Today, we tackle a few of your questions about 529s. We answer some questions about when you have to pay taxes on your rollover IRA contributions to Roth as well as a question about Mega Backdoor Roths. We talk about structured notes and the advantages and disadvantages of saving for minors using a UTMA vs. a parental brokerage.


 

Roth Conversions and Taxes

“If you convert a rollover IRA—in this case $37,000—to a Roth IRA, when do you have to pay the taxes? From what I understand, the IRS doesn't want you holding on to what you owe them for a long time or else they penalize you. Does this apply to IRA conversions?”

Our federal income tax system is a pay-as-you-go system. But not all state systems are like that. Utah is not a pay-as-you-go system. You can pay every dollar you owe on April 15 for the prior year, and they're perfectly fine with that. There's no penalty and no interest. There's no requirement to make quarterly estimated payments to the state of Utah. Many states are that way. Not all of them, though.

But the federal system is pay-as-you-go. You're supposed to pay the taxes as you make the money throughout the year. Whether you're making that money from dividends, whether you're making that money from your W2 income, whether you're making it from 1099 income, or whether you're making it from IRA conversions. Theoretically, when you do an IRA conversion that quarter, you make a quarterly estimated payment in the amount of about what the tax on that thing would be. However, in practice, this system breaks down a little bit. There are two different numbers. One is the amount you have to pay in tax that you actually owe in tax when you settle up with the IRS next April 15. The other number is what you have to have paid the IRS to stay out of trouble. You still have to pay all the tax you owe come April 15, but if you pay enough to stay out of trouble, you don't have to pay any interest or penalties or anything.

That's what the whole quarterly estimated tax payment thing is all about; it is paying enough to stay out of trouble. It may also help with your budgeting if you don't have to come up with a whole bunch of money come next April 15. But mostly the goal is just to pay enough that you stay out of trouble. Then, you can settle up with the IRS later.

For a lot of people, one of the cool tricks you can do with your taxes is you can just have more withheld at the end of the year than you have earlier in the year. The IRS doesn't care when the money is withheld from your paycheck. They look at it all the same, whether it's withheld in January or withheld in December. Same if you have money withheld from an RMD  or if you had money withheld from an IRA conversion (although I generally think you ought to pay the taxes on those conversions from some other source of money—not actually out of the IRA). But my point is that you can just increase your withholding at your W2 job to cover the amount of tax you owe. This is only a $37,000 conversion. So, we'll say that's $15,000 in taxes maybe. Maybe just the last few months of the year you have them withhold an extra $5,000 out of each of your paychecks, and boom, you don't have to do anything else. You don't have to send in quarterly estimated payments. You don't have to do anything else. Now, if you convert a $250,000 rollover IRA, you may not be able to cover that just with withholdings from your W2 job. You might actually have to send in a quarterly estimated payment.

But the goal, of course, is to get into the safe harbor. Safe harbor means you either pay your entire tax due less $1,000, or you pay 110% of what you owed last year. That's for high earners. I think it's 100% for lower earners. That's basically how you get into the safe harbor of not having to pay any penalties. You still owe the taxes, of course, come April 15.

More information here: 

How to Do a Backdoor Roth IRA

How to Fix Backdoor Roth IRA Screw-Ups

 

Advantages and Disadvantages of UTMA Accounts vs. Parental Brokerage

“I was wondering if you could help provide some clarity regarding the advantages and disadvantages of saving for minors using a UTMA account vs. a parental brokerage that ultimately would be transferred down the line. It seems like you could use the UTMA and go up to the yearly IRS gifting allowance. Ideally I'd do a Roth, but I'm still a bit stymied about how to employ my kids legally.”

The main difference between investing in a Uniform Transfer to Minors Account (UTMA) or Uniform Gift to Minors Account (UGMA)—they're almost the same thing—vs. just your own brokerage account is control vs. tax advantages. If it's in your brokerage account, you get total control over it. You don't have to give it to the kid if you don't want. You get to say what it's spent for. You get to say when they get it. You have control over it; it's still your money.

Once you put it in a UTMA or UGMA account, it's no longer your money. It's the kid's money. It's called a custodial account. You still control what it's invested in, but you can only pull the money out in a way that benefits the child. It's their money now. Plus, when they turn the age of majority in your state, which in most states is age 21, it is truly their money, and you exercise no control over it whatsoever. If they want to spend it all on four-wheelers and trips to Cancun or whatever, then that's their right. They get to do it. It's their money. Maybe they can't quite figure out how to handle a brokerage account and how to get their money out of it or maybe you haven't done a great job telling them it's actually there, so maybe you can get a few more years out of it. But if they really wanted it, they could get it. It's their money.

What tax advantages do you get for giving up the control over that money earlier than you otherwise would? You get a few things. One, you get the money out of your estate. If you have an estate tax problem, it's out of your estate. It's now into the kids' estate. Any further growth on it isn't happening in your estate. That might help you avoid estate taxes on that money. Two, the first roughly $2,500 of growth is being taxed at their tax rate. The first half of that, $1,200, $1,300, whatever it is, is maybe 0% if they don't have any other income. Instead of paying taxes up to 23.8% for you, you might be paying 0% in tax on that. Then, the next $1,200 or $1,300 is going to be at 10%. That's a huge tax break. Or even 0% of it's long-term capital gains and qualified dividends. Basically, that money is being taxed at their tax rates rather than your tax rates.

But beyond a certain point, the kiddie tax kicks in, and it's just taxed at your tax rate. If you invest it very efficiently, you can get up to about $100,000 in there before the income starts being taxed at your tax rate. It doesn't really do you any good at that point other than those estate tax benefits that most white coat investors aren't ever going to need. But that's kind of the benefit of a UTMA.

There are also some FAFSA applications, but honestly, those don't matter to most physician families. Most physician families aren't going to have any sort of need-based benefits for college. We use UTMA accounts. That's my kids' 20s funds, the money we give them, telling them this is money to use for missions and a summer in Europe and a first car and a down payment on a first house and all those things you need in your 20s. Weddings, honeymoons, those sorts of things. We didn't put much in for a while because we didn't have that much. Then, when we were making more money, we put $17,000 a year or whatever the equivalent was for that year. This year, we actually put $34,000 into each of our kids' UTMAs because we've stopped funding their 529s. We think we've got four overfunded 529s at this point, given the schools they're talking about and the things they're talking about studying. But the UTMAs are just now starting to get to that size where we have to worry about us paying some of the tax on the income at our tax rates. There are more resources on the blog. You can search on whitecoatinvestor.com for UGMA, UTMA, kids. You search “children,” and you'll pull up blog posts that talk about how we've structured our kids' 20s funds.

More information here:

My Children's Inheritance 

Why a 13-Year-Old Has More Investing Accounts Than You

 

Mega Backdoor Roth Contributions with Minimal 1099 Income

“My question is about the amount one can contribute to a Mega Backdoor Roth if one does not have a lot of 1099 income. For example, I made $60,000 in 1099 income in 2023 and had expenses of $10,000. I'm in the 25% tax bracket and contributed 20% to the solo 401(k). I have a regular W2 job where I fully contribute to the 401(k). So, how much can I contribute to Mega Backdoor Roth?”

