Podcast #171 Show Notes: Six Principles of Asset Location

Asset location is something that is completely missed by a lot of otherwise pretty financially sophisticated people. I do a deep dive into this topic in today’s episode before answering listener questions. Asset location is basically that process of dividing up your investments into your various accounts. Each of them have different issues and are taxed in a different way. This has some bearing on how your investments perform and which investments should be going into which of these various types of accounts.  Unfortunately it is a rather complicated discussion. There are some rules of thumb, but very few absolutes. However if you get this right, it can be worth a million dollars or more. So it is worth looking at, but perhaps not obsessing over. We talk about six principles of asset location that you should be aware of in this episode as well as some basic tips that you should follow if you are trying to invest tax efficiently.

Listener questions that we discuss today include the new charitable deduction that came into being with the CARES Act, paying your spouse for working in your practice, SIPC insurance, how much is too much in assets, UGMA accounts, health insurance premiums, the positives and negatives of having your practice own your life insurance policy, tapping your retirement accounts to invest in real estate, and more.

A lot of physicians have questions about locum tenens, and locumstory.com is the place for them to get real, unbiased answers to those questions, basic questions like, “What is locum tenens?” to more complex questions about pay ranges, taxes, various specialties, and how locum tenens works for PAs and NPs. And then there’s the big question: Is it right for you? Go to locumstory.com and get the answers.

Quote of the Day

Our quote of the day today comes from Charlie Ellis, who said,

“As in other professions, such as law, medicine, architecture, and management consulting, there is a continuing struggle between the values of the profession and the economics of the business. Investment management differs from many other professions in one most unfortunate way. It is losing the struggle to put professional values and responsibilities first and business objectives second.”

I think there is a lot of truth to that. Certainly, when you interact with the financial services industry, this is a time to really be on point and cognizant that there are people with serious conflicts of interest that you are talking to.

Six Principles of Asset Location

Asset location is something that is completely missed by a lot of otherwise pretty financially sophisticated people. I know lots of high income earners that have these incredible portfolios and a really thorough understanding of personal finance and investing that completely missed this subject. So I do a deep dive into this topic in today’s episode before answering listener questions. Asset location is basically that process of dividing up your investments, your asset classes, into your various accounts, your tax free accounts like a Roth IRA, your triple tax-free accounts like a Health Savings Account, taxable accounts, and tax deferred accounts like your 401(k). Each of these have different issues and are taxed in a different way. This has some bearing on how your investments perform and which investments should be going into which of these various types of accounts.  Unfortunately, it is a rather complicated discussion. There are some rules of thumb, but very few absolutes in it because everyone’s combination of accounts is very different. But if you get this right, it can be worth as much as an additional after-tax return of perhaps half a percent per year, which over a 30- or 60-year investing career can add up to a million dollars or more. So, it is worth looking at, but perhaps not obsessing over. Here are the six principles of asset location.

  1. The higher the expected return of the investment of the asset class, the more likely that asset should be in a tax protected account. The reason why is because you want stuff that is going to grow quickly to be in those tax protected accounts, because it makes your ratio of tax protected accounts to your taxable account higher. That return means that less of your money is subject to tax drag every year, as your investments are taxed, as they make money.
  2. The second rule, of course, sometimes contradicts rule #1. But you have to weigh the two of them together. The second rule is that the lower the tax efficiency of the investment, the asset class, the more likely that should be in a tax protected account. Now, what do I mean by tax efficiency? For example, let’s talk about a very tax inefficient investment. A real estate investment trust is required by law to pay out 90% of its income each year to the investors. That comes back as ordinary taxable income. It is not a qualified dividend. It is not a long-term capital gain. It is paid at your ordinary income tax rates. It can be a very tax inefficient asset class. Likewise, a typical nominal bond is very tax inefficient, because  essentially its entire return is paid out at its yield. That is taxed at ordinary income tax rates. So, when most of the return is coming out every year and being taxed at ordinary income tax rates, that’s very tax inefficient. On the flip side, we can look at an investment, let’s say the stock Berkshire Hathaway. This is Warren Buffett’s company. It notoriously does not pay dividends. So, there is no income from this stock whatsoever. There’s nothing to be taxed each year. You pay no taxes on this investment until you sell it. So, this is a very tax efficient investment. When you’re having to choose, and this is “all else is equal,” you put the tax efficient investment in your taxable account and the less tax efficient investments into your tax protected accounts such as your 401(k), Roth IRA, or HSA.
  3.  The third principle is that the more likely you are to avoid paying capital gains taxes, the more willing you should be to put capital gain assets in your taxable account. Let me explain what I mean by this. I don’t really pay long-term capital gains taxes. That is because of the unique way that we use our taxable account. When something goes down in value in our taxable account, we tax loss harvest it and we get the losses. Right now, we have a whole bunch of losses. I think we’re close to half a million dollars in losses that we have accumulated in that taxable account over the years. You can use $3,000 a year of those against your ordinary income. They can be carried over indefinitely. You can use them against any capital gains that you do have to actually take for whatever reason. So, it allows you to be very tax efficient in that taxable account. Now, if something appreciates in that account, I tend to use it for our annual charitable giving. We basically flush those capital gains out of our account, which is a very tax efficient way to invest. If you give a lot of money to charity, this is a great thing that you can do to keep from paying a lot of taxes. When you give that appreciated asset to charity, you still get the charitable deduction for the whole value of that asset, but neither you nor the charity pays the capital gains taxes on it. If you do something like that, then it is great to have these assets where most of the return comes to you as long-term capital gains because you’re not paying those taxes anyway. Same thing if you’re 85 years old  and you’re probably going to die without ever spending this money. Your heirs are going to get a step up in basis at death. That is a great thing to have in a taxable account because it ends up being so tax efficient because no one ever pays those capital gains taxes. If you’re really good at avoiding paying those capital gains taxes because of the way you live your financial life, those are great assets to have in your taxable account.
  4. The more volatile the investment, the more likely it is to be better in taxable. The reason is that volatile investments are more likely to give you taxable losses. A taxable loss is a great thing because you’re harvesting them. You’re swapping that investment for something that’s very similar, but not, in the words of the IRS, substantially identical, you’re capturing the loss, but you really haven’t changed what you’re invested in. The more of those you’re able to capture the better. Of course, you’re able to capture those more frequently with volatile investments, typically stocks.
  5.  A lot of people get confused about what they should put in the Roth IRA versus what they should put in their 401(k). In general, you should place high expected return assets into tax free accounts. The reason is because it improves your ratio of tax-free money to tax deferred money. That’s a good thing because you expect higher returns on those assets. But don’t kid yourself that this is some sort of risk-free lunch. It’s not a free lunch. There is additional risk you are taking on. The fact is when you put money into a tax-free account, you own all of that money. When you put money into a tax deferred account, some of that money is yours and some of it is the government’s. You just haven’t given it to the government yet. If you have equal amounts in the two accounts, they’re not actually equal. You actually have more money in the asset that is in the tax free or Roth account. Because of that, you’re taking on more risk with your portfolio. This is probably still a good thing to do. This is something most people do, but it is not a free lunch. So, keep that in mind.
  6.  If you have a required minimum distribution problem, you should try to increase your tax free to tax deferred ratio. Now, what do I mean by an RMD problem? Remember, starting at age 72, you’re required to start taking money out of your tax deferred accounts. It has to come out of the account. You have to pay the taxes on it, no matter what you do with the money. Now, if you’re spending that money, I would not say that you have an RMD problem. An RMD problem is where you’re taking money out of that account, paying taxes at a very high rate on it and you don’t even need the money. That is an RMD problem. Truthfully, you probably need a very large tax deferred account in order to have an RMD problem. Probably more than 5 million, maybe more than 10 million before you really have an RMD problem. But if you have one, you’re one of those lucky few, you should do what you can to try to increase your tax free to tax deferred ratio. The typical ways that people do that is by doing Roth conversions, by making Roth contributions, rather than tax deferred contributions.

Basic Tips for Investing Tax Efficiently

I share some basic tips that you should follow if you are trying to invest tax efficiently. Just nuts and bolts kind of tips to keep in mind.

  • If you’re going to invest in municipal bonds, do it in a taxable account. Remember their interest is federal and sometimes even state tax free.
  • If you have an investment that has a high expected return, that is very tax inefficient, picture like a hard money loan fund, that’s earning 11%, but it’s totally taxable every year at your ordinary income tax rate, that’s likely worth moving into a tax protected account if you can. Even if you end up paying some fees or dealing with some costs or hassles of doing that.
  • In general, you should put your bonds into tax deferred accounts. This isn’t a free lunch. It’s not always the right thing to do, especially at very low interest rates, as I have written before. But even when you’re wrong about where you put those bonds, you’re not going to be wrong by much.
  • If you have to invest in a taxable account, the types of assets that you generally want in there include equity real estate, where you can shelter the income with depreciation, municipal bonds and total market stock index funds. Things like the total stock market index fund, the total international stock market index fund, those are all very tax efficient investments.
  • Max out your retirement accounts.
  • Consider Roth conversions.
  • Remember that REITs and their mutual funds probably still belong in a tax protected account even with the new 199A deduction that gives you a little bit of a tax break on the income coming out of there.

