Podcast #146 Show Notes: The 5-Year Rule for Roth IRA Conversions

The 5-year rule for Roth IRA Conversions can be confusing because there are two 5-year rules regarding Roth IRAs. The first five-year rule applies to Roth IRA contributions and determines whether the earnings will be tax-free. The second rule applies to Roth conversions and applies to whether or not the principal that was converted will be penalty-free when it comes out.

In the case of conversions, each conversion amount actually has its own five year time period. With multiple conversions, there may be multiple different five year periods underway at once. When withdrawals occur from the conversion amounts, they’re deemed to come out on a first in first out basis, so that means that the oldest conversions, the ones most likely to have finished their five year requirement, come out first, and the most recent conversions come out last.

We discuss in this episode why the rule is set up this way and how it will affect your retirement planning. We also answer listener questions about Roth vs Traditional 401(k) contributions, employers contributing to a different HSA for you, buying into a practice and losing your solo 401(k), defined benefit plans, how much cash to keep on hand, NNN properties, and why every solo 401k or SEP IRA isn’t self-directed.

Have you ever considered a different way of practicing medicine? Whether you are burned out, need a change of pace, or want to see the world, locum tenens might be that option for you. Not sure where to start? Locumstory.com is the place where you can get real, unbiased answers to your questions. They 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 Locumstory.com and get the answers.

Quote of the Day

Our quote of the day today comes from Benjamin Franklin who said,

“Taxes are indeed very heavy, but we are taxed twice as much by our idleness, three times as much by our pride, and four times as much by our folly.”

That is especially the case, I think, for most doctors out there. They’re making so many financial mistakes that the sum total of their financial mistakes is probably bigger than the sum total of their taxes.

The 5-Year Rule for Roth IRA Conversions

A listener left a speak pipe question saying,

“I have an arcane question about mega backdoor 401ks and five year waiting periods. I got into a bit of an argument with a colleague about this and I was hoping that you could help settle it. For background, everybody at my company can put up to 15 percent of each paycheck into a 401k after tax bucket, and from there they can roll it over directly to a Roth IRA or use an automatic feature which will convert it to the Roth 401k. The advantage of this feature is that it does so automatically after each paycheck so you don’t have to call Fidelity, which is nice, and because it’s done immediately there are never any earnings, and therefore no tax due on the conversion, which is also nice.

I figure most people would just use this feature, but my friend is a big proponent of continuing to do these direct rollovers to his Roth IRA every time, and his argument for it surprised me. He said by doing it this way he was getting the clock started on the five year minimum waiting period to be able to withdraw these contributions without a penalty. He said that if you instead convert it to the Roth 401k and then in the future you leave the company and roll that money over to the Roth IRA from there, that starts the timer then, which is undesirable. Which one of us is right?”

This is a very complex question. Remember with regards to the five-year rules that there are two five year rules regarding Roth IRAs. The first five-year rule applies to Roth IRA contributions and determines whether the earnings will be tax-free. The second rule applies to Roth conversions and applies to whether or not the principal that was converted will be penalty-free when it comes out.  In this question, we are talking about the second five-year rule, for Roth conversions.

To learn an unbelievable amount of information about this particular rule, I would refer you to an excellent blog post by Michael Kitces. It was dated January 1st, 2014, but it talks about both five-year rules in great depth,  so I would recommend checking that out.

In the case of conversions, each conversion amount actually has its own five year time period. With multiple conversions, there may be multiple different five year periods underway at once. When withdrawals occur from the conversion amounts, they’re deemed to come out on a first in first out basis, so that means that the oldest conversions, the ones most likely to have finished their five-year requirement, come out first, and the most recent conversions come out last.

Why does it have to be in there for five years before we can get it out penalty-free? Well, imagine this scenario, a 40-year-old wants to get into their traditional IRA money, and if he took a withdrawal at this point he would be subject to not only ordinary income taxes, but a 10 percent early withdrawal penalty.

But if he converted his IRA to a Roth IRA, he would have to obviously pay taxes on that conversion, but he could now take out the after-tax principal without paying any penalties, so by doing the Roth conversion you would be able to get around paying the 10 percent penalty, which obviously would be tapping it before age 59 and a half. The five-year rule is there to prevent that happening so you can’t get around the IRA withdrawal penalty. It does allow you to potentially gain access before age 59 and a half. You just have to wait the five year period.
The gains, of course, on that conversion, would still be taxable.

That is basically how the five-year rule works, so for a conversion, you have to wait five years before you can tap that principal, but that principal you can take out at any time without having to pay a penalty. It’s only earnings on a Roth IRA that you have to pay penalty on if you take them out before age 59 and a half.

In general, the strategy is to start the clock as soon as you can so you can get your money tax free and penalty-free as early as possible. This sort of planning is really important for FIRE types. Someone who is going to retire in their 30s or 40s or maybe even early 50s. But as you get close to age 59 and a half retirement, this becomes much less of an issue.

At that point, you probably have other resources you’re going to be tapping before you get into your Roth IRAs. You can use the substantially equal periodic payment rule to get to your money before age 59 and a half without paying any penalties. It’s really only the really early retirees that mess with this sort of planning.