Here's the way it works. First of all, you have to have a solo 401(k) that allows Mega Backdoor Roth contributions—these are after-tax contributions and also in-plan conversions. But basically, all of your net income you can convert. You can put it in there and convert it to a Mega Backdoor Roth. If you gross $60,000 and you had $10,000 in business expenses, including the employer half of Social Security taxes, that leaves you $50,000. Basically, you could contribute the entire thing in these after-tax contributions and then convert that to a Roth.

That's a pretty cool feature. You can get a whole bunch of money into a retirement account—albeit in Roth, not tax-deferred—on not all that much income. If you're trying to put tax-deferred employer contributions in there, that's limited to about 20% of your net income. If your net income for that business was $50,000, you'd only be able to put in there $10,000 as tax-deferred. If you have not used your employee contribution somewhere else, that's $23,000 for 2024; then you can also put that in. That's in addition to that $10,000 you could put in as an employer. But the total amount you can contribute is what you made. No more than $50,000 for that business. I hope that's a helpful clarification of those rules.

Remember that it's your net business profit. When I say net, we're talking about the business. We're not talking about net on your personal income or on your personal taxes. Just remember that that's what net refers to, because the 401(k) administrator and the IRS really have no idea how much other income you have. That doesn't limit your 401(k) contributions. It's all about the income you have at that job. Basically, you can pay the taxes on that income from somewhere else. You don't have to pay the taxes on it and then have that reduce how much you can put in the 401(k), assuming you have money from somewhere else, of course.

 

To learn more about the following topics, see the WCI podcast transcript below:

  • Can you transfer low-basis shares from a brokerage account to 529s?
  • Changes to the 529 plans when you have multiple kids
  • Structured notes recommended by financial advisors
  • Matching campaigns for charity

 

Milestones to Millionaire

#157 — Dual Income Couple Pays Off Mortgage Among Other Financial Milestones

This dual-doc couple got a later start getting their finances in order. Once they realized that they had been practicing for around 10 years and they had not built the wealth they anticipated, they made some changes and got to work. In only a few years, they paid off their mortgage, became multi-millionaires, cash-flowed new cars, and saved enough to get their kids through college. Now, they are saving lots of money and looking forward to cutting back at work. She shows us that you can make massive progress quickly if you buckle down and do it!

 

Finance 101: Dividend Investing

Dividend investing is a popular strategy for many investors, but it may not be as exciting or beneficial as it seems at first glance. While receiving dividends can provide a stream of income, it's important to recognize that they are simply a portion of the profits that a company chooses to distribute to shareholders. The decision to distribute dividends comes with tax implications, particularly in taxable accounts, where you are required to pay taxes on the dividend income received. This can result in unnecessary tax burdens, especially if the dividends are reinvested rather than needed for living expenses.

Focusing solely on dividend investing can lead to over-saving and inefficient portfolio management. Many investors aim to live off their dividend income entirely, but this approach often results in a significantly larger portfolio size than necessary. With the current low dividend yields in the market, waiting to live off dividends alone can lead to over-saving and delayed financial freedom. Favoring high-yield dividend stocks may expose investors to undue risk and hinder portfolio diversification. Instead of fixating on dividends, it's important to focus on total returns and consider more efficient ways to achieve portfolio goals, such as investing in value stock index funds rather than individual dividend stocks.

It's also essential to distinguish between dividend stocks and bonds. While both provide income, they carry different levels of risk. Investing in dividend stocks doesn't guarantee stability, as stock prices can fluctuate and companies may halt dividend payments. This distinction underscores the importance of a balanced investment approach and highlights that dividend investing primarily tilts portfolios toward value stocks. However, there are more efficient ways to achieve this tilt without solely relying on dividend stocks, such as investing in value stock index funds. Ultimately, investors should carefully consider the implications of dividend investing and ensure their portfolio aligns with their long-term financial objectives and risk tolerance.

 

To read more about dividend investing read the Milestones to Millionaire transcript below.


 

Today’s episode is brought to us by SoFi, the folks who help you get your money right. They’ve got exclusive rates and offers to help medical professionals like you when it comes to refinancing your student loans—and that could end up saving you thousands of dollars. Still in residency? SoFi offers competitive rates and the ability to whittle down your payments to just $100 a month* while you’re still in residency. Already out of residency? SoFi’s got you covered there too, with great rates that could help you save money and get on the road to financial freedom. Check out their payment plans and interest rates at sofi.com/whitecoatinvestor. SoFi Student Loans are originated by SoFi Bank, N.A. Member FDIC. Additional terms and conditions may apply. NMLS 696891.

 

WCI Podcast Transcript

Transcription – WCI – 354

INTRODUCTION 

This is the White Coat Investor podcast where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high-income professionals stop doing dumb things with their money since 2011.

Dr. Jim Dahle:
This is White Coat Investor podcast number 354.

Today’s episode is brought to us by SoFi, the folks who help you get your money right. They’ve got exclusive rates and offers to help medical professionals like you when it comes to refinancing your student loans—and that could end up saving you thousands of dollars. Still in residency? SoFi offers competitive rates and the ability to whittle down your payments to just $100 a month* while you’re still in residency. Already out of residency? SoFi’s got you covered there too, with great rates that could help you save money and get on the road to financial freedom. Check out their payment plans and interest rates at sofi.com/whitecoatinvestor. SoFi Student Loans are originated by SoFi Bank, N.A. Member FDIC. Additional terms and conditions may apply. NMLS 696891.

All right, welcome back to the podcast. It's exciting. We're recording this over the holidays. I think this drops not until February, so it's going to be a little while before you hear this. So, if something seems out of date because the world totally changed in the last six weeks, that's why.

But some of you are listening to this in the car with your kids, I hear from you from time to time. And so, for just a minute I want to talk to you kids. Parents, I guess I don't want you to put your hands over your ears because you're probably driving, but this one's for the kids.

All right, kids, I get it. This podcast is totally boring and I'm sorry your parents make you listen to it. My kids whine when I make them listen to financial podcasts as well. But you know what? There's a few useful things you'll pick up in here from time to time that you'll remember down the road and it'll help you have a happier and more successful life.

But here's something I want to tell you to do. You don't have to do it now, but in a few years maybe make sure you do this at least once. I got a letter from one of my kids this week. This is my oldest kid. She's now almost 20 years old, and sent a letter saying how much she appreciated me as a parent and included a whole bunch of specific things that she had learned from me. Put that on your to-do list. Send that to your parents at some point after you move out of the house. They will really appreciate it.

Hey, one thing I'm doing with my kids this holiday season is I've offered them $10 if they will memorize something. And so, I took it, I printed it out and I put it in front of their toilet and said, “Hey, if you can memorize this before the end of the year, I'll give you $10.” And I bet if you talk to your parents, you can get them to do the same thing. If you'd like $10, suggest to your parent that if you memorize this, they should give you $10.

But I gave them an excerpt from a speech by Teddy Roosevelt. This was given about a hundred years ago in Paris actually. And it's something I think about a lot when I hear criticism. Criticism is not necessarily all bad. Criticism can be very helpful. In fact, if it's really constructive criticism, it's like getting gold. But it's hard sometimes not to take it personally, as well.

