, they will pay the maximum of two years, or until you hit age 65 or 67 with some policies. So, if you get disabled at 35, you’re going to get 30 years of payments out of this sucker. But if you become disabled at 63, you’re only going to get two years out of it. And maybe it’s not worth paying the same premium for two years of benefit versus 30 years of benefit. And so even if you’re not totally financially independent, by the time you’re getting into your 60s, you might consider dropping that disability insurance policy anyway. I’ll leave that in your hands. Some people feel less comfortable doing that whereas other people go, “This really isn’t a good deal for me anymore. I’m going to drop it and save that money”. But I’ll leave that up to you.
Dr. Jim Dahle:
Term-life, similar story, right? When you’re financially independent, you don’t actually need it, but you’re right. It’s a lot cheaper. And so, I think a lot of people kind of do what I’ve done, where I dropped my disability and kept that term policy around. It would provide a little bit of liquidity in the event of my death. I’ve even considered maybe changing ownership of it so the business owns it. The White Coat Investor business would actually be hurt a whole lot more by my untimely death than my family would be. And so, we haven’t exactly decided what we’re going to do with that, but you’re right. It’s relatively cheap. And so, it’s not as big of a deal to keep it around.
Dr. Jim Dahle:
All right, let’s take some questions that aren’t about disability insurance. Now this next one comes from Jackie.

Jackie:
Hi, Dr. Dahle. I am calling with a question about a late contribution for a backdoor Roth IRA that I ended up making. As I realized that we are married filing separately for the first time this year, as I’m ending my residency year as a PGY-3, rolling into an attending salary for the second half of the year, and I will be going for PSLF. And in anticipation for that I wanted our income to look less given that we are in Washington and Washington is a community property state. I have a spouse who was not working last year. So, we thought this was going to be a luxury that splitting my resident salary between the two of us for our community property would make my income look less.
Jackie:
But the side effect is that when you file separately or Roth cap for income is 10k which is significantly below what the income was last year. So now having made a Roth recharacterization to a traditional IRA and now conversion back to a Roth in May, 2020 for the 2019 tax year, I’m now trying to figure out how to do a late conversion through TurboTax with the idea that I need to fill out this 2019 form 8606, but then I also need to fill out a 2020 form as well. Thank you for all you do. I appreciate any advice you have. Thanks.

Dr. Jim Dahle:
Okay. Jackie introduces a pretty cool technique, which for the right person, it can actually help. In a community property state, you were actually allowed to split your income between the two spouses. And if you do this right, it’s possible you can decrease your pay as you earn payments and thus increase the amount left be forgiven under the public service loan forgiveness program. And so that’s a pretty cool trick to look into if you’re one of those a couple of handfuls of states that allow you to do that.
Dr. Jim Dahle:
But if you combine that community property aspect with filing married filing separately, that could be a way you can get a little bit more money forgiven under the public service loan forgiveness program. But in Jackie’s case, the question is really about backdoor Roth IRAs and late contributions to a backdoor Roth IRA, especially when you already kind of screwed up your IRA contributions for the year and actually have to recharacterize them.

Dr. Jim Dahle:
So yes, Jackie, you need to recharacterize the Roth IRA to a traditional IRA. And then as soon as you’re allowed to reconvert it to a Roth IRA. But you can’t do a late conversion. The conversion is always reported on the tax form for the year in which it is actually done. So, if you do the conversion step in 2020, it gets reported on your 2020 taxes. But if the contribution is for the 2019 tax year, even if you do it in 2020, it still goes on your 2019 tax form that 8606 form that you report your backdoor Roth IRA contributions.
Dr. Jim Dahle:
But a recharacterization is basically going back and tell the IRS that I didn’t really do a Roth IRA contribution. I really did a traditional IRA contribution. So, it’s reported on your taxes exactly the same as if it were just a simple IRA contribution in the first place. So, it’s not really a big deal there.