But don’t worry too much beyond those basic steps. You’re probably just as likely to be wrong as right with what you do with your asset location beyond that point. Even if you are right, is not going to make that much of a difference.

Reader and Listener Q&As

Charitable Giving Changes with the CARES Act.

“I’d like to hear about changes in the CARES act that involved deductions for charitable giving. Are there considerations to optimize charitable deductions specifically for those of us using donor advised funds?”

This is basically a charitable deduction for those who don’t itemize. It’s an above the line deduction. It’s up to $300 per year for individuals. I did some research. I couldn’t figure out if that’s doubled if you’re married, filing jointly or not. I’m sure as soon as I publish this, someone’s going to send me an email and tell me whether it is or isn’t, but I could not find that answer anywhere I looked.

Only cash counts. You can’t use appreciated securities to get this deduction. So it’s $300 cash. You also can’t go through a donor advised fund to get this. I don’t know why, but that’s the way the law is written. It has to go directly to the charity. This deduction is supposed to stay in place beyond 2020.

However, in 2020, there are a couple other benefits that have to do with charitable deductions. For example, you can normally, I think it’s 60% that you can take as an itemized deduction, up to 60% of your adjusted gross income. If you’ve given that much to charity that year, you can deduct up to 60% of your adjusted gross income. This year it’s a hundred percent.

Normally for a corporation it’s 10% of its income, this year it’s 25%. I think it’s only for cash though. I don’t think the law changed for donated securities. So, keep that in mind. If you’re planning to donate a huge chunk of money, this year might be a good year to do it.

Paying Your Spouse for Working in Your Practice

“I am in private practice and I max out my employer side of my 401(k), my employees’ side of my 401(k) and a cash balance pension plan. My wife does lots of work for the practice and we have never paid her because it seems like a pointless exercise to just increase my business expenses and send our income basically in a circle. However, since I’ve become more financially literate, I realize I should be paying her a fair and reasonable wage. Then we could invest that income that she generates in retirement accounts for her. Should we do a solo 401(k) for her, or a mega backdoor Roth IRA?”

This is a common question. Lots of doctors want to pay their spouse for helping with the practice. Yes, if you do put your spouse on the payroll, you can put that income into retirement accounts. It’s a great benefit of having a spouse on payroll. Obviously even without being on payroll, without any earned income at all, you can still do a backdoor Roth IRA for your spouse.

But, keep in mind, I assume there are other employees in this practice, which means that she can only use the practice retirement plan if she’s an employee of the practice. It’s not like she gets to go open up an individual 401(k) when she is an employee. Being an employee doesn’t entitle you to do that.

You have to ask yourself, do you really want to do this? There are downsides to employing your spouse that otherwise has no other earned income. The main one is that you have to pay her social security taxes. Whereas, for most doctors you’ve already paid the maximum social security tax. So if you shift that income from your column to your spouse’s column, all of a sudden, those social security taxes have to be paid again.

In a lot of ways, a lot of spouses are better off in retirement taking 50% of your benefit, rather than their own benefit. You’re not getting any benefit to paying thousands of extra dollars in social security taxes. Social security tax is 6.2% for the employee and 6.2% for the employer. Although some of that is deductible, it is a big tax.

It’s pretty hard to get a deduction big enough into a 401(k) that it makes sense to pay those unnecessary taxes in order to get it. So, keep in mind, that cost is likely higher than the benefits of getting some more 401(k) contributions.

But if you decide that cost is not too high, you’re still stuck with only using the practice 401(k). If the only people working there are you and your spouse, you can use an individual 401(k).

SIPC Insurance

In some ways SIPC insurance is like FDIC insurance at your bank or NCUA insurance at your credit union. But in other ways it’s a little bit different. It protects against the loss of cash and securities such as stocks and bonds that are held by a financially troubled brokerage. The limit is $500,000, with a lower limit for cash. Not money market funds because they’re considered securities, but for cash of $250,000. But keep in mind that most customers who have failed brokerage firms are protected.

Just because the brokerage firm goes out of business, it doesn’t mean you don’t still own the securities. You still own the securities, the shares of stock. They’re not tied up with Fidelity. Just because Fidelity goes out of business, it doesn’t mean you don’t still own your shares of Apple.

So, it’s not quite the same as FDIC insurance that you might see in a bank where if that bank goes out of business, if you didn’t have FDIC insurance, you’d lose all your cash in that bank. That’s not necessarily the case at a brokerage firm.

But SIPC insurance protects up to $500,000 per institution, per account owner. So, you could have up to one and a half million protected at Vanguard. If you have $500,000 in an account in your name, $500,000 in your spouse’s name and $500,000 in a joint account. And of course, if you have IRAs there, they also get $500,000 of protection, apiece.

Keep in mind, this is slightly different from the FDIC. If you go to a bank it is $250,000 per person. So, you get $250,000 for your account, $250,000 for your spouse’s account. And you get $500,000 for your joint account. $250,000 for each of you. That’s just the way FDIC insurance works. SIPC insurance is a little bit different.

But remember that this isn’t a bank. Even if your brokerage does shut down or becomes insolvent, there’s other layers of protection that will shield you from loss before the SIPC steps in. FINRA has actually said in virtually all cases where a brokerage firm ceases to operate, customer assets are safe and typically are transferred in an orderly fashion to another registered brokerage firm. You are not investing in the brokerage firm. You’re investing through the brokerage firm in other investments, and those investments are fine.

Keep in mind what SIPC does not protect against. It does not protect against losses. If your investment loses money, this does not protect against that. It does not protect against you getting bad advice from a financial advisor. So, keep that in mind. What it protects against is the brokerage firm going out of business. Just like a bank going out of business with the FDIC.

We have all our taxable assets at one account at Vanguard. It’s much more than $500,000. I guess I would say I’m not terribly worried about this. But if you’re really worried about it, I guess you could have his, hers and ours account at Vanguard, Fidelity, Schwab and E-Trade. You put all that together, it adds up to 6 million bucks of protection. I’m not sure the insurance is worth all that hassle, but if you think it is, feel free to do that. That’s what you would do.

How Much is Too Much in One Asset

A listener has a net worth of $1 million and wants to buy a second home in her neighborhood to do short term rentals. The loan would be $450,000. She wondered if she was too real estate heavy? Too much of her assets in real estate?

There are kind of two schools of thought when it comes to diversification. The first is don’t put all your eggs in one basket. The other school of thought is put all your eggs in one basket and keep very close watch on that basket. That is kind of what you do when you’re an entrepreneur. That is kind of the same way when you become an entrepreneur with an Airbnb business. Really, you’re going into the hotel business not really real estate investing. In those sorts of situations, there’s potential to make lots and lots of money. But there’s obviously higher levels of risk as well. So, keep that in mind. This is just entrepreneurship. There is not a lot you can do about it if you want to be an entrepreneur other than taking those risks. You have  to run the numbers, add in the value of your time when you’re calculating that return.

UGMA Accounts

A listener asked about using UGMA accounts. Each of my kids has a UGMA account. We call this their twenties fund. The expectation is that this is money they will use for some good cause in their twenties. The problem with inheritances is that you get them when you don’t need them. You get them when you’re in your sixties. If you’ve been good with money, you don’t need money in your sixties. You’ve got plenty.

When do you need money in your life? In your twenties. That’s when you need money for college, for a car, for an engagement ring, for a honeymoon, for a wedding, for a first house. That’s when money is most valuable to you in your life. So that’s why we tried to give our kids a chunk of money in their twenties to use however they like. That is what their UGMA account is. It’s separate from the Roth IRA where their earned money goes. It’s separate from their 529, which is lined up for college and graduate school. It’s just to use for these other things.

I wouldn’t say that everybody has to have UGMA account. Even everyone with kids doesn’t have to have a UGMA account. I don’t think it’s a critical aspect of your financial plan by any means. What’s the main purpose? Well, it depends on you. If it’s to help your kids buy a house, that is great. If it’s to help them do missionary work or spend a year with the Peace Corps or whatever, that’s great too. It’s fine whatever the purpose is.

Just remember that when they become 18 or in some states 21, it doesn’t matter what your purpose is for it. It’s all about what their purpose is for it because it’s their money. It’s not like a 529 where it remains your money. It becomes their money when they hit the age of majority, and they can do whatever they want with it.

It has excellent asset protection for you. It’s basically absolute. It’s not your money anymore. You gave it away to your kid. So, when something’s not yours anymore, it gets great asset protection from your creditors. Of course, it’s 100% exposed to their creditors. When you hit the age of majority, it just becomes a taxable account for them. And just like your taxable account is exposed to your creditors, so is theirs exposed to their creditors.