This listener’s question was not necessarily about IRAs but about 401ks. When a designated Roth account from an employer retirement account is rolled into a Roth IRA, the years in the Roth employer account do not count toward the five-year rule. You get your own five-year rule once it goes into the Roth IRA. All that counts is that original five-year rule for the Roth IRA.

If there was no existing Roth IRA and the rollover from the Roth 401k created the account for the first time, that starts a new five year clock for the IRA even if the old Roth 401k had satisfied its own five year rule. They just don’t carry over. Basically, in answer to the question, your friend is right. If this matters to you because you’re going to FIRE soon, and you plan to use that money long before age 59 and a half, you should go through the hassle of doing the Roth IRA rollovers like your friend is doing.

But for many, many people this just doesn’t matter because they’re either not going to retire early or they have other funds to spend first rather than their Roth IRA principal. I mean, that would be one of the last things I would be wanting to spend in retirement. I would be going through my taxable money and any 457 plan money I had before trying to go after my Roth IRA money. If that’s your situation, then you’re right, too, so both you and your friend are right depending on what your situations are for getting money out of there.

As a general rule, you want to be burning through your taxable money and your 457 money as an early retiree, and save your retirement account money, especially Roth money, to be used later in retirement. In my case, I’ll bet my taxable portfolio right now makes up about 60 percent of my portfolio. Tax-deferred is probably 30 percent and Roth money is probably 10 percent. I’ll bet those ratios are pretty similar for most FIRE types. They are just saving too much money to be able to save it all inside retirement accounts.

Reader and Listener Q&A

Advice for Debt-Free Medical Student

A medical student will graduate with no debt thanks to his family and he asked for specific advice for someone in his shoes. I know many of you are frustrated with your student loan burden but the truth is about one-quarter of medical students don’t have any debt at graduation. That oftentimes comes from them getting a lot of support from their family. Remember that the population of medical school definitely skews towards the higher income quintiles. I think something like 70 or 80 percent of medical students come from the top 20 to 40 percent of the population, and so it’s not surprising, I guess, that a fair number of medical students don’t have any debt at all.

But a significant chunk of those just have contracts like what I had. I had a military contract and when they asked me that question on the exit survey as an MS4, I put no debt because I didn’t have any financial debt, but I owed a time debt, and so I think a significant chunk of those folks are also military docs and people with other sorts of contract-style debt rather than financial debt.

But what do you do if you don’t have debt? You’re basically just starting $200-300,000 ahead of everybody else. Rather than having to focus on those student loans, and coming up with a student loan management plan during residency, and a plan to wipe them out after residency, you just get to skip all of the hassle. Your financial life just became a lot more simple. It allows you to focus on a few other things. You can save up an emergency fund. If you have any earned income, you can put that into a Roth IRA. You can get the saver’s credit for doing that because you’ll be at such a low-income level you should be able to get a pretty significant saver’s credit. You may also start looking a little bit earlier into getting things like disability insurance.

A lot of times, you actually can buy that as a medical student. I have a hard time telling people to buy it using borrowed money, but I suppose if you’re not living on borrowed money, maybe you can justify buying that as a med student rather than waiting until you’re an intern.

If you are not in debt because you saved up a bunch of money before medical school, maybe you had another career or something like that, medical school is a great time to do some things with your retirement plans. If you have a bunch of tax-deferred money, you can do Roth conversions during medical school for free, and so as long as you keep your income below the minimum taxable income and take advantage of the standard deduction or any other deductions you may have, you might be able to convert tens of thousands of dollars during four years of medical school without paying any taxes on it at all.

A lot of people wonder if they should cash out of their retirement accounts that they saved up before medical school in order to pay for medical school, but I think a better use of that money is just to do free Roth conversions in medical school. For the most part, I like the idea of using up your personal assets and any family assets you have before you borrow, but if it’s inside a retirement account I kind of feel a little bit differently about that.

Roth Versus Traditional 401K Contributions

“My question revolves around Roth versus traditional 401k contributions. I know your traditional advice is that residents go Roth. After going through the numbers, I’m thinking I may be better off doing predominately tax deferred, but wanted to get a second opinion.

Through my employer I can do either Roth or traditional 401k contributions. I’m a fellow, so I can do a fair amount of moonlighting. My gross pay is around 150,000. My wife is a resident who makes around 55,000. I’m going for PSLF but I owe about 250K in loans and I’m already five years through and have at least two and a half more years at fellowship. At the time I should theoretically qualify for forgiveness, my loan balance will still be around 200, assuming I continue to make my payments based on my taxable income, and where I file them separately. I maxed out my employer sponsored 401k. In my tax deferred 401k, I get a 1.75 percent match which tops out after I put more than four percent in, and no match for Roth contributions.”

I get lots of questions about Roth versus traditional 401k contributions and they’re difficult to answer. It would be easy to just say, “Oh, always use Roth all the time,” but the problem is that’s not always right, and it’s difficult to come up with a really good rule of thumb that always works every time. The basic rule of thumb is to use tax-deferred accounts during your peak earnings years, but there are exceptions to that, particularly for Supersavers.