And so, I think this is a great quote to help you learn not to take criticism personally. Teddy Roosevelt said this. He said, “It is not the critic who counts; not the man who points out how the strong man stumbles, or where the doer of deeds could have done them better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood; who strives valiantly; who errs, who comes short again and again, because there is no effort without error and shortcoming; but who does actually strive to do the deeds; who knows great enthusiasms, the great devotions; who spends himself in a worthy cause; who at the best knows in the end the triumph of high achievement, and who at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who neither know victory nor defeat.”

Now if you're listening to this podcast with your parents, your parent is probably a high achiever. They've probably achieved a lot in their lives. They've passed on some great genes to you, and you're getting a head start in life. Because of that, you are likely to achieve something really impressive, too, in your life. So, think about what you want to do in life. Make your contribution to the world. Don't pay too much attention to those critics.

All right. By the way, if you are interested in real estate investing, we have a little intro thing that doesn't require you to buy our whole No Hype Real Estate course. We call it the Real Estate Masterclass. It's three videos. You get them by email. You can sign up for that at whitecoatinvestor.com/remasterclass. And it's pretty cool because if you do decide you want to take the full course after that, you get $200 off it. So, check that out at the whitecoatinvestor.com/remasterclass as in Real Estate Masterclass.

Okay. By the way, a change was just made, six weeks ago, I guess, by the time you're hearing this, but the deadline to consolidate your income driven repayment direct loans has been pushed back. It was at the end of the year. It's now been pushed back to April 30th. This is often called the IDR waiver. And so, if you're one of those people with FFEL loans, you definitely want to consolidate those so you can bring those into the IDR program, maybe qualify for IDR forgiveness or even Public Service Loan Forgiveness.

If you need advice on your student loans, by the way, studentloanadvice.com is the company we started because we wanted to make sure people were getting high quality advice about their student loans. I think the last time they checked, their average client saves $190,000 on their student loans. A lot of people are helped with public service loan forgiveness, obviously, but they'll help you with refinancing decisions, how to file your taxes to maximize your student loan benefits and which retirement accounts to contribute to, to maximize your student loan benefits, how to be in the right IDR program, when to refinance your loans. All those sorts of questions, if you're not 100% sure, it's great, it's a flat fee. You meet with them for an hour and you get advice from a true expert on student loans.

All right, let's take a question off the Speak Pipe.

 

CAN YOU TRANSFER LOW BASIS SHARES FROM BROKERAGE ACCOUNT TO 529S?

Mike:
Hi, Dr. Dahle, this is Mike from the East Coast. I was wondering, is it possible to transfer low basis shares from my brokerage account to my kids 529? Thanks.

Dr. Jim Dahle:
Good question. The simple answer is no. You put cash in 529s. I don't think you can contribute anything else. No securities, no houses, no properties, no gold, no Bitcoin, nothing. Cash has to go in there. However, there may be a workaround here. What you're trying to avoid, I can tell, is paying capital gains taxes. So, what if you did this? What if you gave the money to your child, the securities to your child? Now they sell it, they realize the gains right at their tax bracket and then they can put it in a 529 for themselves. That might help you save some money on taxes. Obviously, the kiddie tax applies. You get a certain amount of income each year that's basically tax free and a certain amount of tax at the kid's tax rate. And then the rest is taxed at your tax rate until they're no longer minors. But that might help you a little bit in that regard.

Another great option if you have appreciated shares and you're a charitable person, is you can give those appreciated shares to charity instead of cash. Then use the cash to go into the 529. That might be another option for you if you are a charitable person.

All right. We are in one of those weeks where we're recording a whole bunch of these podcasts. We're actually trying to get a little bit ahead because our audio video person has tons of work around WCICON, which by the time you hear this, will be over. So, we have to do things in advance sometimes and we often batch our podcasts. That's why the one I recorded yesterday ran like five weeks ago. But that's just the way it is.

But what happens when we batch them is we run out of Speak Pipes because the Speak Pipe questions come in kind of regularly. But if we do a whole bunch of podcasts at once and try to get ahead, we tend to run out of them. I just want to encourage you. That was actually our last Speak Pipe question. I don't have another one. And we got a whole episode here to record and we're going to do another one later this week, which is fine. We get lots of other questions from Reddit and Facebook and my email box and comments on the blog or whatever. But my point is, hey, we'll take some more Speak Pipe questions, whitecoatinvestor.com/speakpipe.

 

ROTH CONVERSIONS AND TAXES

This question comes off Reddit. The question is, “If you convert a rollover IRA, in this case $37,000 to a Roth IRA, when do you have to pay the taxes? From what I understand, the IRS doesn't want you holding on to what you owe them for a long time or else they penalize you. Does this apply to IRA conversions?”

Well, our federal income tax system is a pay-as-you-go system. All state systems are not like that. Utah is not a pay-as-you-go system. You can pay every dollar you owe on April 15th for the prior year, and they're perfectly fine with that. There's no penalty, no interest, nothing associated with that. There's no requirement to make quarterly estimated payments to the state of Utah or anything like that. And lots of states are that way. Not all of them though.

But the federal system is pay-as-you-go. You're supposed to pay the taxes as you make the money throughout the year. Whether you're making that money from dividends, whether you're making that money from your W2 income, whether you're making it from 1099 income, whether you're making it from IRA conversions.

And so, theoretically, when you do an IRA conversion that quarter, you make a quarterly estimated payment in the amount of about what the tax on that thing would be. However, in practice, this system kind of breaks down a little bit. There's two different numbers. One is the amount you have to pay in tax that you actually owe in tax when you settle up with the IRS next April 15th. The other number is what you have to have paid the IRS to stay out of trouble. You still have to pay all the tax you owe come April 15th, but if you pay enough to stay out of trouble, you don't have to pay any taxes or penalties or anything.

And that's what the whole quarterly estimated tax payment thing is all about, is paying enough to stay out of trouble. It may also help with your budgeting if you don't have to come up with a whole bunch of money come next April 15th. But mostly the goal is just to pay enough that you stay out of trouble. Then you can settle up with the IRS later.

And so, for a lot of people, one of the cool tricks you can do with your taxes is you can just have more withheld at the end of the year than you have earlier in the year. Because the IRS doesn't care when the money is withheld from your paycheck. They look at it all the same, whether it's withheld in January or withheld in December. Same if you have money withheld from an RMD take, a required minimum distribution. If you're of RMD age, or if you had money, I suppose withheld from an IRA conversion, although I generally think you ought to pay the taxes on those conversions from some other source of money, not actually out of the IRA.

But my point is that you can just increase your withholding at your W2 job to cover the amount of tax you owe. This is only a $37,000 conversion. So, we'll say that's $20,000 in taxes maybe. Well, probably not that much. $15,000 in taxes you owe on that conversion. Maybe just the last few months of the year you have them withhold an extra $5,000 out of each of your paychecks, and boom, you don't have to do anything else. You don't have to send in quarterly estimated payments. You don't have to do anything else. Now, if you convert a $250,000 rollover IRA, you may not be able to cover that just with withholdings from your W2 job. You might actually have to send in a quarterly estimated payment.