So, how much do you put in there? Well, if you have it in a very tax efficient investment, such as the total stock market index, that has a yield of about 2% a year. If you have a $100,000 in there, it’s going to kick out about $2,000 a year in income. Half of that is not going to be taxed. The other half is going to be taxed at their tax rate. You get much more than that, or you invested in tax inefficient investments and there’s not really a great tax play there anymore.

So, these things, it doesn’t really make sense to have a million-dollar UGMA account. Once you get beyond about $100,000, I don’t know that this makes a ton of sense for you to be using UGMA accounts. You might as well keep it in a taxable account and keep control over it. Although if you’re really worried about asset protection, this is a good way to protect it from your creditors.

Health Insurance Premiums

A listener was going to enroll in her employer’s high deductible health savings plan but noticed that the high deductible plan actually had a much higher premium than the traditional PPO plan, about 25% higher. It is highly unusual to have the traditional PPO plan, a low deductible plan, have lower premiums than the high deductible health plan. But it reinforces the concept that the first thing you do in this process is choose the plan that’s right for you and your family. If your family uses a lot of healthcare resources, you probably want to be in a traditional PPO, low deductible plan. If you don’t use much health resources, you’re usually better off in a high deductible health plan.

But in this sort of a situation where the low deductible plan also has the lower premiums, that has to be the right plan for you. It just doesn’t make sense for the other plan to be the right plan for you.

If the plan that’s right for you and your family is the high deductible health plan, then of course use the HSA that’s available to you. But don’t beat yourself up that you can’t use an HSA because the high deductible health plan doesn’t make sense for you.  Just move on with life, invest your money elsewhere. No big deal.

Pros and Cons of Your Practice Owning Your Life Insurance Policy

There are really three people involved in a life insurance policy. There is the owner of the policy, there is the insured person and there is the beneficiary. Those can all be different people and often are.

So, there are lots of different ways to do this and it really comes down to what your goals are. For example, I don’t really have a personal life insurance need anymore. Katie has plenty of money to go on and live the rest of her life in relative financial security. But on the other hand, the White Coat Investor business would certainly be severely impacted by my death. So, it might make sense to transfer one or both of the policies I have on me to the business. The business pays the premium and receives any death benefit, but I’m still the insured.

The benefit of transferring a policy like that in my case, where it’s a term life insurance policy, is that the business then pays the premium and I no longer have to pay it. That allows the premium to be paid with pretax dollars. Of course, the benefit is then paid to the business. In which case it’s basically still pretax dollars. If we want to take it out as profit, then you have to pay tax on it. So that’s one downside and one upside to moving it to the business.

The death benefit, of course, increases the value of the business. So, that’s pretty straightforward. However, if it’s a cash value or whole life insurance policy it becomes much, much more complicated. It is probably a more frequent occurrence that a policy is transferred from a business to an individual. Oftentimes a business offers that kind of a policy as some kind of a benefit or incentive package, part of the compensation for an employee. But frankly, these are usually sold to businesses by very slick insurance agents.

A business owner could transfer a personal cash value policy to a business. That would be treated like a capital contribution to the business as far as taxes go. Why might you do that? Well, if the business had a need for a policy that you no longer needed, this key man insurance, as it is often called, might be a reasonable use of doing it.

But you basically just have to look at what the insurance needs are for the individual and the business and see what the best way to accomplish that is. Sometimes it’s by transferring a policy rather than buying a new one.

Tapping Your Retirement Accounts to Invest in Real Estate

I brought Leti Alto and Kenji Asakura, the creators of the Zero to Freedom Through Cash-Flowing Rentals course on the episode to address a question asked a couple of weeks ago about tapping your retirement account to invest in real estate. The initial questioner thought they were recommending that for their students but they felt like that was maybe a little too strong of a statement.

But they wanted to share why they chose to liquidate one of their 401(k)s. It is because Kenji has real estate professional tax status which allows them to be able to actually shelter taking that money out, which is outside the norm for most doctors.

The common wisdom is that you don’t touch your retirement accounts. There is a reason for that. It is a good rule of thumb. But there are times when you have such great opportunities, whether it’s investing in your own education, your own entrepreneurial pursuit, your own practice when it’s possible it can make sense. This couple were in a fairly unique situation, actually, for doctors that led them to tap that money in order to basically invest in real estate in a nonqualified account, if you will.

One of those reasons was the real estate professional status. So, for those who don’t know what real estate professional status is, this essentially gets you around a big limitation in using losses in your real estate investments against your regular income. A normal person that’s not a real estate professional, basically can only use the real estate losses to offset real estate gains and real estate income. Leti explained what happens when you achieve real estate professional status and how that changes.

“It is just one member of the couple. And what it allows us to do is take all these losses and shelter active income, which is mostly my active income, but also our blog income. Then how we do that is we create massive losses using a hundred percent bonus depreciation, which is basically a way that the government allows you to write off a portion, a significant portion of your property, the year you buy it as a loss. And so, an example we give to a lot of people is we just bought a $3 million apartment complex, and we’re going to write off $770,000 in bonus depreciation losses this year. So, that will shelter our $770,000 of income. And if we don’t have that much income, we can actually carry it forward. Or actually because of the CARES Act, we can carry it backwards.

And so, what we realized is if we liquidated the 401(k) and we paid that 10% penalty, we have no state income tax. And then we could take that money, which was I think like $350,000, buy a property and then use bonus depreciation to write off all the taxes, to cover taking out that 401(k). And so, for us, it was just the 10% penalty. And so, it made sense for us to access that money now and build our wealth. And we feel very confident that we can do that because we have so much real estate experience.”

They had a lot going for them in that decision. If I went and took money out of my retirement account, I’d pay 37% federal, 5% state,  plus 10% for the penalty, 52% total. Basically, if I want to get $100,000 to use as a down payment on a property, I have to take $208,000 out of that account to do it, to cover all the taxes, which that’s obviously stupid to do. But if you’re not going to pay the taxes on that, because you’re wiping out all of your earned income with bonus depreciation, if you’re not paying state taxes, it obviously becomes a different decision.

People need to recognize that most doctors aren’t going to qualify for real estate professional status. Unless you’re basically transitioning from medicine to real estate as a career, you’re probably not going to get that status. Your spouse might, but you’re probably not going to get it. And so, I think that provides good clarification for why they did that and why it might not be a great idea for the average doctor.

Ending

I hope that discussion on asset location and the Q&As from this episode were helpful. If you have questions you would like answered on the podcast please record them at the speak pipe.

Full Transcription

Transcription – WCI – 171

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 171 – Asset location. Have you ever considered a different way of practicing medicine? Whether you were burned out, need to change your pace or looking to supplement your income, locum tenens might be the solution for you.
Dr. Jim Dahle:
Not sure where to start? locumstory.com is a place where you can get real unbiased answers to your questions. To answer basic questions, like what is locum tenens to more complex questions about pay ranges, taxes, various specialties, and how locum tenens works for PAs and NPs. Go to whitecoatinvestor.com/locumstory and get the answers today.
Dr. Jim Dahle:
Thanks for what you do. It’s not easy work you do out there, especially those of you on the front lines of this pandemic. So, there’s a lot of liability involved. There is a lot of stress. There are some late nights, and there’s some demanding patients out there, and it’s not easy.
Dr. Jim Dahle:
Some of you are on your way to work and you’re going to face this, whereas you get in there. Some of you are on your way home, and you’re just trying to wind down a little bit from what you faced. If no one said “thanks” to you today, let me be the first, thank you for what you do.
Dr. Jim Dahle:
Our quote of the day today comes from Charlie Ellis, who said, “As another professions, such as law, medicine, architecture, and management consulting, there is a continuing struggle between the values of the profession and the economics of the business. Investment management differs from many other professions in one most unfortunate way. It is losing the struggle to put professional values and responsibilities first and business objectives second”.

Dr. Jim Dahle:
And I think there’s a lot of truth to that. Certainly, when you interact with the financial services industry, this is a time to really be on point and cognizant that there are people with serious conflicts of interest that you are talking to.
Dr. Jim Dahle:
If you haven’t checked out the WCI network blogs, I would encourage you to do so. There are three of those. The first is the Physician on FIRE. This was written by now retired anesthesiologist, Leif Dahleen, who does an excellent job of talking about the issues involved in becoming financially independent and retiring early.
Dr. Jim Dahle:
He was able to retire from medicine at age 43, and he documents his journey there on the blog, as well as what he’s doing since he’s retired. And so, it’s a great opportunity for those interested in the FIRE movement from a physician perspective.
Dr. Jim Dahle:
The second one of these is Passive Income MD. And this is written by anesthesiologists Peter Kim in California. And he talks about all kinds of side gigs, about how to bring in additional income and about how to really diversify your streams of income. Lots of great information there about real estate in particular. So, be sure to check that out.
Dr. Jim Dahle:
The third WCI network blog is The Physician Philosopher written by Jimmy Turner, an anesthesiologist out in North Carolina. And this blog talks all about the intersection of personal finance, as well as burnout and really physician wellness. And so, when you combine all of that, it makes for a lot of interesting material and information about how you can really align your values and your life and find happiness with what you’re doing, both at work and at home.
Dr. Jim Dahle:
Now, each of these guys, well, I suppose with the exception of Leif at the Physician on FIRE have come out with some other courses and products you may be interested in. Peter Kim periodically sells a course on investing passively in private real estate. He also has a podcast out that you can listen to. Jimmy also has a course that he sells periodically. He calls it the Anti Budget course in a lot of ways, because it helps you to really get a handle on your money without that onerous budgeting perspective that so many people take to personal finance. He also is the cohost of a podcast on money and medicine. So, be sure to check those resources out if you have not yet, I do endorse them. And there’s a lot of great information there.