If you’re going to have 20 million dollars in retirement, you may want to favor using Roth contributions, for example, even during your peak earnings years. Then, of course, the rule of thumb when you’re not in a peak earnings year is to use a Roth account, but there are exceptions to that. For example, if you are in residency and want to lower your IDR payments and hopefully get more forgiven through public service loan forgiveness, you might use a tax-deferred account instead of a tax-free account. There are exceptions in every respect.

But this doctor is wondering if he’s an exception as a fellow who’s moonlighting making 150,000 dollars, whose spouse is making 50,000 dollars as a resident and is going for public service loan forgiveness. Well, you may be just because you’re going for public service loan forgiveness. The lower your taxable income, the less you’re going to pay in IDR payments, and the more will be left to be forgiven, but that requires doing what you’re doing, which is being enrolled in the pay as you earn program, and filing your taxes, married, filing separately.

That sounds like that’s what you’re doing, so that’s a reasonable exception to use a tax-deferred account at least for her. Now, since you’re married filing separately, you don’t actually need to do that, but those are really the considerations to take in there. The truth of the matter is if you’re saving something during residency or fellowship, you’re winning. Even if it’s a tax-deferred account, that’s not the end of the world. The general rule during residency is use a Roth account unless you have a really good reason not to, which usually means going for public service loan forgiveness.

He also mentions that he’s not getting a match for Roth contributions but is getting a match for tax-deferred contributions. That doesn’t make any sense at all. I wonder if there’s some confusion on that point. I don’t think you can legally match one kind and not the other. Obviously, if that is somehow the case, that would be an argument against a Roth account but mostly the reason why this doctor would be an exception is because of the pay as you earn, and the married filing separately, and the public service loan forgiveness plan.

Not so much the fact that your income’s a little bit higher than a typical fellow.

HSA Contributions

A listener asked if his employer can contribute directly to his HSA of choice instead of the one that all his partners want to use with higher fees. I guess the employer could but generally, they won’t. It typically has to go to the employer’s designated HSA in order to get those employer dollars contributed or for you to save payroll taxes on it. Now, you’re allowed to put HSA money anywhere you like, but if you want to save the payroll taxes, the social security, and Medicare taxes on it, it has to go through payroll, and that usually means it is at least going to stop in your employer’s designated HSA for a while.

Now, you can do a rollover once a year and move that to your preferred HSA location, whether that’s Lively or Fidelity, or whatever, but otherwise you either have to not get those payroll tax savings, or you have to go through your employer’s designated HSA. If you’re self-employed, of course, it doesn’t really matter.

Retirement Accounts When You Buy into a Practice

“My question today relates to 401(k)s. In my situation, I am currently set up as an S corporation. I currently work at a few different offices, and I have an individual 401k that I took out last year, I started contributing to, and maxed out. Now, this summer, in about six months, I will have the opportunity to buy into one of those offices that I’ve been working at and I’m planning to do so. Now, it’s my understanding that once I buy in I cannot contribute to my individual 401k as I will have to contribute to the company, or that practice’s 401k that is available to all employees. Am I still able, for these first six months before I buy in, am I still able to max out my individual 401k or come as close to maxing it out as possible?

If I am, I would love to do that. Also, once I have bought into that practice, I will still have other 1099 income from other practices. Can I use that income to contribute to my solo 401k and contribute to that in many years to come?”

It sounds like you are currently an independent contractor and you’re becoming a partner in a multi-partner group, while still functioning as an independent contractor for at least some of your income, so you’ll soon be able to use two 401ks, since those two employers are totally unrelated.

That gives you two $57,000 per year maximum for the employee plus employer contribution limits. One for each 401k, as dictated by the rules of each 401k, but between the two of them you only get one 19,500 dollar employee contribution, so use that one wisely. The way most people in this situation use it is they max out the employer 401k employee contribution, or at least put in enough to max out the match, and then just put 20 percent of their self-employed earnings into the individual 401k.

If you didn’t use your whole employee contribution in your employer’s 401k, you can put that into your individual 401k, but usually, you only do that if your employer’s 401k is really terrible and you’re just trying to get the match out of it and that’s it.

Defined Benefits Plan

“My accountant states this type of plan would be beneficial for me. I’m paid around $430,000 dollars yearly as a 1099 contractor. I have an S corp with a solo 401k which I max out each year. I also max out my backdoor Roth IRA. According to my accountant, I’m able to put away $134,000 dollars a year into a defined benefit pension plan. We’re trying to save as much pre-tax money as possible, given our large dual-physician income.”

$134,000 a year into a defined benefit cash balance plan seems awfully high for a 37-year-old. I’m a little bit skeptical, but if that’s what the actuary says it works out to be, I suppose it could be true. Certainly, I know doctors in their 50s that can put up to $200,000 or so into a defined benefit cash balance plan.

Unfortunately, my stupid plan only lets me put in $17,500 as a 44-year-old. It goes up every five years as you get older, but it’s really not until you’re in your 50s that you get to put a big chunk of money in there, so I’m a little bit jealous if you really can put quite that much money into a defined benefit plan.