Dr. Jim Dahle:
If you need help with these subjects, take a look at my backdoor Roth IRA tutorial on the blog. Just Google “Backdoor Roth IRA Tutorial”, it’ll pop right up. There’s also a post about late contributions to the backdoor Roth IRA, which will walk you through what you need to put on the tax forms if you do your contribution for the previous year in the next year. So, if you’re making contributions for 2019 in May of 2020, then you’ll want to fill that out according to that late contribution to the backdoor Roth IRA tutorial.
Dr. Jim Dahle:
And if you need help with TurboTax, one of my favorite backdoor Roth IRA TurboTax tutorials is done by the finance buff Harry Sit, who spoke at the White Coat Investor conference last March. So, check that out too. And if you’re still stuck, we’ve got a bunch of recommended tax folks on the site. Just go to whitecoatinvestor.com. Look at the recommended tab and go down to tax strategists. Those guys will help you sort out your taxes.
Dr. Jim Dahle:
All right, let’s take our next question from Jean who is a relatively fortunate resident.

Jean:
Hello, Dr. Dahle. First of all, I just wanted to thank you for all that you do and the tremendous resource you’ve offered to all of us working towards and learning how to effectively don our white coat. Many, many thanks. I’m fresh internal medicine intern, trying to determine how best to allocate my income over the course of residency. I have a Roth IRA and will be enrolled in a 457 plan through my employer and we’ll have the option of enrolling into a 403(b) plan as well with matching contributions.
Jean:
The 457 plan is attractive as it’s essentially free money. My employer will contribute 3% of my gross income per year of the plan, regardless of my own contribution. Additionally, I have an old 403(b) plan from an employer predating medical school. I was initially planning to roll this over into my new 403(b) plan offered with my new employer. This seems like the simplest solution to ensuring the money I’ve been previously invested continues to grow with matching contributions, but I’m unsure if there’s a more efficient option I have not considered. For example, even if I incur taxes on the rolling over of this 403(b) into my Roth, would I not have greater overall growth potential in the Roth compared to rolling this over into another 403(b)? Thank you.

Dr. Jim Dahle:
Okay. So, what should you do with your money in residency? Well, if they’re going to give you 457 money, obviously take that. If they’re going to give you a match, make sure you’re putting enough in the 403(b) to get the match. That’s basically part of your salary. You don’t want to leave part of your salary on the table. So, make sure you get that match.
Dr. Jim Dahle:
It’s generally great to roll your old 403(b) into your new 403(b), unless you have the money to convert it to a Roth IRA. That can be a great move as well, especially when you’re in a low tax year, like you often are in during residency. Bear in mind though that a Roth conversion will increase your income and thus your income driven repayment program payments. And possibly decrease any subsidy you might get under the repay program and any future forgiveness you might get such as that available through public service loan forgiveness. But in general, low income year is a great time to do a Roth conversion.
Dr. Jim Dahle:
All right, let’s take a question from a serviceman. This is Justin in Germany.

Justin:
Hello, Dr. Dahle. Thanks for all that you do. My name’s Justin. I am a family medicine active duty physician in Germany. I wanted to go over my financial plan with you after reviewing your article as well as the “Physician on FIRE” article about your respective asset allocations. My current, I have written a financial plan, it’s currently since I’m just a few years outside of residency, I decided to do a more aggressive plan and I’m also in the military. So, I’m low paying. So currently I have a Roth TSP and I’m with the blended retirement system. So, I have 70% in the C common fund, as well as 30% in the S fund, the small cap fund with a blended retirement system match.
Justin:
Also, with my assets, total asset allocation, since I’m in my 30s, I decided not to go with bonds until I’m in my 40s, but I wanted to do it 80% stock, which is split up between 50% total VTSAX, or equivalent, 15% small value and 15% international. And then eventually 20% into real estate with half being REITs and half being syndications once I’m an accredited investor. A couple of questions for you. Does that seem like a reasonable plan? And second question with the REITs, would you recommend putting those into the Roth IRA, given their tax drag? Thank you for your time.