Dr. Jim Dahle:
Today I wanted to talk before we get into your questions, because I like to keep this podcast about you. And so, I like to take your questions on here and really talk about the things that you’re thinking about.
Dr. Jim Dahle:
But before we get into that, I wanted to talk a little bit about asset location. And this is something that is completely missed by a lot of otherwise pretty financially sophisticated people. I have had lots of docs that have these incredible portfolios and a really thorough understanding of personal finance and investing that completely missed this subject. And so, I think it’s worth talking about.
Dr. Jim Dahle:
Asset location is basically that process of dividing up your investments, your asset classes, these types of investments into your various accounts. There are tax free accounts like a Roth IRA. There are triple tax-free accounts, like HSA – Health Savings Account. And there are taxable accounts.
Dr. Jim Dahle:
There are also tax deferred accounts like your classic 401(k). And each of these has different issues and is taxed in a different way. And these have some bearing on how your investments perform and which investments should be going into which of these various types of accounts. So, we’re going to talk about that today.
Dr. Jim Dahle:
Unfortunately, it’s a rather complicated discussion and there are some rules of thumb, but very few absolutes in it. And the reason why is that everybody’s combination of accounts is very different.
Dr. Jim Dahle:
Some people have more of their money in a tax deferred account while others have more of their money in a taxable account, for instance. And so, these discussions are all over the place. But if you get this right, it can be worth as much as an additional after-tax return of perhaps half a percent per year, which over a 30- or 60-year investing career can add up to a million dollars or more. So, it’s worth looking at, but perhaps not obsessing over it.
Dr. Jim Dahle:
So, today I want to go over a couple of things that you ought to be aware of. Let’s call them “Six principles of asset location that you should be aware of”.

Dr. Jim Dahle:
And here’s the first one. This is principle one. The higher the expected return of the investment of the asset class, the more likely that asset should be in a tax protected account. And the reason why is because you want stuff that’s going to grow quickly to be in those tax protected accounts, because it makes your ratio of tax protected accounts to your taxable account higher. And that return means that less of your money is subject to tax drag every year, as your investments are taxed, as they make money. And so, that’s the first rule to keep in mind.
Dr. Jim Dahle:
The second rule, of course, sometimes contradicts it. But you have to weigh the two of them together. The second rule is that the lower the tax efficiency of the investment, the asset class, the more likely that should be in a tax protected account.
Dr. Jim Dahle:
Now, what do I mean by tax efficiency? For example, let’s talk about a very tax inefficient investment. For example, a real estate investment trust is required by law to pay out 90% of its income each year to the investors. And that comes back as ordinary taxable income. It is not a qualified dividend. It is not a long-term capital gain. It is paid at your ordinary income tax rates.
Dr. Jim Dahle:

And so, it can be a very tax inefficient asset class. Likewise, a typical nominal bond is very tax inefficient, because it’s essentially its entire return is paid out at its yield. And that is taxed as ordinary income tax rates. So, when most of the return is coming out every year and it’s coming out and being taxed, ordinary income tax rates, that’s a very tax inefficient.
Dr. Jim Dahle:
On the flip side, we can look at an investment, let’s say the stock Berkshire Hathaway. This is Warren Buffett’s company. It notoriously does not pay dividends. So, there is no income from this stock whatsoever. There’s nothing to be taxed each year. You pay no taxes on this investment until you sell it. So, this is a very tax efficient investment.
Dr. Jim Dahle:
And so, when you’re having to choose and this is “all else is equal”. You put the tax efficient investment in your taxable account. If something has to be in your taxable account, obviously if everything’s in your Roth IRA, this isn’t an issue. But if something has to be in your taxable account, you can put that tax efficient investment in your taxable account and the less tax efficient investments into your tax protected accounts such as your 401(k) or your Roth IRA or your HSA.
Dr. Jim Dahle:
The third principle is that the more likely you are to avoid paying capital gains taxes, the more willing you should be to put capital gain assets in your taxable account. Let me explain what I mean by this. I don’t really pay long-term capital gains taxes. And that’s because of the unique way that we use our taxable account.
Dr. Jim Dahle:
When something goes down in value in our taxable account, we tax loss harvest it and we get the losses. And right now, we have a whole bunch of losses. I think we’re close to half a million dollars in losses that we’ve accumulated in that taxable account over the years. Lots and lots and lots of tax losses.
Dr. Jim Dahle:
And that’s great. You can use $3,000 a year of those against your ordinary income. They can be carried over indefinitely. You can use them against any capital gains that you do have to actually take for whatever reason. And so, it allows you to be very tax efficient in that taxable account.
Dr. Jim Dahle:
Now, if something appreciates in that account, I tend to use it for our annual charitable giving. And so, we basically flush those capital gains out of our account. So very tax efficient way to invest.
Dr. Jim Dahle:
And if you give a lot of money to charity, this is a great thing that you can do to keep from paying a lot of taxes. Because when you give that appreciated asset to charity, you still get the charitable deduction for the whole value of that asset, but neither you nor the charity pays the capital gains taxes on it.
Dr. Jim Dahle:
So, if you do something like that, then it’s great to have these assets where most of the return comes to you as long-term capital gains because you’re not paying those taxes anyway. Same thing if you’re 85 years old, right? And you’re probably going to die without ever spending this money. And your errors are going to get a step up in basis at death.
Dr. Jim Dahle:
That is a great thing to have in a taxable account because it ends up being so tax efficient because nobody ever pays those capital gains taxes. And so, if you’re really good at avoiding paying those capital gains taxes because of the way you live your financial life, those are great assets to have in your taxable account.

Dr. Jim Dahle:
Okay, principle number four. The more volatile the investment, the more likely it is to be better in taxable. And the reason why is that volatile investments are more likely to give you taxable losses. And a taxable loss is a great thing because you’re harvesting them, right? You’re swapping that investment for something that’s very similar, but not in the words of the IRS substantially identical, you’re capturing the loss, but you really haven’t changed what you’re invested in. And so, the more of those you’re able to capture the better. And of course, you’re able to capture those more frequently with volatile investments, typically stocks.
Dr. Jim Dahle:
All right, principle, number five. A lot of people get confused about what they should put in the Roth IRA versus what they should put in their 401(k). In general, you should place high expected return assets into tax free accounts. The reason why is because it improves your ratio of tax-free money to tax deferred money. That’s a good thing because you expect higher returns on those assets.
Dr. Jim Dahle:
But don’t kid yourself that this is some sort of risk-free lunch. It’s not a free lunch. There is additional risk you are taking on. And the fact is when you put money into a tax-free account, you own all of that money. When you put money into a tax deferred account, some of that money is yours and some of it’s the governments. You just haven’t given it to the government yet.
Dr. Jim Dahle:
And so, if you have equal amounts in the two accounts, they’re not actually equal. You actually have more money in the asset that is in the tax free or Roth account. And because of that, you’re taking on more risk with your portfolio. So, this is probably still a good thing to do. This is something most people do, but it is not a free lunch. So, keep that in mind.
Dr. Jim Dahle:
And principle number six. If you have a required minimum distribution problem, you should try to increase your tax free to tax deferred ratio. Now, what do I mean by an RMD problem? Remember, starting at age 72, you’re required to start taking money out of your tax deferred accounts. It has to come out of the account. You have to pay the taxes on it, no matter what you do with the money.
Dr. Jim Dahle:
Now, if you’re spending that money, I would not say that you have an RMD problem. An RMD problem is where you’re taking money out of that account. You’re having to pay taxes at a very high rate on it and you don’t even need the money. That’s an RMD problem.
Dr. Jim Dahle:
And truthfully, you probably need a very large tax deferred account in order to have an RMD problem. I’m talking in the millions. Probably more than 5 million, maybe more than 10 million before you really have an RMD problem.
Dr. Jim Dahle:
But if you have one, you’re one of those lucky few, you should do what you can to try to increase your tax free to tax deferred ratio. And the typical ways that people do that is by doing Roth conversions, by making Roth contributions, rather than tax deferred contributions and trying to improve those things.
Dr. Jim Dahle:
So, some basic tips that you should follow if you are trying to invest tax efficiently. Here’s just nuts and bolts kind of tips to keep in mind.
Dr. Jim Dahle:
If you’re going to invest in municipal bonds, do it in a taxable account. Remember their interest is federal and sometimes even state tax free.
Dr. Jim Dahle:
If you have an investment that has a high expected return, that is very tax inefficient. Picture like a hard money loan fund, that’s earning 11%, but it’s totally taxable every year at your ordinary income tax rate, that’s likely worth moving into a tax protective account if you can. Even if you end up paying some fees or dealing with some costs or hassles of doing that.
Dr. Jim Dahle:
In general, you should put your bonds into tax deferred accounts. This isn’t a free lunch. It’s not always the right thing to do, especially at very low interest rates, as I have written before. But even when you’re wrong about where you put those bonds, you’re not going to be wrong by much.
Dr. Jim Dahle:
Fourth, if you have to invest in a taxable account, like I said, if you don’t have to, don’t bother. If you can get all your investments into tax protected accounts, that’s great. But if you have to invest in a taxable account, the types of assets that you generally want in there include equity real estate, where you can shelter the income with depreciation, municipal bonds and total market stock index funds. Things like the total stock market index fund, the total international stock market index fund, those are all very tax efficient investments.
Dr. Jim Dahle:
If you’re taxable, the tax protected ratio gets so large that you have to find another asset class to move into taxable, congratulations. You’re going to be very rich. But for the most part, you don’t need to worry too much about that stuff.
Dr. Jim Dahle:
Max out your retirement accounts, consider Roth conversions. Remember that REITs and their mutual funds probably still belong in a tax protected account even with the new 199A deduction that gives you a little bit of a tax break on the income coming out of there.
Dr. Jim Dahle:
But don’t worry too much beyond those basic steps. You’re probably just as likely to be wrong as right. And what you do with your asset location beyond that point. And even if you are right, is not going to make that much of a difference.
Dr. Jim Dahle:
All right, enough on asset location. I hope that was helpful to you. Let’s take some questions off the Speak Pipe. If you’d like to have your questions answered on the podcast, leave them at whitecoatinvestor.com/speakpipe.
Dr. Jim Dahle:
Our first question comes from Mike from New York. Let’s hear Mike’s question.