Given your goal to put away more tax-deferred money, it sounds like it would be a good idea for you to do it. Even if you can only put in $20,000 a year, which is kind of what I expected you to say, I’d still go for it. I think that’s probably, given your goals, a good idea.

How Much Money to Keep in Cash

“I keep hearing that keeping too much money as cash in the bank is not a great idea because it’s not doing anything for you. My question is how much money should you keep cash in the bank, and how much is too much? $1,000, $5,000, $10,000? At what point after saving it would you consider moving it to investments?”

It’s really difficult for me to answer this situation because I’m in such a different situation than most doctors these days. We keep much, much more money than that in cash and it’s mostly just for cashflow needs. We have payroll to make and we have business expenses coming out, and we have to make our 401k contributions, and all that kind of stuff, and so we end up with lots of money in cash compared to those amounts that you’re talking about in this.

How much is too much? Well, I think most people try to keep an emergency fund of three to six months of expenses placed away somewhere, whether that’s in a short term bond fund, or whether that’s in I-bonds, or whether that is in a high yield savings account, or a money market fund, or CDs. I think that’s really all you have to keep in cash.

Above and beyond that, I think it’s mostly just for your own cashflow needs, and if your cashflow needs aren’t very significant then you don’t have to keep very much in cash, but if you’re spending $15,000 a month, you might need $15,000 in the checking account just to keep from bouncing checks, keep from bouncing your automatic credit card payments, and that sort of a thing.

It really depends on how closely you’re going to watch that account and be moving money in and out knowing when the expenses are coming in and going out. If you just don’t want to deal with that, you tend to do what I do and just leave more cash in there. If you are willing to watch it really closely, you can obviously earn a little bit more money on that cash.

It is a constant weighing game of hassle versus a little bit of extra interest, and depending on how much that interest is worth to you, you might be willing to deal with the hassle a little bit more.

Going Back into Debt to Change Careers

“I make $300,000 as a general dentist but don’t get a lot of enjoyment at my job. I would love to go back to residency for orthodontics, but residency for three years costs $300,000 dollars. I’m not sure how much more I would make as an orthodontist, but I would enjoy the job more. Am I committing financial suicide by going back into student debt to be an orthodontist?”

It sounds like it’s time to do some more research, to decide whether the investment is worth it or not. For example, I know an orthodontist making $225,000 dollars a year, and I know orthodontists making seven figures. If it’s going to make you happier and it’s going to make you enough additional money to justify the investment of time and money, I’d go for it. If not, I’d just figure out ways to optimize your practice to get you to FIRE as soon as possible.

But I think those are the decisions to make. If you expect you’re going to go into a half time practice in a tiny town that doesn’t have very many patients to do orthodontics, it’s probably not worth paying $300,000 dollars, not to mention the opportunity cost in order to do that.

But if you’re really committed that you’re going to do this for 20 or 30 years, and you have a pretty good business mind, and you’re going to open a practice, and you’re going to run it as efficiently as my kids’ orthodontist, you’re going to make a killing, and so it would be a good financial move.

But the truth is you only get one life, and if being an orthodontist is going to make you happy and being a general dentist is not making you happy, maybe it’s worth it even if it doesn’t work out perfectly well financially. Certainly, most orthodontists are not going to have trouble knocking down an extra $300,000 dollars in student loans.

They generally make enough, more than a typical dentist, to be able to take care of that. That assumes you do a good job, and get a nice, high income as an orthodontist.

Backdoor Roth IRA

“I have a question about my backdoor Roth IRA. I opened it in January 2019, contributed to my traditional IRA for 2018 and 2019, and did the conversion to my Roth IRA the same month through Vanguard. I’m going to fill out my form 8606 for my 2019 taxes as per your tutorial, My 2019 1099 for Vanguard says my contributions are $11,500, as it should, but TurboTax is saying I contributed $5,500 excess to my IRA for 2019, resulting in a six percent penalty until it is corrected.

Since this was for my 2018 contribution, I don’t think it is correct that I am in excess, will filling my form 8606 correctly resolve this issue?”

 

Remember when you do late contributions, meaning you’re contributing for 2018 in calendar year 2019, or you’re contributing from 2019 in calendar year 2020, that the contribution goes on the 8606 for the tax year, so if it was a 2018 contribution made in 2019 it goes on your 2018 8606.

The conversion goes on the tax form for the calendar year that you did the conversion in, so if you made a contribution in January of 2019 for 2018, and then converted it in 2019, the contribution would go in your 2018 8606, and the conversion would go in your 2019 8606, and if you keep that straight usually the paperwork won’t be screwed up.

This is why it’s so much easier to just do the contribution and conversion during the same calendar year, but that’s basically what the problem is. If you go back and realize that you didn’t file a 2018 8606, or you filled it out wrong, you need to go back and correct that, file a 1040X with it, and then it should be correct for this year.

NNN Properties

One listener asked about NNN properties or triple net properties. A triple net lease is not a specific asset class or an investment. It’s just the way the rental contract is written. A triple net property is net of taxes, net of maintenance costs, and net of insurance, so the landlord doesn’t pay any of that stuff. The tenant does. You’re transferring some risk from the landlord to the tenant in exchange for a lower rent.