But the goal, of course, is to get into a safe harbor. Safe harbor means you either pay your entire tax due less $1,000, or you pay 110% of what you owed last year. That's for high earners. I think it's 100% for lower earners. That's basically how you get into the safe harbor of not having to pay any penalties. You still owe the taxes, of course, come April 15th. I hope that's helpful.

 

STRUCTURED NOTES RECOMMENDED BY FINANCIAL ADVISOR

All right, another question comes in from my email box. “I've been retired for a year with over $12 million in investments.” Congratulations. That's pretty awesome. “I sold my practice to investors. My financial advisor is recommending structured notes as a way to guarantee future income without the downside of losing my money. What do you think of this?”

Well, the first thing I think is that you probably need to get a new advisor. This is a huge red flag to me. This is like your financial advisor recommending whole life insurance or coming to you and recommending some sort of equity indexed annuity. These are products that are generally, each of them is individual, so it's hard to say perfectly that every one of them is this, but most of these are products designed to be sold, not bought.

And so, I don't know anything about you or your advisor other than these four lines you sent me in an email, but my first recommendation is you probably need a new advisor. And you can find a good advisor that's not going to do this to you at whitecoatinvestor.com and just go to the recommended tab and you go down and you look up recommended financial advisors and you will find people that aren't going to sell you crap like this. Because that's probably what this is.

Now, every structured note is unique and there might be one out there that's perfect for some client out there, but probably not. Probably not. You've probably mistaken a commissioned salesman for a financial advisor.

There are lots of products out there that are designed to prevent the loss of money, at least on a nominal basis, and provide income. But most of the time you're simply giving up too much upside to get those features. You're essentially buying insurance. And if you don't need the insurance, and someone with $12 million almost surely doesn't need the insurance, you're throwing money away. I would not do that.

What causes people to do this is fear. We're worried about, we worked so hard our whole life to build this nest egg, we're certainly not going to earn another $12 million in our life. And so, we're fearful about losing it. And they take advantage of that fear to sell us these high fee, crummy products that you don't really need.

Financial advisor Phil DeMuth said this about this fear, this psychology, this behavioral problem that we have, that we don't want to lose money. He said “Our psychological predisposition to take or shun risk is irrelevant to the ultimate means to reach your financial or your investment objectives. If you are a sensitive soul who can brook no paper losses, the solution is to get a grip, not to invest safely if that locks in running out of money when you are old.”

Now you're not going to run out of money when you're old because you got $12 million. But you get the point. The point is get a grip on yourself. It's $12 million. Who cares if one year it goes down to $10 million and takes two years to come back? That's not going to affect your lifestyle. It's not going to affect how much money you leave behind to your heirs. You don't need this essentially an insurance type product in order to provide for your retirement security.

Now, if you're trying to retire on half a million dollars, there might be a role for an insurance product in your financial life. Something like a Single Premium Immediate Annuity. You give an insurance company a lump sum of money, and they basically guarantee you a certain amount of income each month for the rest of your life, whether you live to 80 or whether you live to 103. That's probably not a bad idea. If you're kind of on the line, barely have enough, don't quite have enough, want to get as much as you can out of it, then it starts making sense for you to use an insurance sort of product to help with your retirement income needs.

But at $12 million, just think about if that was all in a total stock market ETF or mutual fund, your yield on that is like a quarter million dollars a year. And that's extremely tax advantaged. You're getting it at qualified dividend rates, and it's going to go up every year. Even if that was all you ever did, you probably have enough money, you're never going to run out of money and you'll probably have an estate tax problem for your heirs because you're going to accumulate so much wealth. You don't need a structured note in your sort of situation. And I wouldn't necessarily recommend a 100% stock portfolio for you, but it wouldn't be insane to have one at $12 million.

Congratulations, by the way. That is no small feat. I think surveys I've seen with physician net worth, only about 10% of them have more than $5 million. At $12 million, you're multiple standard deviations above average, and you can really do whatever you want with your money and be fine for the rest of your life. If you put it all in cash, you're probably fine. Put it all in CDs, you're probably fine. Put it all in stocks, you're probably fine. But I think truthfully in this situation, you're going to be a lot happier if you look into this particular product a lot more before you leap, get a second opinion from a fee-only financial advisor looking at this product. And I bet the message you'll get is that this is a product designed to be sold, not bought.

 

QUOTE OF THE DAY

All right. A quote of the day today comes from a Boglehead who goes by the handle KlangFool. He has been around on Bogleheads for a long time. But I really like this quote that KlangFool said one time. “If you care about the price of the house that you bought, you bought too much house.”

I think there's a lot of truth to that. I think the point is that your house should not be a huge piece of your financial life. It should be a relatively small piece of your financial life that you just don't care about. If it's like your truck, who cares what you paid for your truck? You're not going to care in five years or 10 years. But if you're constantly looking at what your house is worth, it's probably too big of a piece of your financial life and my condolences to those who live in areas where your house is by necessity a huge piece of your financial life.

 

CHANGES TO THE 529 PLANS WHEN YOU HAVE MULTIPLE KIDS

Okay, another question comes in by email. “I'm excited about the changes to 529 plans to allow excess contributions to be transferred to the beneficiary's Roth IRA, subject to certain restrictions such as account open for 15 years and funds in the plan for five years and annual IRA contribution limits. How does this work when one has multiple children? Do I need to open an account for each child i.e. does it need to be in the beneficiary's name for 15 years or just have the account open that long?

Also, does the $35,000 limit apply to each child i.e. for three kids would I be able to pass on up to $105,000 to their Roth IRAs? I'm getting mixed message regarding some of these questions, between the Virginia 529 website and the White Coat Investor and other websites I look it all up on. I think it'd be a good topic for general readership. Thanks for all your help.”

Well, I have written this post. There's a blog post all about this topic because people have been bugging me about it since the day Secure Act 2.0 dropped. The problem is, we haven't gotten any more clarification in the last year than we knew before on how this is going to work. But I finally gave up, I wrote the blog post on this of everything we know about it and gave you as much guidance as I could for those of you interested in this technique. It hasn't been published yet. Maybe it's already run by the time you actually hear this podcast, but at some point in the next few weeks we'll publish that blog post.

But yeah, if you're going to do this for multiple kids, you're going to need an account for each kid. I don't know why people try to put all their 529 money in one pile anyway. I have 35 529s I'm keeping track of. How big of a deal is it to have three? It's no big deal whatsoever. Just open three accounts for your kids. It's ridiculous try to put it all in one account, I think. You may get more tax benefits by having multiple accounts, too. I know I do.

But nobody has clarified this rule on whether it has to be in that kid's account for 15 years or just in a 529 for 15 years. I'm not sure anybody knows the answer to that. If anyone has ever seen anything definitive about that, please send it to me. I'll do a correction. But I'm pretty sure that nobody knows the answer to that question. So, better to be safe than sorry. Put it into the kid's account. Let it sit there for 15 years rather than having it in somebody else's account or your account or something like that.