Dr. Jim Dahle:
Okay. That’s a lot of stuff that just went by you there. I know when I listen to the Speak Pipe, I had to listen to it three or four times to actually figure out what was going on. But it sounds like Justin is a family medicine doc in Germany, looking for feedback on his asset allocation. He currently got 70% of his TSP, which is the government 401(k) funds in the C fund, which is basically an S&P 500 index fund. And he’s got 30% in the S fund, which is basically an extended market index fund. It’s the rest of total stock market. So basically, he’s got it all in total stock market. He is planning to add bonds in his 40s. I think that’s reasonable. I think you really need to watch your own risk tolerance to make sure you’re not going to panic sell, but certainly, if you don’t need money for 30 years, it’s not crazy to have none of it in bonds.

Dr. Jim Dahle:
But as you get into your 40s, I think it’s wise to probably start adding some bonds or at least some less risky investments to the mix. He’s talking about going 80% stock and 20% real estate for now. I think that’s a reasonable mix. You could probably reverse those numbers. And I would still think it was a reasonable mix. 80% real estate and 20% bonds if you’re really into real estate. The key is to pick something reasonable and stick with it so that whenever that investment has his day in the sun, you’re still invested in it. But it sounds like his desire to asset allocation, at least until he adds bonds is 50% in total stock market, 15% in small value, 15% in international, 10% in REITs and 10% in private investments. Is it reasonable? Sure. Sure, it’s a reasonable asset allocation.

Dr. Jim Dahle:
It’s a pretty good tilt though. So, you really need to make sure you are committed to both holding small value stocks and REITs in the long run. Remember, over the last decade, a decision to do that has not paid off. You would have been better off in large growth stocks because large growth stocks have outperformed small value stocks over the last decade. But in the long run, the data suggests that the riskier small and the riskier value stocks do pay a premium. You earn more money in them in the long run, but bear in mind that that data is not, and this isn’t physics, it’s finance, and there’s not nearly as much data and finances that there is in physics.
Dr. Jim Dahle:
Your international tilt is fairly small in my opinion. I wonder if some of that is performance chasing. For instance, Vanguard is trying to look into their crystal ball and predict returns for the next decade. And they’re suggesting that they think international stocks are gonna make 9.5% to 6.5% for U.S. stocks. And that’s worth about what you paid for it. Obviously, they don’t know any more than you do what’s going to do well in the future.
Dr. Jim Dahle:
But there is this idea that the pendulum swings back and forth between these two and domestic stocks have certainly outperformed international stocks over the last 10 years. It would not surprise me one bit to see international stocks now outperformed domestic stocks over the next 10 years. So, I don’t know, it feels like a 15% tilt to international, it feels pretty small to me. I might bump that up a little bit, but otherwise, I think it’s a reasonable asset allocation.
Dr. Jim Dahle:
You’re asking where should you REITs go. They should probably go in the Roth IRA. Obviously, they’re not an available asset class in the TSP. You may not have a taxable account and they’re not a very tax efficient asset class anyway, so what does that leave? That leaves the Roth IRA. And that’s where my REITs are. They’re still in my Vanguard Roth IRA. They’ve been there for 15 years. I just haven’t had any other place that I really could put them.
Dr. Jim Dahle:
Okay, let’s take our next question. This one comes from Anthony.

Anthony:
Hey, Dr. Dahle. This is Anthony with the question about asset allocation. In my own portfolio I’ve always tried to model the three-fund portfolio to an extent roughly, and I like to keep it simple. And I’ve always tried to stick to my desired asset allocation. I was recently going through my portfolio and I realized what a tiny percentage I have in small cap stocks. I know some people prefer to have a small value tilt. And this got me thinking to “Is it a problem that I’m, so over weighted in large cap stocks?” If I wanted to have some kind of small value tilt, would it just be as simple as selling a portion of the total stock market index that I have in my Roth IRA and buying a smaller percentage of a small cap index? Any thoughts you have would be greatly appreciated and thanks for all that you do.