Lots of landlords like this because it’s a little bit decreased risk and a little bit decreased hassle, but it’s not some sort of extra special investment. It’s just basically a different type of contract to put in place on the property. I suppose you could do it on a residential property, but almost always these are commercial, especially retail and industrial properties in which the tenant’s responsible for all that sort of stuff.

But if you’re looking for even less hassle in direct real estate ownership, a triple net lease can be a way to do that.

 

Timing for Contributing to Traditional IRA vs Backdoor Roth IRA

“I have a question about the timing of when to contribute to a traditional IRA versus doing a backdoor Roth IRA. Currently, my wife and I have only been doing backdoor Roths. We’re both in our early 30s but we have a marginal tax rate of 35 percent. I’m a private practice urologist and she’s a CRNA, and I understand the advantage of doing the traditional IRA contribution for the pretax write off, but my issue is the fact that we are still in our early to mid 30s, and we are not going to touch this money until we are at least 59 and a half, and hopefully much later.

Would it be more wise to take advantage of the longterm gains with the Roth IRA being tax free versus taking the pretax break right now? I understand that later in our career when the money doesn’t have as long to compound it would make sense to do it traditional. Just curious on your thoughts on this, and about what age would you definitely start switching to traditional contributions in your peak earning years?”

Most urologists and CRNAs have a retirement plan at work, and they make too much money so they cannot deduct traditional IRA contributions at all. They also cannot contribute directly to a Roth IRA, so their only option there as far as their IRA accounts go is a backdoor Roth IRA. Regarding a Roth versus a tax-deferred 401k, it’s a lot more complicated question. The usual answer is tax-deferred during your peak earnings years and Roth at all other times, but there are lots of exceptions.

In your case, though, this is really straightforward. A backdoor Roth IRA is what you ought to do.

Self Directed 401k vs Not Self Directed 401k

“I had a quick question about people with individual LLCs. I am in the process of trying to start a solo 401k versus a SEP IRA for 2020, and the question I had is what is the difference between a self directed solo 401k versus a not self directed? I know the versatility is a little bit more for the self directed, and to my understanding you can invest in honestly whatever you want, with some limitations, so why aren’t every solo 401k and SEP IRA self directed, then?”

Why aren’t they all self-directed?  Well, it’s a little bit more of a hassle to be self-directed, and the classic example of a self-directed 401k or IRA is a checkbook account, where basically you can write a check and invest it in any allowed investment; usually, this means real estate.

You know, you can write a check and put it into a private real estate fund, or a syndication, or something like that, and use that 401k or IRA money in order to invest in that sort of thing, but there’s a little bit more of a hassle to running the account. Someone has to keep track of the checks. They have to provide you checks to start with, and so it’s usually the big brokerage houses, the big mutual fund houses don’t have this feature.

You usually have to go to a separate company, usually, a smaller company like one of our partners My Solo 401K or Rocket Dollar and they will help you set up an account like this. It’s going to cost you a few hundred dollars in fees to set up, and then $100 or $200 a year to maintain it.

So it costs more than going to E-Trade, Vanguard, or Fidelity and just opening a solo 401k and investing in mutual funds there, but you won’t have quite as many investment choices. There is not a right answer or a wrong answer. I’ve had a standard solo 401k at Vanguard. I’ve had a self-directed 401k, and they both have their pluses and minuses. It’s just a matter of whether you’re willing to pay a little bit more in fees in order to have some other investment options.

Ending

Would you have answered any of these questions differently? Let me know in the comments. If you have questions you would like answered on the podcast, you can record them at Speak Pipe. 

 

Full Transcription

Intro:
This is the White Coat Investor podcast, where we help those who wear the white coat get a fair shake on Wall Street. We’ve been helping doctors and other high income professionals stop doing dumb things with their money since 2011. Here’s your host, Dr. Jim Dahle.

Jim:

This is White Coat Investor number 146, the five year rule for Roth conversions. Welcome back to the podcast. Hopefully, we’re giving you some useful information here. Common sense stuff, a lot of it, but sometimes we really get into the weeds when it comes to financial matters.

Jim:
If you feel like we’re getting out there in the weeds a little bit too much, just give us a couple of minutes, and we’ll get back to the basics. We don’t spend too much time talking about that sort of stuff. We try to focus on the real issues that real doctors and other high income professionals are dealing with.

Jim:
Have you ever considered a different way of practicing medicine? Whether you are burned out, need a change of pace, or want to see the world, Locum Tenens might be that option for you. Not sure where to start? Locumstory.com is a place where you can get real, unbiased answers to your questions. They 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 MPs.

Jim:
Go to Whitecoatinvestor.com/locumstory and get the answers. All right, our quote of the day today comes from Benjamin Franklin who said, “Taxes are indeed very heavy, but we are taxed twice as much by our idleness, three times as much by our pride, and four times as much by our folly.” And that’s especially the case, I think, for most doctors out there.