Mike:
Hi Jim. This is Mike from New York. Thanks for what you do. I’d like to hear about changes in the cares act that involved deductions for charitable giving. Are there considerations to optimize charitable deductions specifically for those of us using donor advised funds? Thanks so much.

Dr. Jim Dahle:
Okay. Mike’s talking about this new charitable deduction that came into being with the cares act. This is basically a charitable deduction for those who don’t itemize. It’s an above the line deduction. It’s up to $300 per year for individuals. I did some research. I couldn’t figure out if that’s doubled if you’re married, filing jointly or not. I’m sure as soon as I publish this, someone’s going to send me an email and tell me whether it is or isn’t, but I could not find that answer anywhere I looked.
Dr. Jim Dahle:
And remember that only cash counts. You can’t use appreciated securities to get this deduction. So, it’s $300 cash. You also can’t go through a donor advised fund to get this. I don’t know why, but that’s the way the law is written. It has to go directly to the charity. And this deduction is supposed to stay in place beyond 2020.

Dr. Jim Dahle:
However, in 2020, there’s a couple other benefits that have to do with charitable deductions. For example, you can normally, I think it’s 60% that you can take as an itemized deduction up to 60% of your adjusted gross income. If you’ve given that much to charity that year, you can deduct up to 60% of your adjusted gross income.
Dr. Jim Dahle:
This year it’s a hundred percent. So, that’s great. Normally for a corporation it’s 10% of its income, this year it’s 25%. So, that’s great. I think it’s only for cash though. I don’t think the law changed for donated securities. So, keep that in mind. If you’re really donating a huge chunk of money this year might be a good year to do it.
Dr. Jim Dahle:
All right, let’s take our next question. It’s actually a combination of a couple of speak pipes from Ben from Florida.

Ben:
Hello, my name is Ben. I live in Florida. I have a question about how I should pay my wife and invest her income. I am in private practice and I max out my employer side of my 401(k), my employees’ side of my 401(k) and a cash balance pension plan. My wife does lots of work for the practice, such as QuickBooks, bookkeeping, running errands. And we have never paid her because it seems like a pointless exercise to just increase my business expenses and send our income basically in a circle.
Ben:
However, since I’ve become more financially literate, thanks to you, I realize I should be paying her a fair and reasonable wage. And then we could invest that income that she generates in retirement accounts for her. And my question for you is, should we do a solo 401(k) for her, or a mega backdoor Roth IRA?
Ben:
I recently read your blog post from I think 2019 and how you changed your wife’s retirement investing from a solo 401(k) to a mega backdoor Roth IRA. So, a few more details to help solve this problem. I differ about $125,000 between the employer and the employee side on my 401(k), which are maxed out in a cash balance pension plan, which is another $75,000 a year. We are 37 years old. So, we have a rather long-time horizon.

Ben:
And I’m thinking maybe we’re better off paying the taxes, paying the taxes as she gets paid, and then using that money as a larger mega backdoor Roth contribution versus deferring the taxes and maxing out the employee side of a solo 401(k).

Dr. Jim Dahle:
Okay, this is a common question. Lots of docs want to pay their spouse for helping with the practice. Yes, if you did put your spouse on the payroll, you can put that income into retirement accounts. It’s a great benefit of having a spouse on payroll. And obviously even without being on payroll, without any earned income at all, you can still do a backdoor Roth IRA for your spouse.
Dr. Jim Dahle:
But, keep in mind, I assume there’s other employees in this practice, which means that she can only use the practice retirement plan if she’s an employee of the practice. It’s not like she gets to go open up an individual 401(k) because she’s an employee. Being an employee doesn’t entitle you to do that. And so, she can’t just go open an individual 401(k).
Dr. Jim Dahle:
But you got to ask yourself, do you really want to do this? There are downsides to employing your spouse that otherwise has no other earned income. The main one is that you got to pay your social security taxes. Whereas, for most doctors you’ve already paid the maximum social security tax. And so, if you shift that income from your column to your spouse’s column, all of a sudden, those social security taxes have to be paid again.
Dr. Jim Dahle:
And in a lot of ways, a lot of spouses are better off in retirement taking 50% of your benefit, rather than their own benefit. And so, you’re not getting any benefit to paying thousands of extra dollars in social security taxes. I mean, keep in mind how much social security tax is, right? It’s 6.2% for the employee and 6.2% for the employer. Although that’s deductible, on like the first $135,000 or something you make. It’s a big tax. I mean, that could be, what? $15,000 or something.
Dr. Jim Dahle:
It’s pretty hard to get a deduction big enough into a 401(k) that it makes sense to pay those unnecessary taxes in order to get it. So, keep that in mind, that cost is likely higher than the benefits of getting some more 401(k) contributions.