But yeah, it's definitely going to be $35,000 per kid. I think we're pretty clear on that one. It's not going to be $35,000 total. That's totally unfair. What if you had eight kids versus someone that had one kid? That's not fair. Yeah, it's going to be $35,000 per kid.

 

ADVANTAGES AND DISADVANTAGES OF UTMA ACCOUNTS VS PARENTAL BROKERAGE

All right, our next question comes in by email as well. “I was wondering if you could help provide some clarity regarding the advantages and disadvantages of saving for miners using a UTMA account versus a parental brokerage that ultimately would be transferred down the line. It seems like you could use the UTMA and go up to the yearly IRS gifting allowance. Ideally I'd do a Roth, but I'm still a bit stymied about how to employ my kids legally.”

All right. The main difference between investing in a uniform transfer to minors account or uniform gift to minors account, they're almost the same thing, versus just your own brokerage account is control versus tax advantages. If it's in your brokerage account, you get total control over it. You don't have to give it to the kid if you don't want. You get to say what it's spent for. You get to say when they get it. You have control over it, it's still your money.

Once you put it in a UTMA or UGMA account, it's no longer your money. It's the kids' money. It's called a custodial account. So you still control what it's invested in, but you can only pull the money out in a way that benefits the child. It's their money now. And so, that's a bit of an issue. Plus when they turn the age in your state, which in most states is age 21, it is truly their money and you exercise no control over it whatsoever. If they want to spend it all on four-wheelers and trips to Cancun or whatever, then that's their right, they get to do it. It's their money. Now maybe they can't quite figure out how to handle a brokerage account and how to get their money out of it or maybe you haven't done a great job telling them it's actually there, so maybe you can get a few more years out of it, but if they really wanted it, they could get it. It's their money.

So, what tax advantages do you get for giving up the control over that money earlier than you otherwise would? Well, you get a few things. One, you get the money out of your estate. If you have an estate tax problem, it's out of your estate. It's now into the kids' estate. And so, any further growth on it isn't happening in your estate. That might help you avoid estate taxes on that money.

Two, the first, and I think it's about $2,500, basically is being taxed at their tax rate. The first half of that, $1,200, $1,300, whatever it is, if they don't have any other income, maybe is 0%. Instead of paying it up to 23.8% for you, you might be paying 0% in tax on that. And then the next $1,200 or $1,300 is going to be at 10%. That's a huge tax break or even 0% of its long-term capital gains and qualified dividends. Basically that money is being taxed at their tax rates rather than your tax rates.

But beyond a certain point, the kiddie tax kicks in and it's just taxed at your tax rate. So, if you invest it very efficiently, you can get up to about $100,000 in there before the income starts being taxed at your tax rate. And it doesn't really do you any good at that point other than those estate tax benefits that most White Coat Investors aren't ever going to need. But yeah, that's kind of the benefit of UTMA.

There are also some FAFSA applications, but honestly, those don't matter to most physician families. Most physician families aren't going to have any sort of need-based benefits for college. We use UTMA accounts. That's my kids' twenties funds, the money we give them, telling them this is money to use for missions and summer in Europe and first car and down payment on a first house and all those things you need in your twenties. Weddings, honeymoons, those sorts of things. And we didn't put much in for a while because we didn't have that much. Then when we were making more money we put $17,000 a year or whatever the equivalent was for that year.

This year we actually put $34,000 into each of our kids UTMAs because we've stopped funding their 529s. We think we've got four overfunded 529s at this point given the schools they're talking about and the things they're talking about studying. But the UTMAs are just now starting to get to that size where we have to worry about us paying some of the tax on the income at our tax rates.

All right, I hope that's helpful. There are more resources on the blog. You can search on whitecoatinvestor.com UGMA, UTMA, kids. You search “children’s”, you'll pull up blog posts that talks about how we've structured our kids' twenties funds.

Thanks so much by the way for what you do. Your work is not easy. It's difficult and a lot of you are coming back from a difficult day. Maybe you had to tell somebody their family member was dead or dying or that they have cancer. I don't know what you had to do today but it can be a thankless job. So, I appreciate what you're doing.

 

MEGA BACKDOOR ROTH CONTRIBUTIONS WITH MINIMAL 1099 INCOME

All right, another question out of the email box. “My question is about the amount one can contribute to a mega backdoor Roth if one does not have a lot of 1099 income. For example, I made $60,000 in 1099 income in 2023, had expenses of $10,000. I'm in the 25% tax bracket and contributed 20% to the solo 401(k). I have a regular W2 job where I fully contribute to the 401(k). So, how much can I contribute to make a backdoor Roth?” And then he gives some examples.

Well, here's the way it works. First of all, you have to have a solo 401(k) that allows a mega backdoor Roth contributions. These are after tax contributions and also in plan conversions. But basically, all of your net income you can convert, you can put in there and convert to a mega backdoor Roth. So, if you gross $60,000, you had $10,000 in business expenses, including the employer half of social security taxes, that leaves you $50,000. And basically you could contribute the entire thing in these after tax contributions and then convert that to a Roth.

That's a pretty cool feature is you can get a whole bunch of money into a retirement account, albeit in Roth, not tax deferred, on not all that much income. Now, if you're trying to put tax deferred employer contributions in there, that's limited about 20% of your net income. If your net income for that business was $50,000, you'd only be able to put in there $10,000 as tax deferred.

If you have not used your employee contribution somewhere else, that's $23,000 for 2024, then you can also put that in. That's in addition to that $10,000 you could put in as an employer. But the total amount you can contribute is what you made. So, no more than $50,000 for that business. I hope that's helpful clarification of those rules.

But yeah, remember that it's your net business profit. When I say net, we're talking about the business. We're not talking about net on your personal income or on your personal taxes. Just remember that that's what net refers to because the 401(k) administrator and the IRS really has no idea how much other income you have. And that doesn't limit your 401(k) contributions. It's all about the income you have at that job.

But yeah, basically you can pay the taxes on that income from somewhere else. You don't have to pay the taxes on it and then have that reduce how much you can put in the 401(k) assuming you have money from somewhere else, of course.

 

MATCHING CAMPAIGNS FOR CHARITY

All right, here I thought this was a great question. This came in, it was part of a series of questions I got in an email, but I don't think this is something I've ever talked about on the blog. It's related to charitable giving. It came in after the charitable giving podcast we did a couple of months ago.

He said “Only partially related, but was going to ask your opinion on matching campaigns and whether you're really getting the charity more or is that just charity porn? One charity I like to give to, an international rescue committee, often has matching campaigns. Recently it sent me a notice of someone matching up to 5X contributions up to $2.5 million. Since I was going to give anyway, I did it through that campaign. The problem is there was no way to give and get that match through the DAF. You had to contribute directly, check, credit card, PayPal, etc.

Do you think my contribution really gets them more money or they would just get the money anyway? I prefer to keep the charity porn away, but want to maximize the benefit.”

Well, first of all, when I use the term “charity porn”, that's not what I'm referring to. For me, charity porn is those glossy pamphlets that show up in my mailbox. And the greatest benefit in my opinion of going to using a Donor-Advised Fund is that you don't get that stuff in your mailbox. They have to spend their money on their charity rather than trying to get more money out of me because they don't know who I am. I give anonymously. And so, I think that's a great benefit of a Donor-Advised Fund, it facilitates your ability to give anonymously while still being able to deduct the contributions.