Jim:
They’re making so many financial mistakes that the sum total of their financial mistakes is probably bigger than the sum total of their taxes. Speaking of taxes, it’s kind of tax time right now. If you need help with your taxes, we have a great resource for you. If you go to the Whitecoatinvestor.com website and you go up under our recommended pages, you can go up under that menu and you will find at the bottom tax strategists.

Jim:
And it’s been years we’ve spent trying to build this list up because of always being asked by people, “Who can I go to for help with my taxes?” But now we finally got, oh, looks like one, two, three, four, five, six, seven, eight, nine firms there that you can check out and get help preparing your taxes and coming up with a strategy to lower your taxes, so a great option there. Check it out at Whitecoatinvestor.com/tax-strategists.

Jim:
Thanks for what you do. Medicine is not always easy. Sometimes it’s boring, sometimes it’s chaotic, sometimes it’s difficult, and sometimes it’s just heart wrenching, but if nobody’s told you thanks today, let me be the first. Okay, I got to do amia culpa to start with here. Apparently I did not answer a question a couple of weeks ago, and in fact not only did I not answer it but I titled the entire podcast according to the question I didn’t actually answer.

Jim:
I got some, not hate mail, I got some feedback on it. What’s interesting though is apparently Cindy caught this just before we went to press and she just let it go, so she has to share the blame with me for this one. Apparently the question I thought they asked was how to send money from the United States to India when in reality the question was how to sent money from India to the United States.

Jim:
Here’s one of the emails I got. I’m a big of your podcast. Just listened to your podcast today, money to India. The caller asked you about how to manage the money they from his dad in India, and I think you answered as if the caller wants to send money to India. I’m pretty sure there are a lot of legal issues with that. Could you elaborate on that in your future podcast, and remember there are some rich parents in India who can give 500,000 dollars or more to their kids in the US.
Jim:
And I got another one. I just listened to this podcast. I think you misunderstood the question from Bershont based on which you have titled the podcast. I think what he was asking is his parents way to send him 500,000 dollars worth of money from India to the US. I think that’s what he was asking, about how can he park that huge sum here. Well, it turns out that it’s actually even easier to send money from India to the US.
Jim:
During any given financial year, which in India is April to March, you can send 250,000 dollars from India to the US no questions asked. There are no regulations on it, there are no taxes due on it, so if you wanted to send half a million dollars to the US, you could do it. You just have to split it between two different financial years. No big deal.

Jim:
Although it’s not incredibly difficult to send money to India as well, that wasn’t really what they were asking. In the US, it’s interesting. The US has a gift tax on the person who gives the gift. In India, it taxes the person who receives the gift, which makes it even easier to bring money from India to the US because you are doing neither of those things. You are neither giving the gift in the US nor receiving the gift in India, so it’s pretty easy.

Jim:
Okay, let’s go onto our next question, this one from Michael.
Michael:
Hi, Dr. Dahle. My name is Michael. I’m a first year medical student in Kentucky. I’m married to a physician assistant who has about 110, 115, somewhere in that thousand dollars of debt, from all of her schooling combined. I currently have no debt from undergrad thanks to my father who’s also a physician who suggested that I start thinking about finances now and try to learn from some of his failures. He’s actually paying for my education, so I will graduate medical school with no debt.

Michael:
I’m very fortunate. Because I’m so fortunate, I’ve been thinking a lot, and listening to a lot of things, and I’ve been on your podcast for a while now and I have your book and I would just like to know if you had any specific advice for a youngun like me. I know a lot of my classmates haven’t even thought about that. They just kind of write it off as, “Well, I’m in debt anyways, who cares?”
Michael:
But I don’t want to be that way, but especially since I’m not in debt or I won’t be in debt from medical school. I do have some family debt, like I said, with my wife, but I would just like to know if you had any advice for getting a jump on the game because I don’t want to be the average person who’s got a lot of debt.
Michael:
I want to capitalize on my blessings, which is being debt free, so any advice you have would be great. Thank you, and I really appreciate your podcast. Thanks.
Jim:
All right. What advice do I have for a medical student with no debt at all? First of all, congratulations. There are a lot of very bitter people who just heard that who are frustrated with their student loans, and can’t believe that you are so fortunate as to not have any, but the truth is about one quarter of medical students don’t have any debt at graduation, and that oftentimes comes from them getting a lot of support from their family.
Jim:
Remember that the population of medical school definitely skews towards the higher income quintiles. I think something like 70 or 80 percent of medical students come from the top 20 to 40 percent of the population, and so it’s not surprising, I guess, that a fair number of medical students don’t have any debt at all.