Dr. Jim Dahle:
All right. So, Anthony is basically asking, “Should I add small caps to my three-fund portfolio?” Well, it certainly hasn’t been a problem lately to not have small caps in your portfolio. Large cap stocks are big stocks that have outperformed small stocks over the last decade or so. But yes, you could certainly add a small cap tilt by swapping some total stock market for a small cap index fund. That would achieve your goal.
Dr. Jim Dahle:
Historically, there has been a premium for small stocks, meaning you got paid more, they earn more over the long run. But of the factor premiums out there like values, size momentum, small, or the size of the company is generally recognized as the weakest or the smallest of the premiums. It’s the worst of the factors. Yes, it’s still a factor, but it has the smallest benefit. The academics would tell you if you’re only going to add one tilt, add a value tilt to your portfolio. You can get both a small and a value tilt with just the addition of one more fund to your portfolio. You just add a small value fund instead of a straightforward small cap index fund.

Dr. Jim Dahle:
All right, let’s take our last question from Richard. I think it’s a really good one.

Richard:
Good morning. I appreciate all of your hard work. I recently sold my practice and moved from South Carolina after practicing for 30 years. I did a large real estate deal prior to leaving and received a large state and federal historic preservation tax credit. My question is how to sell my greater than $160,000 state tax credit as I will no longer be earning any income in South Carolina. Many thanks.

Dr. Jim Dahle:
Okay. So, this is interesting. A lot of you may not be aware, but there are tax credits out there, both state and federal, primarily state that can actually be bought and sold. These are transferable tax credits. And so, there’s a few brokers out there who for a fee we’ll sell these sorts of things. At a discount of course. That discount is about 10 cents on the dollar to willing buyers. So, I don’t have a recommended broker for this. I just haven’t had enough White Coat Investors ask me for this particular service. We haven’t gone out and found somebody that we tried to vet who does a good job with this. But if you do a quick Google search of tax credit brokers, you’ll bring up some names. I’d call up two or three of them and go with the one that seems the least slimy. You get into this field and sometimes things can be a little bit interesting.

Dr. Jim Dahle:
It’s a little bit like the conservation credits that you’ve been seeing go around from time to time where people are using this technique of buying a property, deciding it’s worth more than what they paid for it, transferring it to a charity basically, or dedicating it to conservation, and then ending up with a tax credit that’s bigger than your cost of buying the property in the first place. And there’s a lot of gray there. You need to really make sure you’re working with somebody reputable and not being crazy on how large of a tax credit you’re taking for it.
Dr. Jim Dahle:
All right. If you’ve been shopping for disability insurance, you know that it’s already complicated enough. If you’re wondering if you’re getting the right coverage and unbiased advice and the best prices and discounts, there is somebody you can go see. You can go see Matt Wiggins at Pattern Insurance. He’ll make the process less overwhelming.
Dr. Jim Dahle:
Pattern knows doctors and more important things to do than spend hours sorting through numerous insurance options. This is why thousands of White Coat Investors have trusted Pattern to help them compare and understand the disability insurance they are buying. Their online process is simple. First, request your quotes online. Second, compare your options and ask questions. And third, apply risk-free. You should be confident that you have the right policy at the best price. Request your disability insurance quotes with Pattern at whitecoatinvestor.com/patternpodcast.
Dr. Jim Dahle:
Be sure also to check out those White Coat Investor courses, especially if you have some CME money you need to use up pronto. That can be a great option for you. You can find those at whitecoatinvestor.com underneath the course’s menu.
Dr. Jim Dahle:
Thanks to those of you who have left us a five-star review. Remember positive feedback goes on the five-star reviews and negative feedback comes to me by email. Thanks also for those of you who told your friends about the podcast. Keep your head up and your shoulders back. You’ve got this and we can help. Stay safe out there. We’ll see you next time on the White Coat Investor podcast.

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