Dr. Jim Dahle:
But if you decide that cost is not too high, you’re still stuck with only using the practice 401(k). Only if the only people working there are you and your spouse, can you use an individual 401(k). And this is the issue we have with the White Coat Investor this year. We got employees now. So, we’ve got to change from an individual 401(k) to a real 401(k). And of course, you can’t just open an individual 401(k) as an employee. It’s not allowed.
Dr. Jim Dahle:
All right, our next question comes from anonymous and let’s hear what they have to ask.
Speaker:
Hi, Jim, thanks for everything that you do. You’ve played without question, a huge role in my financial success so far. I’m an early career physician, three years out of training. The largest bucket of my net worth is in a taxable brokerage account at Vanguard. That account is about $400,000 now and invested primarily in passive index funds.
Speaker:
My question is about SIPC insurance. I understand that SIPC insurance brokerage accounts up to $500,000. Does that mean that I should open a new taxable investment account at a different brokerage firm once my taxable account at Vanguard exceeds $500,000?
Speaker:
And then, should I be doing that again each and every time my taxable account assets increased by another $500,000? It seems that would get very cumbersome and complex, especially as assets in my taxable accounts grow into the multiple millions.
Speaker:
Do you keep all your taxable index fund investments at the same firm? Or do you recommend opening multiple brokerage accounts that keep the balance of each account less than $500,000?
Speaker:
Similarly, I know that FDIC ensures regular bank accounts up to $250,000. So, does that mean that you recommend opening multiple bank accounts in order to keep each account under $250,000? Thanks for all your valuable help.
Dr. Jim Dahle:
Okay. This is a really insightful question about SIPC insurance. And SIPC insurance is pretty interesting stuff. This is basically the insurance that helps brokerage that’s a member of this organization to provide insurance to the people who are using the brokerage.
Dr. Jim Dahle:
In some ways it’s like FDIC insurance at your bank or NCUA insurance. But in other ways it’s a little bit different. It protects against the loss of cash and securities such as stocks and bonds that’s held by a financially troubled brokerage. The limit is $500,000. With a lower limit for cash. Not money market funds because they’re considered securities, but for cash of $250,000. But keep in mind that most customers who have failed, brokerage firms are protected.
Dr. Jim Dahle:
Anyway, just because the brokerage firm goes out of business, it doesn’t mean you don’t still own the securities. You still own the securities, the shares of stock. They’re not tied up with Fidelity. Just because Fidelity goes out of business, it doesn’t mean you don’t still own your shares of Apple.
Dr. Jim Dahle:
So, it’s not quite the same as FDIC insurance that you might see in a bank where if that bank goes out of business, if you didn’t have FDIC insurance, you’d lose all your cash in that bank. That’s not necessarily the case at a brokerage firm. And so, keep that in mind.
Dr. Jim Dahle:
But here’s the way it works. It protects up to $500,000 per institution, per account owner. So, you could have up to one and a half million protected at Vanguard. If you have $500,000 in an account in your name, $500,000 in your spouse’s name and $500,000 in a joint account. And of course, if you have IRAs there, they also get $500,000 of protection, a piece.
Dr. Jim Dahle:
Keep in mind, this is slightly different from the FDIC. If you go to a bank is $250,000 per person. So, you get $250,000 for your account, $250,000 for your spouse’s account. And you get $500,000 for your joint account. $250,000 for each of you. That’s just the way FDIC insurance works. SIPC insurance is a little bit different.
Dr. Jim Dahle:
But remember that this isn’t a bank. Even if your brokerage does shut down or becomes insolvent, there’s other layers of protection that will shield you from loss before the SIPC steps in. And FINRA has actually said in virtually all cases where a brokerage firm, ceases to operate, customer assets are safe and typically are transferred in an orderly fashion to another registered brokerage firm.
Dr. Jim Dahle:
Because you’re not investing in the brokerage firm. You’re investing through the brokerage firm in other investments, and those investments are fine.
Dr. Jim Dahle:
Keep in mind what SIPC does not protect against. It does not protect against losses. If your investment loses money, this does not protect against that. It does not protect against you getting bad advice from a financial advisor. So, keep that in mind. What it protects against is the brokerage firm going out of business. Just like a bank going out of business with the FDIC.
Dr. Jim Dahle:
So, you asked what would I do. Well, we have all our taxable assets at one account at Vanguard. It’s much more than $500,000. So, I guess I would say I’m not terribly worried about this. But if you’re really worried about it, I guess you could have his, hers and ours account at Vanguard, Fidelity, Schwab and E-Trade. You put all that together, it adds up to 6 million bucks of protection. I’m not sure the insurance is worth all that hassle, but if you think it is, feel free to do that. That’s what you would do.
Dr. Jim Dahle:
All right. Let’s take our next question from the Toecutter.
Toecutter:
Hello, this is the Toecutter. Thank you very much for all that you do Jim. I’m a big fan. I listened to the podcasts. I read the blogs. I’ve read your books and it had a big impact on me. Appreciate it.
Toecutter:
My question is, I’m married filing jointly with a net worth of $1 million. I’ve paid off my loans. I have a stable job. I’m looking to buy a second home in my neighborhood that has an in-law unit and rent both units as Airbnb’s. It looks like I should be able to make under ideal conditions, 30% cash on cash return. So, it looks like a sound investment to me when I run the numbers and comps in my area.
Toecutter:
However, it would require a sizable loan of $450,000 and I’m putting $100,000 down on that. My question is, am I real estate heavy? Am I putting too much of my assets in real estate? Thank you very much for taking the time to listen to my question.

Dr. Jim Dahle:
Okay. Sounds like you’re looking to buy a house with an in-law and renting with an in-law apartment and renting them both out as Airbnb properties. That sounds great. Lots of people have had a lot of success with this. Obviously in 2020, there’s a lot of risk to be in an Airbnb host. But, congratulations on being a millionaire.
Dr. Jim Dahle:
Your question is how much is too much in assets? If you only have a million bucks and you’re talking about putting $550,000 into an Airbnb – Yes, that’s a huge chunk of your net worth.
Dr. Jim Dahle:
There’s kind of two schools of thought when it comes to diversification. The first is don’t put all your eggs in one basket, right? And we all know what that means. So, if the baskets dropped all the eggs are broken.
Dr. Jim Dahle:
The other school of thought is put all your eggs in one basket and keep very close watch on that basket. And that’s kind of what you do when you’re an entrepreneur. Think about the White Coat Investor, right? Two thirds of my net worth are tied up in some stupid little internet business called the White Coat Investor. It’s terribly undiversified, right? But at the same time, there’s nobody on the planet that knows this business as well as I do.
Dr. Jim Dahle:
And it’s kind of the same way when you become an entrepreneur with an Airbnb business. Really, you’re going into the hotel business is what you’re going into. It’s not even really real estate investing. It’s the hotel business. That’s what you’re doing. And so, I presume you’re going to know your particular business better than anybody else in the world, and you’re going to watch it very closely.
Dr. Jim Dahle:
And so, in those sorts of situations, there’s potential to make lots and lots of money. But there’s obviously higher levels of risk as well. So, keep that in mind. This is just entrepreneurship. And there’s not a lot you can do about it if you want to be an entrepreneur, other than taking those risks.
Dr. Jim Dahle:
And you’re talking about getting 30% cash on cash returns. That sounds very good, but keep in mind, it takes a lot of time and effort to run an Airbnb business. Much more than just putting a tenant in there that sends you rent once a month.
Dr. Jim Dahle:
And so, you got to keep in mind, you’ve got to run the numbers, honestly. You got to add in the value of your time when you’re calculating that return. 30% cash on cash obviously sounds awesome, but it may not quite be that once you calculate in the value of your time managing this property, especially if you’re putting in new tenants every one to seven days. Airbnb, isn’t just an investment. And this year you’ve had a great opportunity to see what risk looks like in Airbnb entrepreneurship. Just take a look at how Airbnb as a company and its hosts in particular are doing this year.
Dr. Jim Dahle:
Our next question comes from Ben about UGMA accounts.

Ben:
Hello. I have a question about the UGMA accounts. So, it looks like per my research, the first $1,050 of the child’s income, which would be the gains on that investment is tax-free. The next $1,050 is taxed at the child’s income tax rate, which is far lower than mine. And then anything above $2,100 in earnings from the UGMA account would be taxed at my income tax rate, which should be the highest marginal tax rate.
Ben:
So, my question is how important is using a UGMA account as part of your financial plan? Is the real advantage so that you can help your kids buy a house in the future and other things like that without worrying about a gift tax? And is it also considered maybe an asset protection because some of your wealth is transferred to your kids’ names. I just wanted to get a little more information on how the UGMA accounts fit into an overall financial plan for a high-income physician. Thank you for all you do.

Dr. Jim Dahle:
Okay. Ben is asking about these UGMA accounts. Each of my kids has a UGMA account. We call this their twenties fund. The expectation is that this is money they will use for some good cause in their twenties. The problem with inheritances is that you get them when you don’t need them. You get them when you’re in your sixties. And if you’ve been good with money, you don’t need money in your sixties. You’ve got plenty. At that point you’re giving money away to other people.
Dr. Jim Dahle:
When do you need money in your life? In your twenties. That’s when you need money for college, for a car, for an engagement ring, for a honeymoon, for a wedding, for a first house. That’s when money is most valuable to you in your life. So that’s why we tried to give our kids a chunk of money in their twenties to use however they like. And that’s what their UGMA account is.
Dr. Jim Dahle:
It’s separate from the Roth IRA where their earned money goes. It’s separate from their 529, which is lined up for college and graduate school. It’s just to use for these other things. So that’s what we use it for.
Dr. Jim Dahle:
I wouldn’t say that everybody has to have UGMA account. Even everybody with kids doesn’t have to have a UGMA account. I don’t think it’s a critical aspect of your financial plan by any means. What’s the main purpose? Well it depends on you. If it’s to help your kids buy a house, get a house down payment, that’s great. If it’s to help them do missionary work or spend a year with the Peace Corps or whatever, that’s great too. It’s fine. Whatever the purpose is.
Dr. Jim Dahle:
Just remember that when they become 18 or in some states 21, it doesn’t matter what your purpose is for. It’s all about what their purpose is for it because it’s their money. It’s not like a 529 where it remains your money. It becomes their money when they hit the age of majority and they can spend it on prostitutes and cocaine, if they want. They can do whatever they want with it. So, keep that in mind.
Dr. Jim Dahle:
So, is its main purpose asset protection? Well, it’s got excellent asset protection for you. It’s basically absolute. It’s not your money anymore. You gave it away to your kid. So, when something’s not yours anymore, it gets great asset protection from your creditors. Of course, it’s 100% exposed to their creditors. When you hit the age of majority, it just becomes a taxable account for them. And just like your taxable account is exposed to your creditors, so is theirs exposed to their creditors.
Dr. Jim Dahle:
So, how much do you put in there? Well, if you have it in a very tax efficient investment, such as the total stock market index, that’s got a yield of about 2% a year. So, that’s going to kick off about if you have a $100,000 in there, it’s going to kick out about $2,000 a year in income. And a half of that it’s not going to be taxed. The other half is going to be taxed at their tax rate. You get much more than that, or you invested in tax inefficient investments and there’s not really a great tax play there anymore.
Dr. Jim Dahle:
So, these things, it doesn’t really make sense to have a million-dollar UGMA account. That’s just being taxed at your own tax rate. So, once you get beyond about $100,000, I don’t know that this makes a ton of sense for you to be using UGMA accounts. You might as well keep it in near taxable account and keep control over it. Although if you’re really worried about asset protection, this is a good way to protect it from your creditors.
Dr. Jim Dahle:
All right, our next question comes from Blake.