Jim:
But a significant chunk of those just have contracts like what I had. I had a military contract and when they asked me that question on the exit survey as an MS4, I put no debt because I didn’t have any financial debt, but I owed time debt, and so I think a significant chunk of those folks are also military docs and people with other sorts of contract-style debt rather than financial debt.
Jim:
But what do you do if you don’t have debt? Well, I think you’re basically just starting two or 300,000 dollars ahead of everybody else. You know, rather than having to focus on those student loans, and coming up with a student loan management plan during residency, and a plan to wipe them out after residency, you just get to skip all of the hassle, so your financial life just became a lot more simple. But it does allow you to focus on a few other things.
Jim:
You know, you can save up an emergency fund. If you have any earned income, you can put that into a Roth IRA. You can get the saver’s credit for doing that because you’ll be at such a low income level you should be able to get a pretty significant saver’s credit. You may also start looking a little bit earlier into getting things like disability insurance.
Jim:
A lot of times, you actually can buy that as a medical student. I have a hard time telling people to buy it using borrowed money, but I suppose if you’re not living on borrowed money, maybe you can justify buying that as a med student rather than waiting until you’re an intern.
Jim:
If you are not in debt because you saved up a bunch of money before medical school, maybe you had another career or something like that, medical school is a great time to do some things with your retirement plans. If you have a bunch of tax deferred money, you can do Roth conversions during medical school for free, and so as long as you keep your income below the minimum taxable income and take advantage of the standard deduction or any other deductions you may have, you might be able to convert tens of thousands of dollars during four years of medical school without paying any taxes on it at all.
Jim:
A lot of people wonder if they should cash out of their retirement accounts that they saved up before medical school in order to pay for medical school, but I think a better use of that money is just to do free Roth conversions in medical school. For the most part, I like the idea of using up your personal assets and any family assets you have before you borrow, but if it’s inside a retirement account I kind of feel a little bit differently about that.

Jim:
All right, let’s go onto our next question from Christian, this time.
Christian:
Hey, Jim. This is Christian and I’m a second year cardiology fellow. First, thanks for everything you do. My question revolves around Roth versus traditional 401k contributions. I know your traditional advice is that residents go Roth. After going through the numbers, I’m thinking I may be better off doing predominately tax differ, but wanted to get a second opinion.
Christian:
Through my employer I can do either Roth or traditional 401k contributions. As stated, I’m a fellow, so I can do a fair amount of moonlighting. My gross pay is around 150,000. My wife is a resident who makes around 55,000. I’m going for PSLF up but I owe about 250 in loans and I’m already five years through and have at least two and a half more years at fellowship.
Christian:
At the time, I should theoretically qualify through forgiveness. My loan balance will still be around 200, assuming I continue to make my pay as year end payments based off my projected income, so I’m in pay as you earn, as my loan payments are based on my taxable income, and where I file them separately. I maxed out my employer sponsored 401k.

Christian:
In my tax deferred 401k, I get a 1.75 percent match which tops out after I put more than four percent in, and no match for Roth contributions.
Jim:
Okay, always getting lots of questions about Roth versus traditional 401k contributions, and they’re difficult to answer. It would be easy to just say, “Oh, always use Roth all the time,” as some other podcast hosts sometimes do, but the problem is that’s not always right, and it’s difficult to come up with a really good rule of thumb that always works every time. The basic rule of thumb is use tax deferred accounts during your peak earnings years, but there are exceptions to that, particularly for Supersavers.
Jim:
If you’re going to have 20 million dollars in retirement, you may want to favor using Roth contributions, for example, even during your peak earnings years, and then, of course, the rule of thumb when you’re not in a peak earnings year is to use a Roth account, but there are exceptions to that. For example, if you are in residency and want to lower your IDR payments and hopefully get more forgiven through public service loan forgiveness, you might use a tax deferred account instead of a tax free account, and so there’s exceptions in every respect.
Jim:
But this doc is wondering if he’s an exception as a fellow who’s moonlighting making 150,000 dollars, whose spouse is making 50,000 dollars as a resident and is going for public service loan forgiveness. Well, you may be just because you’re going for public service loan forgiveness. The lower your taxable income, the less you’re going to pay in IDR payments, and the more that will be left to be forgiven, but that requires doing what you’re doing which is being enrolled in the pay as you earn program, and filing your taxes, married, filing separately.

Jim:
And that sounds like that’s what you’re doing, so that’s a reasonable exception to use a tax deferred account at least for her. Now, since you’re married filing separately, you don’t actually need to do that, but those are really the considerations to take in there. You know, the truth of the matter is if you’re saving something during residency or fellowship, you’re winning, here. Even if it’s tax deferred account, that’s not the end of the world, but the general rule is during residency, use a Roth account unless you have a really good reason not to which usually means going for public service loan forgiveness.
Jim:
He also mentions that he’s not getting a match for Roth contributions but is getting a match for tax deferred contributions. That doesn’t make any sense at all. I wonder if there’s some confusion on that point? I don’t think you can legally match one kind and not the other. Obviously, if that is somehow the case, that would be an argument against a Roth account but mostly the reason why this doc would be an exception is because of the pay as you earn, and the married filing separately, and the public service loan forgiveness plan.
Jim:
Not so much the fact that your income’s a little bit higher than a typical fellow. All right, for those of you who have heard about AlphaInvestingFund1, that’s closing here at the end of the month. If you’re still interested in investing in that, go to www.Whitecoatinvestor.com/alphainvesting. If you have no idea what I’m talking about but you’re interested in learning more about private real estate, syndications, or funds, be sure to sign up for our real estate opportunities email list at Whitecoatinvestor.com/newsletter.