At any rate, matching. I've thought about this a lot and if somebody is going to go to a charity and say, “I'll match your contributions up to $2.5 million”, they really like that charity. They really support its mission. They're probably giving $2.5 million either way.

So, I think it's probably a little game that charities play to try to get you to donate more. And that's fine, if you support the charity, give more and feel good about it. But I think we're just playing games here. I think they're getting the money either way. So, I wouldn't put a lot of stock into matching campaigns, but I've watched it actually help raise money. I think behaviorally it helps us to know that our money is going to go further but I'll bet most of those donors, they end up giving most of that money anyway, if not all of it.

 

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Thanks for that very kind review and for helping us get this word out to those who need this information. We want you to be financially literate. We want you to be financially disciplined because we know if you are, you're going to be a better spouse, better partner, better parent, better physician or practitioner or whatever you do.

We just think when you remove that financial stress from your life, you're better at everything else and it's going to make your life happier. So, take the principles you're learning here, apply them in your own life. Share your successes with others and we will all be lifted together.

Keep your head up, shoulders back. You've got this, and we can help. We'll see you next time on the White Coat Investor podcast.

 

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Milestones to Millionaire Transcript

Transcription – MtoM – 157

INTRODUCTION

This is the White Coat Investor podcast Milestones to Millionaire – Celebrating stories of success along the journey to financial freedom.

Dr. Jim Dahle:
This is Milestones to Millionaire podcast number 157 – Dual income couple pays off mortgage among other financial milestones.

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All right, it's good to be back with you. It's good to be here celebrating another milestone. This is the podcast where we celebrate what you've accomplished with you and use it to inspire others to do the same. If you'd like to be a guest on this, you can apply at whitecoatinvestor.com/milestones.

By the way, if you're looking for the best credit cards out there, not to carry a balance on them, but for convenience, maybe to get a little bit of rewards back, maybe to get a little bit of protection on some purchases, that sort of a thing, we actually have a recommended credit card page now. It's at whitecoatinvestor.com/creditcards. Check that out, help support the site if you apply for them through there. You can see some of the best credit cards on the market there.

All right, we're going to get into our interview now, but stick around afterward, we're going to talk about what you need to know about dividends and about dividend investing. Let's get Susan on the line here and talk about all these milestones that she and her husband have accomplished.

 

INTERVIEW

Our guest today on the Milestones to Millionaire podcast is Susan. Thanks for coming on the podcast.

Susan:
My pleasure. I'm so excited.

Dr. Jim Dahle:
Tell us what you've accomplished. Actually, I think there's multiple milestones here, but let's list them off.

Susan:
Well, the main thing that I wanted to come on for is that we paid off our house. We paid off about $560,000 in the last four years, and in the process we became completely debt free. We also cash flowed a new roof on our house. We paid cash for four cars, two for me and my husband, two for our teenagers, and we became millionaires and we became multimillionaires.

Dr. Jim Dahle:
You've had a good run recently.

Susan:
Yeah, it was worth it.

Dr. Jim Dahle:
Yeah. That's pretty cool. You could have brought any one of those to this podcast and we would've celebrated it with you and you have come accomplished all of them in the relatively recent past it sounds like.

Susan:
Yeah, the whole thing, the debt-free, we started about five years ago. The house, we paid off our student loans and our cars. And then four years ago we decided to start on our house.

Dr. Jim Dahle:
Is this a conscious decision? You're like, “We don't like debt, we want to get rid of debt, we're going to pay it off?”

Susan:
Yeah, we graduated over 20 years ago. I’m 20 years out of residency and my husband is 16 years out of fellowship. He is a cardiologist. We were 10 years at our attending jobs and I always run the numbers every month, keep up track of our net worth and our spending. And I realized that we had almost a million dollars in assets, but our net worth was barely positive and it didn't make any sense to me. We were making attending salaries for 10 years.

So, we kind of did some soul searching and realized that it was our debt payments. Our student loans had an interest rate of 0.8% when we came out in 2001. We were given the advice never to pay them off early because they were so low interest. But there we found ourselves 17 years out of med school and we were still making $1,500 a month payments on other stuff.

We never had credit card debt and we were always savers. So I really expected us to be a little further ahead. We decided to do the snowball method and we paid off all of our student loans, our consumer debt. It only took about nine months. And then we were starting to think about saving for our kids' college, which was coming up in the next five years. And I had an idea that if we continued on to be debt free, if we paid off the house, we could cash flow our three kids in college at the same time using the mortgage money.

We pretty much worked backwards, saw how much we needed to pay off, found little spots of revenue that we get through our work and we allocated it towards the house. And as we did, it kind of got faster and faster. We got stronger and stronger at it and yeah, we paid it off pretty quickly.

Dr. Jim Dahle:
Yeah. It's amazing when these dominoes start falling how quickly the next ones come, isn't it?

Susan:
Yeah. Yeah. And you get stronger and stronger and more disciplined over time seeing the goal at the finish line.

Dr. Jim Dahle:
Yeah. 10 years essentially to get back to broke or a little bit beyond.

Susan:
Yeah, basically.

Dr. Jim Dahle:
How depressing was that to add it all up 10 years out of residency and realized that you were basically still broke?

Susan:
It was pretty shocking, especially because our assets we had saved, our 401(k) balances were high. We had savings, but it was the debt. In the end, we realized that was the thing holding us back and I still believe that's definitely true based on everything we accomplished in the last five years.

Dr. Jim Dahle:
And so, you made a mindset shift. You pay cash for stuff, you still buy stuff.

Susan:
We do.

Dr. Jim Dahle:
But you save up for it.

Susan:
Yeah.

Dr. Jim Dahle:
And so, now interest works in your favor instead of against you.

Susan:
Exactly. Our mortgage interest was 4.3%. We kind of reasoned during the pandemic that that was a pretty good return on our money.

Dr. Jim Dahle:
Yeah. Back then when you could only make 1% in a high-yield savings account, 4% is a pretty good return.

Susan:
Exactly. And the other thing is that I didn't calculate that saving $4,000 or $3,500 a month in a mortgage payment is one thing, but we were saving so much every month putting it towards the house, I forgot that we were going to have that money back as well.

Dr. Jim Dahle:
Yeah. Pretty cool.

Susan:
So, we wound up with a lot more on our cash flow than I actually predicted in the beginning.

Dr. Jim Dahle:
Yeah, yeah. It's pretty awesome how much money you have to spend or invest or do whatever with when you don't have payments.

Susan:
Exactly.

Dr. Jim Dahle:
You're both docs?

Susan:
Yeah, he's a cardiologist and I'm a family doc.

Dr. Jim Dahle:
Okay. So, range of income throughout your careers, total household income, what do you think it's been?

Susan:
Throughout our careers, about $400,000 to $600,000.

Dr. Jim Dahle:
$400,000 to $600,000 throughout your careers.

Susan:
Yeah. I work part-time.

Dr. Jim Dahle:
Okay. All right.

Susan:
I've always worked part-time.