Blake:
Hi, dr. Dahle. My name is Blake and I have a question about health insurance plans. I’m a first-year fellow and I had planned on enrolling in my employer’s high deductible health savings plan. However, when I went to enroll for benefits, I noticed that the high deductible plan actually had a much higher premium than the traditional PPO plan, about 25% higher to be exact.
Blake:
I’ve talked to my benefits representative about this, and they could not give me a good reason why the high deductible plan was more expensive than the traditional PPO. Am I missing something, or is this highly unusual as it doesn’t make a lot of sense to me to be paying a higher premium as well as higher deductible? Thanks for your insight on this. And I appreciate your help.

Dr. Jim Dahle:
Well, that’s an interesting case. Occasionally things like this happen. The market is not perfectly efficient for health insurance. I really have no idea what is going on with Blake’s health insurance plans. It is highly unusual to have the traditional PPO plan, low deductible plan, have lower premiums than the high deductible health plan.
Dr. Jim Dahle:
But it reinforces the concept that the first thing you do in this process is choose the plan that’s right for you and your family. If your family uses a lot of healthcare resources, you probably want to be in a traditional PPO, low deductible plan.
Dr. Jim Dahle:
If you don’t use much health resources, if you’re pretty healthy folks and only occasionally have something expensive happen to you, you’re usually better off in a high deductible health plan.
Dr. Jim Dahle:
But in this sort of a situation where the low deductible plan also has the lower premiums, that’s got to be the right plan for you. It just doesn’t make sense for the other plan to be the right plan for you. And so, choose the plan first.
Dr. Jim Dahle:
If the plan that’s right for you and your family is the high deductible health plan, then of course use the HSA that’s available to you. But don’t beat yourself up that you can’t use an HSA because the high deductible health plan doesn’t make sense for you. That’s just silly. Just move on with life, invest your money elsewhere. No big deal.

Dr. Jim Dahle:
Okay. Our next question comes from Mark. Let’s take a listen.

Mark:
Hello, White Coat Investor. And thanks for all that you do. In a recent podcast, you briefly touched on somebody who inquired about putting their life insurance policy under their business. As a solo practitioner and owner of my LLC medical practice I am interested to learn what are the positives and negatives of considering doing this and how does that work in terms of payout and who would get the money if the policy is paid for under the business. Thank you very much.
Dr. Jim Dahle:
Okay. What are the positives and negatives of having your practice or your business own your life insurance policy? Who pays the premiums, who gets the death benefit? Well, there are really three people involved in a life insurance policy. There’s the owner of the policy, there’s the insured person and there’s the beneficiary. And those can all be different people. And often are.
Dr. Jim Dahle:
So, there’s lots of different ways to do this and it really comes down to what your goals are. For example, I don’t really have a personal life insurance need anymore. We’re financially independent. If I killed over tomorrow, Katie has plenty of money to go on and live the rest of her life in relative financial security. And so, I don’t really have a need for it.
Dr. Jim Dahle:
But on the other hand, the White Coat Investor business would certainly be severely impacted by my death. So, it might make sense to transfer one or both of the policies I have on me to the business. And the business pays the premium and receives any death benefit, but I’m still the insured.
Dr. Jim Dahle:
The benefit of transferring a policy like that in my case, where it’s a term life insurance policy, is that the business then pays the premium and I no longer have to pay it.
So, in a lot of ways that allows a premium to be paid with pretax dollars. Of course, the benefit is then paid to the business. In which case it’s basically still pretax dollars. If we want to take it out as profit, then you have to pay tax on it. And so that’s one downside, one upside to moving it to the business.
Dr. Jim Dahle:
The death benefit of course increases the value of the business. So, that’s pretty straightforward. However, if it’s a cash value policy, a whole life insurance policy or something like that, it becomes much, much more complicated. And it’s probably a more frequent occurrence that a policy is transferred from a business to an individual. Oftentimes a business offers that kind of a policy as some kind of a benefit or incentive package, part of the compensation for an employee. But frankly, these are usually sold to businesses by very slick insurance agents. And I think most of the time, it would be better to offer a better 401(k) match, a defined benefit plan, or even a higher salary instead.

Dr. Jim Dahle:
A business owner could transfer a personal cash value policy to a business, of course. That would be treated like a capital contribution to the business as far as taxes go. Why might you do that? Well, if the business had a need for a policy that you no longer needed, this key man insurance it’s often called might be a reasonable use of doing it.
Dr. Jim Dahle:
But you basically just have to look at what the insurance needs are for the individual and the business and see what the best ways to accomplish that is. And sometimes it’s by transferring a policy rather than buying a new one.
Dr. Jim Dahle:
All right. So, I’ve got a couple of special guests on the White Coat Investor podcast right now. We have Leti Alto and Kenji Asakura. These two fine doctors, you may know. Leti spoke at WCI con 20, and you may have taken their course. They have an online course on real estate called “Zero to Freedom with Cash Flowing Rentals”. Did I get that title, right? I think I’ve got it right.
Dr. Jim Dahle:
We had a podcast question a couple of weeks ago that I read on the air from an email I got from a listener and I got some feedback from these guys about it. Probably because the question involved their course. I don’t think we specifically mentioned that it was their course, but a lot of you probably realized it was.
Dr. Jim Dahle:
And so, I wanted to record a brief segment here with them as part of this podcast, just to provide a bit of clarification on the topic we addressed there.
Dr. Jim Dahle:
So, welcome to White Coat Investor podcast, guys. Do one of you want to explain what clarification was needed?

Kenji Asakura:
Sure, yeah. I think the main thing it’s about what we’ve done with our 401(k)s and the thought process behind liquidating our 401(k)s to invest in real estate.
Dr. Jim Dahle:
Yeah. So, it sounds like the writer, the email writer thought that you were recommending that for your students. And you felt like that was maybe a little too strong of a statement. Do you want to explain that a little bit more?

Leti Alto:
Sure. We really try to stay away from recommending anything. What we do is really share what we are doing and why. And so, that article to us was really about why we chose to liquidate one of our 401(k)s. And it was because we have real estate professional tax status or Kenji does, which allows us to be able to actually shelter taking that money out. And so, for us, we just wanted to explain why we went through that thought process because we know it is way outside the norm.

Dr. Jim Dahle:
Yeah. So, this is a really interesting topic and we’re actually going to do a deep dive on this, on the blog here in a few weeks. Kind of a pro con post about tapping your retirement accounts, whether it’s a 401(k) or Roth IRA or whatever, in order to do something else.
Dr. Jim Dahle:
And a lot of times the common wisdom is that you don’t touch your retirement accounts. And there’s a reason for that. It’s a good rule of thumb. But there are times when you have such great opportunities, whether it’s investing in your own education, your own entrepreneurial pursuit, your own practice when it’s possible, it can make sense. And so, these guys were in a fairly unique situation actually for doctors that led them to tap that money in order to basically invest in real estate in a nonqualified account, if you will.
Dr. Jim Dahle:
And one of those reasons, was the real estate professional status. So, for those who don’t know what real estate professional status is, this essentially gets you around a big limitation in using losses in your real estate investments against your regular income.
Dr. Jim Dahle:
A normal person that’s not a real estate professional, basically can only use the real estate losses to offset real estate gains and real estate income. Leti, do you want to explain what happens when you achieve real estate professional status and how that changes?

Leti Alto:
Great question. So, Kenji has real estate professionals, so it’s just one member of the couple. And what it allows us to do is take all these losses and shelter active income, which is mostly my active income, but also our blog income.
Leti Alto:
Then how we do that is we create massive losses using a hundred percent bonus depreciation, which is basically a way that the government allows you to write off a portion, a significant portion of your property, the year you buy it as a loss. And so, for example, an example we give to a lot of people is we just bought a $3 million apartment complex, and we’re going to write off $770,000 in bonus depreciation losses this year. So, that will shelter our $770,000 of income. And if we don’t have that much income, we can actually carry it forward. Or actually because of the cares act, we can carry it backwards.

Leti Alto:
And so, what we realized is if we liquidated the 401(k) and we paid that 10% penalty, we have no state income tax. And then we could take that money, which was I think like $350,000, buy a property and then use bonus depreciation to write off all the taxes, to cover taking out that 401(k). And so, for us, it was just the 10% penalty. And so, it made sense for us to access that money now and build our wealth. And we feel very confident that we can do that because we have so much real estate experience.

Dr. Jim Dahle:
So, the really interesting part about that, well, it got even better in 2018 when bonus depreciation became an even better deduction than it was before. But the really interesting thing here is everything you had going for you in that decision. Right? Because if I went and took money out of my retirement account, 37% federal, I’m going to pay, 5% state I’m going to pay plus 10% for the penalty, 52%. Basically, if I want to get $100,000 to use as a down payment on a property, I got to take $208,000 out of that account to do it, to cover all the taxes, which that’s obviously stupid to do.
Dr. Jim Dahle:
But if you’re not going to pay the taxes on that, because you’re wiping out all of your earned income with bonus depreciation, if you’re not paying state taxes, it obviously becomes a different decision.

Dr. Jim Dahle:
I just think people need to recognize that most doctors aren’t going to qualify for real estate professional status. This is a very unique thing among doctors in a lot of ways unless you’re basically transitioning from medicine to real estate as a career, you’re probably not going to get that status. Your spouse might, but you’re probably not going to get it. And so, I think that provides good clarification for why you did that and why it might not be a great idea for the average doctor.

Kenji Asakura:
Yeah. I think everybody has to look at their personal situation. Even, like we mentioned, you have to look at the state you live in and think about all the ramifications of your decision. I think for some of the people taking our course, they’re going for real estate professional status this year. And I think what happened was for some, they said, “Well, what sources of money do I have to invest in real estate to help me achieve real estate professional status?”
Kenji Asakura:
And so, for some people, this money was worth tapping because maybe they lived in a state where they didn’t have income tax. Maybe it was a situation very much like ours, where they could actually shelter all of that income that they liquidated. Again, it’s a case by case thing. Everybody has to look at their own situation. We put it out there as something that, “Hey, this is what we did, it’s not for everybody”. But again, these are the things you want to think about and decide if it’s right for you.
Dr. Jim Dahle:
Awesome. Well, I appreciate you guys coming on the White Coat Investor to provide that clarification. And for those of you interested in more information, more detail on this topic, we’re going to have a post running here in a few weeks. So, watch for that.
Kenji Asakura:
Thank you.
Leti Alto:
Thanks for having us.
Dr. Jim Dahle:
You are very welcome. All right, let’s take our next question from Bethany in North Carolina.

Bethany:
Hi, dr. Dahle. This is Bethany in North Carolina. Thanks for all you do to help us manage our money. I met your blog about two and a half years ago and I started getting my financial house in order. I met the Bogleheads. I figured out the Physician on FIRE and sat down and made an investor policy statement. I started an HSA, my HSA, a backdoor Roth. I finished my student loans at a very low interest rate. I started 529s and I was already maxing out my tax deferred spaces, but I started a taxable account just to see how that was going to work. And then this year I’ve learned how to tax lost harvest, which has been pretty fun.
Bethany:
My specific question comes as I sit down to review my financial situation and rebalance and make kind of intelligent decisions about what I’d like the next year, five years to look like. And I’m having a difficult time keeping all of that data in the same place in my head, in the same place in a spreadsheet.
Bethany:
I had originally started spreadsheets using the Physician on FIRE templates, and those have been pretty helpful. But now when I sit down to look at it all again and make sure that I understand our asset location, I understand our percentages, I understand our expense ratios that I’m having a hard time pulling it together. Any help that you can give or any place you can direct me to figure out how you hold all of these decision-making capacities would be helpful. Thanks so much.

Dr. Jim Dahle:
Okay. Well, congratulations, Bethany on your success. You’ve certainly accomplished a lot and you’re reaping the rewards of your diligence. So, how do you keep all this straight? Well, I don’t know if there’s a right answer to this, but I can tell you what we do.
Dr. Jim Dahle:
We use multiple documents. We have an investing policy statement. This is our written financial plan. That’s a word document. We have our investment worksheet. This keeps track of all the inflows and outflows of our investments and how much we have in each of our investments compiled across to all of our various accounts. It’s a very complicated worksheet. It has a thousand of entries on it that have occurred over the last 16 years.
Dr. Jim Dahle:
But it also has a little small worksheet at the end that helps me to know where to direct new money, which I find very helpful on a month to month basis, because it tells me which asset I’m behind on, so where I put my new investments for that given month.
Dr. Jim Dahle:
We have our monthly budget spreadsheet, which tells us where our money’s going that particular month. We have a separate spreadsheet that tells where our current cash holdings are, what they’re designated for, for instance. And we reconcile that once each month with the actual cash we have.
Dr. Jim Dahle:
So, we look at what we think we have that’s supposed to go to the tax, that’s supposed to go toward our short-term savings goals, et cetera. And reconcile that with the actual cash holdings in our cash accounts, like our checking account or savings account, et cetera.
Dr. Jim Dahle:
And then we also have a tithing sheet where we keep track of how much we are going to pay in tithing and into charity. And so, it’s a separate sheet. But once a month we go over each of those spreadsheets.
Dr. Jim Dahle:
You remember, there’s some things you don’t have to keep track of though, right? You don’t need to keep the expense ratios of your investments updated at all times. That’s just not relevant to your ongoing financial management. But anything that is relevant to your ongoing financial management, you’ll probably have to look out every month or so, and reconcile that with your other accounts.
Dr. Jim Dahle:
So, the way we do that is multiple spreadsheets. I think that’s probably what most people who actually keep track of this stuff are doing. You do have to spend some time with this stuff to keep it straight. It’s just the price you pay to become and stay wealthy.
Dr. Jim Dahle:
Okay. Our next question comes from Kelly, a military anesthesia resident.

Kelly:
Hi, Dr. Dahle. Thank you for taking my question. I am a military anesthesia resident with no student loan debt and several tax and deferred investment accounts. I’m in a really fortunate position that in 2018 my parents gifted me two UTMA accounts that were at Fidelity and Vanguard respectively. And at that time, I transitioned them into individual brokerage accounts.
Kelly:
Over the last year, I’ve been more interested in personal finance and I’ve been trying to simplify my portfolio and reduce fees. And to that end, I was considering transition all of those tax investments into Vanguard mutual funds.
Kelly:
Whoever when I went to try and figure out the cost basis at Fidelity of those accounts, in order to think about what the tax implications of that would be, I discovered that the cost basis was listed as unknown. And that’s going all the way back to the first statement I have, which was in 2018, when I became an individual brokerage account. I can’t find any statements from when the account was a UTMA.
Kelly:
And as far as I understand, I have the onus of proving to the IRS, what the cost basis is so as to not be tapped in the entirety of the amount as a capital gain. Is that correct? Is there something unique about the money having originally been invested as a UTMA account? How else could I go about trying to figure this out? Thank you so much.

Dr. Jim Dahle:
Oh, this is a dilemma. You do not want a cost basis of zero on this account because the consequences of that are that you’re going to pay capital gains taxes on the entire value of the account when you sell it. But it’s true. The onus of proving basis is yours.
Dr. Jim Dahle:
So, the first thing I would do is try to get records from your parents. Of when they originally bought these things, because that will establish cost basis. If they don’t have them, go to the companies that held the UTMA or UGMA accounts and see if they have old statements. Because then you can use that to establish the basis.
Dr. Jim Dahle:
Otherwise you’re going to pay capital gains taxes on all of that money. I mean, even if you can just get the approximate dates of purchase from your parents, you can look up the fund values on those dates and come up with a reasonable estimation and hopefully that’ll fly with the IRS if they ask you about.
Dr. Jim Dahle:
But ideally you got to come up with some way to establish cost basis. And if you don’t have old records and you can’t estimate it, you may end up paying taxes on the entire value which is really unfortunate.

Dr. Jim Dahle:
Have you ever considered a different way of practicing medicine? Whether you’re burned out, need a change of pace or looking to supplement your income, locum tenens might be the solution for you.
Dr. Jim Dahle:
If you’re not sure where to start, locumstory.com is a place where you can get real unbiased answers to your questions, to answer basic questions, like what is locum tenens to more complex questions about pay ranges, taxes, various specialties, and locum tenens works for PAs and NPs. Go to whitecoatinvestor.com/locumstory and get the answers.
Dr. Jim Dahle:
Be sure to check out the WCI network blogs at the physicianphilosopher.com at passiveincomemd.com and at physicianonfire.com. A lot of great information there available from a different viewpoint than mine, which I think will provide some value to you if you are interested in those subjects.
Dr. Jim Dahle:
Thank you to those of you who have left us a five-star review and told your friends about the podcast. Keep your head up, your shoulders back. You’ve got this and we can help. We’ll see you next time on the White Coat Investor podcast.

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.