Dr. Jim Dahle:
Okay, very cool. So, I'm guessing based on how this has worked out, you're actually spending less now than you used to.

Susan:
Yes, that's exactly right.

Dr. Jim Dahle:
Or at least over the last four years you were spending less than you were in the 10 years prior to that.

Susan:
Yes, exactly.

Dr. Jim Dahle:
Did you feel like you were being punished? Did you feel like you were struggling? Did you feel like this was a big sacrifice to change your lifestyle in that way?

Susan:
Not at all. I think originally we've always been more savers than spenders, naturally, so that's fine. But I never could really budget. I have a spreadsheet of what we spent, but we never budgeted in advance. I started using an app EveryDollar and that really helped us actually find more money to both pay down debt and do the other stuff with. We put a $76,000 roof on our house a year and a half ago and we cash flowed it and I used the app to make sinking funds and just save up and knew when we were ready to do it.

And so, we actually felt like we found more money, believe it or not, instead of cutting back. We really didn't deny ourselves. We went on vacation, we have a housekeeper. We didn't really deny ourselves, but yeah, we did see where the dollars were going and we did feel like looking at it actually helped us optimize where the money was going.

Dr. Jim Dahle:
Yeah. The dollars were there before. It's not like you found them out of thin air. You stopped spending on something you didn't care about, that wasn't affecting your life, that wasn't making you happier.

Susan:
Exactly.

Dr. Jim Dahle:
And told those dollars where to go.

Susan:
And the pandemic helped because we got big refunds from trips that we had had planned and we decided to make something happy out of a sad, canceled trip that we were going to put that money towards the house. And it accelerated things for sure.

Dr. Jim Dahle:
Yeah, very cool. Yeah, it's amazing if you spend a lot on travel and then you can't travel, it does free up a lot of money in your budget for sure.

Susan:
Yeah.

Dr. Jim Dahle:
Okay. It sounds to me like you're the finance person in this couple, am I right?

Susan:
That is true.

Dr. Jim Dahle:
Okay. I'm guessing that you kind of came to this realization and there was some sort of a conversation involving maybe convincing your spouse. Can you tell me how that went?

Susan:
We've always pretty much been on the same track. Even when we graduated med school, back then we didn't have you. We would sit in Barnes & Noble and take all the personal finance books we could and read up on them. We've always had an interest and it wasn't until I started listening to you and using the budgeting app and things like that and opened my eyes to what we thought we could do.

My husband was always on board with paying off the debt. It wasn't something he was bothering me about, but when I pointed it out, he saw the logic in it and completely agreed. And then we were pretty much on board. When I said, “Hey, what do you think of this idea? If we pay off the house, we'll have the money to cash flow the college for three kids at the same time and also be debt free.” And he just jumped right on board and said, “Yes, sure, let's do it.”

Dr. Jim Dahle:
It sounds like it was a pretty easy conversation then.

Susan:
It was not hard. Yeah.

Dr. Jim Dahle:
Yeah. So, what was your mortgage payment? Do you remember?

Susan:
Yeah, the mortgage payment, it included the escrow. It was about $5,000 a month. And it was going to increase. Because of the insurance rates going up, it was going to increase to about $5,500 but our actual principal was about $3,500 a month.

Dr. Jim Dahle:
And how much did you owe four years ago?

Susan:
Four years ago, we owed $560,000.

Dr. Jim Dahle:
$560,000 four years ago. And your payment was $5,000. So, how much did you actually pay every month to the mortgage and how did that change over the four years?

Susan:
Yeah. We started off slow the first year. I think we paid probably 2,000 or 4,000 just to get started until I could see where the money was going to come from each month and how we were going to allocate it. And then we were doing $10,000 or $11,000 a month in the middle two years. And then this year, it was probably like $2,000 or $4,000. It wasn't too hard.

Dr. Jim Dahle:
And then a few lump sums along the way it sounds like.

Susan:
Yeah. We're both small business owners so we own our own business and we get distributions. We would allocate from the lump sums and we would also do a little bit cash flow each month. Real combination.

Dr. Jim Dahle:
Very cool. Okay, now you're multi-millionaires.

Susan:
Basically. Yes.

Dr. Jim Dahle:
Tell us about your net worth. Some of that is a paid off house, but how's the rest of your net worth broken down?

Susan:
Yeah. The net worth, it's half the house I guess, and half are mostly our retirement is about $1.3 million now, 401(k)s and Roth IRAs. And then we've got about $160,000 in cash and we saved up about $300,000 for the kids for college. In the end, we did wind up saving some for them.

Dr. Jim Dahle:
Funny how that works. The big debate I run into in my email box, on the forums, the Subreddit, the Facebook group is “Should I pay down debt or invest?” And the truth is, the people that are winning, they're doing both. They're paying down debt and they're investing. And if you're finding yourself in that situation where it's either or, you're probably need to carve out a bigger chunk of your income to build wealth with.

Susan:
Yeah, we did the snowball method and once we were done with the regular debt, we were most of the time maxing out our 401(k)s and retirement and then we started putting money into the kids' college until we realized, “Hey, there's $300,000 in there so we could probably stop and start putting some of that money toward the house too.”

Dr. Jim Dahle:
Yeah, absolutely. That sounds like their college is going to be well taken care of. All right. Is anybody out there supporting you in this? Anybody cheerleading for you? Did you keep this just to yourselves or did you share this with family or friends?

Susan:
Yeah. We live in an area where debt is well loved and the credit card game is the number one top of conversation at dinner parties. So, that was part of why I wanted to come on because your audience and talking to you, there's someone that can really understand. Because a lot of people can't really understand and they think it's weird, which it might be a little odd, but yeah, we're super excited. Only really our families knew and our kids were very excited. They wanted us to announce it or do something like a debt-free screen, that kind of thing.

Dr. Jim Dahle:
Cool, cool. It sounds like you've had a little bit of Dave Ramsey influence there. You make your kids listen to the show?

Susan:
Yeah. Back in the day when we were trying to pay off our regular debt, yeah, we did listen to the podcast and the kids, they know all about the Dave Ramsey method. Just setting them up for the future too.

Dr. Jim Dahle:
How old are they?

Susan:
19, and two soon to be 17 year olds.

Dr. Jim Dahle:
Okay. They're on the verge of leaving home.

Susan:
Yeah.

Dr. Jim Dahle:
And what do you think they're going to take from being present in your lives when you took control of your money in this way?

Susan:
Well, I see it in my daughter already. She left to college and ironically she got a full scholarship to her school. So, we didn't have to worry as much. But I see them knowing that when you have money, save a little bit of it, enjoy it if you can, but don’t rack up debt and don't owe anyone anything because you're better off, you'll move a little faster if you don't start off with payments and things like that.

Dr. Jim Dahle:
All right. What advice do you have for somebody out there that's sitting there mid-career, maybe they're 10 years out of residency, they don't feel like they're moving, they've got a little bit in saving, they've still got some student loans, maybe they got a car loan, they got a mortgage, and all their friends talk about credit cards at dinner parties? What advice do you have for them?

Susan:
I would say it's not too late, and the earlier you start the better, obviously.

Dr. Jim Dahle:
Very cool.

Susan:
And being on board with your spouse and maybe not coveting things, but finding contentedness within yourself and pride in the things that you can accomplish without anyone help or outside inheritance or anything is something that feels really good.

Dr. Jim Dahle:
So, what's next in your financial goals?

Susan:
We just started a taxable account for our retirement. My husband just turned 50. I work part-time and it's great. We're looking at him maybe backing off of a couple call situations and extra work that he does to let him decide if he wants to stay in practice for the next 15 years or not.

Dr. Jim Dahle:
Yeah, it's pretty awesome. It’s pretty awesome to have work become optional in your life or at least full-time work.

Susan:
Yes, exactly.

Dr. Jim Dahle:
Awesome. Well, congratulations to you Susan. You should be very proud of what you guys have accomplished.

Susan:
Thank you.

Dr. Jim Dahle:
5, 6, 8, whatever they are milestones that you've done that we're talking about today, you're clearly winning and you should be proud of yourself. We're proud of you and thanks for coming on the show and encouraging others to do the same.

Susan:
Thank you so much. I really appreciate it.

Dr. Jim Dahle:
All right. I hope you enjoyed that. The part I love about that interview was that it all kind of kicked in at mid-career. Because I've run into lots of people that feel like they got a late start. And the truth is, it's never too late to do something to improve your finances. And when you have a big shovel like doctors do, particularly a two doc couple, you can do amazing things at any time. Even if you didn't do them right in the beginning, you can still do it now.

And there is a whole bunch of whatever you want to call it in your budget, slack, flack, crap, whatever, that you can find money from and take money from things that don't matter that much to you and put it toward things that do matter to you. Maybe you need one of these apps out there, You Need a Budget or EveryDollar or one of these apps to help you find it, to help you budget and to help you realign your spending with what you actually care about. But you can do it. Susan did it and you can do it too.

 

FINANCE 101: DIVIDEND INVESTING

All right. I promised you we were going to talk about dividend investing. This is something you hear all the time out there from these people that love dividends. Well, maybe you shouldn't be that excited to get dividends. I actually still do get excited when I get dividends. The ETFs and mutual funds I invest in pay dividends. And in taxable account, that's money we could use to live off of. We could live just off of our dividend income and some people get excited about building a portfolio of dividend stocks that could provide that same thing for them.

But getting a dividend really shouldn't be that exciting. You see a company, a stock, that's what a company is, that's what a stock is, is a company. They have a choice of what to do with their profits. They can keep it in the company, find some way to reinvest it and make money off it, and the value of the company goes up. Or they can send it to the owners.

It's the same decision I have every month with the White Coat Investor. White Coat Investor makes some profits. I can figure out a way to reinvest that. Maybe we buy some advertising, maybe we hire somebody else to help those sorts of things. Or I can take it as a dividend. It's the same thing that every CEO and every publicly traded company across the country has to make that decision every year. Are we going to pay out dividends or we're not going to pay out dividends? And so, the company is doing exactly the same, whether they send you a dividend or not. They make the same amount of money.

The problem with getting the dividend is you have to pay taxes on it, at least if you're investing outside of a retirement account. Rather than being able to choose when you take money out of the investment by selling a few shares of it, you're forced to take money out of the investment and in a taxable account, pay taxes on it. It’s hard to be excited about paying taxes on income that you don't actually need yet.

And so, that's why maybe getting a dividend shouldn't be really all that exciting. But people get super excited about it out there. I think the issue is they start looking at those dividends and they compare what's coming in in dividends to what they're actually spending, and they figure when the dividends equal what they're spending, now they're free. They don't have to work anymore.

But the truth is, they're probably free long before the dividends equal what they're spending. Because the stock market these days has a dividend yield of something like 1.5%. And so, if you wait until you can live off just the dividends instead of a 4% sort of withdrawal from the portfolio, you will actually have a portfolio that's over twice as large. That's going to take you another decade to acquire. You will have over saved.

And so, that is the main issue with dividend investing. If you are committed to only spending your dividends, I want to be your heir because I'm going to inherit a whole lot of money. On average, taking 4% out of a portfolio every year, after 30 years on average, the portfolio is 2.7X the value of the original portfolio. If you're only taking out 1.5%, you can imagine how much larger that portfolio was than what it started with when you retired.

But the bigger problem, if you are just over saving, the bigger problem is people start looking for investments that pay out more than 1.5%. They find a stock that pays 5% or 6% or 3.5% or whatever, and they preferentially invest just in those stocks. And the problem when you do that is you start taking on uncompensated risk. You're no longer diversified, you're taking risks that you're not being paid to take.

And it can also cause a lot of people to fail to even look at their total return, which is really what matters. Because there are investments out there that will pay you more income than they're actually making. If the return on the investment is 5% and it's paying you 8%, your investment is shrinking as you go along. That is not a sustainable situation long term. And so, you got to be careful about that.

A lot of people sometimes also mistake dividend stocks for bonds. Yeah, stock pays a dividend and that's income, and bonds pay coupon payments, these interest payments, and that's income, but they're not the same thing. Dividend stocks can drop dramatically in value. The stock can stop paying a dividend. It is not the same thing. There's a lot more risk in owning a stock, even if it pays a dividend than there is in owning a bond.

The truth is, buying dividend stocks is really just kind of tilting your portfolio toward value stocks. And it turns out there's a lot more efficient ways to get a value tilting your portfolio than investing in dividend stocks preferentially. You can just buy a value stock index fund. You'll have a higher dividend yield, you'll have this similar tilt to your portfolio, you'll have similar portfolio performance, and you don't have to go out there and select individual dividend stocks, much less a dividend focused mutual fund.

The counter argument to this is that “Well, if the C-suite of the company has to pay a dividend, they'll manage the company better.” And maybe there's a little bit of truth to that, but long term when you look at the entire market, that's really not a factor that causes you to do better by focusing on dividend stocks. All you're really getting is a value tilt. And this is not the best or most efficient way to do that according to the stems.

This doesn't necessarily hurt you so much in a tax protected account like a 401(k) or an HSA or 529, but in a taxable account, you're paying more taxes than you have to if you are focusing on dividend stocks exclusively. I hope that's helpful to you and as you design your portfolio, and don't get lured by the siren call of dividend stock investing.

 

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All right, we've come to the end of another episode. We'd love to hear what you thought about it. You can email us [email protected]. Better yet, leave us a five star review. Those five star reviews help spread the word about this. Of course, if you don't like something, send me the email. If you do like something, put it in a five star review. If you'd like to come on the podcast, www.whitecoatinvestor.com/milestones is where you apply.

Keep your head up and shoulders back. Keep knocking out those milestones. Knock out the dividends too, but especially knock out the milestones. We'll celebrate them with you, we'll encourage you onto the next one, and you'll inspire someone else to do the same. See you next time on the Milestones to Millionaire podcast.

 

DISCLAIMER

The hosts of the White Coat Investor podcast are not licensed accountants, attorneys, or financial advisors. This podcast is for your entertainment and information only. It should not be considered professional or personalized financial advice. You should consult the appropriate professional for specific advice relating to your situation.