Jim:
All right, our next question comes from Andrew.
Andrew:
Hi, Jim. I have a somewhat unique question regarding HSA contributions. I’m a partner in a medium sized private practice radiology group. We use health equities for our partners and employees. The practice funds each partner’s HSA in full in January of each year. For example, 7,100 dollars one time contribution for 2020 to be made in January. Last year, I transferred the entirety of my health equity balance into a personally held Fidelity HSA account for its lower fee structure.
Andrew:
All of my other partners continued to hold their assets with health equity and are not interested in switching for various reasons. Will I need to continue to have our bookkeeper deposit my funds into my health equity account each year going forward and then transfer it to my Fidelity account every year, which requires some paperwork, or am I allowed to have her deposit it directly into my personally held Fidelity account? Our benefits manager seemed stumped when I asked this, and I cannot seem to find a good answer online. Thank you for your time and all that you do.

Jim:
Okay. He wants to know if his employer can contribute directly to the HSA he’s opened on the side. Well, I guess they could, but they generally won’t. It typically has to go to the employer’s designated HSA in order to get those employer dollars contributed, or for you to save payroll taxes on it. Now, you’re allowed to put HSA money anywhere you like, but if you want to save the payroll taxes, the social security, and Medicare taxes on it, it’s got to go through payroll, and that usually means it’s at least going to stop in your employer’s designated HSA for a while.
Jim:
Now, you can do a rollover once a year and move that to your preferred HSA location, whether that’s Lively, or Fidelity, or whatever, but otherwise you’ve either got to not get those payroll tax savings, or you’ve got to go through your employer’s designated HSA. If you’re self-employed, of course, it doesn’t really matter. You know, if you’re a partner, you’re on a 1099, you might as well contribute directly from Fidelity, but I couldn’t tell from this question whether Andrew was an employee or not so I had to be a little bit more general in the answer.
Jim:
If you need a self-directed 401k, you can check out Whitecoatinvestor.com/my401k to learn more about how you can use your 401k to invest in more than mutual funds. All right, next question comes from Phil.

Phil:
Hi, Jim. My name is Phil and I’m a software engineer in the Bay Area with an arcane question about mega backdoor 401ks and five year waiting periods. I got into a bit of an argument with a colleague about this and I was hoping that you could help settle it. For background, everybody at my company can put up the 15 percent of each paycheck into a 401k after tax bucket, and from there they can roll it over directly to a Roth IRA or use an automatic feature which will convert it to the Roth 401k, and the advantage of this feature is that it does so automatically after each paycheck so you don’t have to call Fidelity, which is nice, and because it’s done immediately there are never any earnings, and therefore no tax due on the conversion, which is also nice.
Phil:
I figure most people would just use this feature, but my friend is a big proponent of continuing to do these direct rollovers to his Roth IRA every time, and his argument for it surprised me. He said by doing it this way he was getting the clock started on the five year minimum waiting period to be able to withdraw these contributions without a penalty. He said that if you instead convert it to the Roth 401k and then in the future you leave the company and roll that money over to the Roth IRA from there, that starts the timer then, which is undesirable.

Phil:
I thought initially that he was just plain wrong but after some googling about this, specifically with how it works for the mega backdoor 401k, and going through some very long Boggleheads threads, I realized this is much more confusing than I thought, so I was hoping that you could shed some light on the subject. Which one of us is right? Thanks.
Jim:
All right. Here’s the question I named the podcast after, and this is a very complex question, but the first thing we’ve got to get to here is that the man’s name is Jack Bogle, it’s not Jack Boggle, and so his followers are the Bogleheads, not the Boggleheads, and if you’ve only ever read the word I suppose I can forgive you for mispronouncing that, but once you’ve met the man it’s hard to mispronounce his name, so I think it’s important to correct that.
Jim:
But remember with regards to the five year rules that there are two five year rules regarding Roth IRAs. The first five year rule applies to Roth IRA contributions and determines whether the earnings will be tax free. The second rule applies to Roth conversions and applies to whether or not the principal that was converted will be penalty free when it comes out, so what we’re talking about this question is the second five year rule. The five year rule for Roth conversions.
Jim:
And if you want to learn an unbelievable amount of information about this particular rule, I would refer you to an excellent blog post at Kitchies.com. It was dated January 1st, 2014, but it talks about both five year rules in great depth in that podcast, so I would recommend checking that out, and he talks about on that podcast that in the case of conversions each conversion amount actually has its own five year time period.

Jim:
With multiple conversions, there may be multiple different five year periods underway at once. When withdrawals occur from the conversion amounts, they’re deemed to come out on a first in first out basis, so that means that the oldest conversions, the ones most likely to have finished their five year requirement, come out first, and the most recent conversions come out last, and so that’s a good thing.
Jim:
But to understand the purpose of this rule, why do we have this rule? Why does it have to be in there for five years before we can get it out penalty free? Well, imagine one of those scenarios, okay? Let’s say somebody’s 40. They want to get into their traditional IRA money, and if he took a withdrawal at this point he would be subject to not only ordinary income taxes, but a 10 percent early withdrawal penalty.
Jim:
But if he converted his IRA to a Roth IRA, he would have to obviously pay taxes on that conversion, but he could now take out the after tax principal without paying any penalties, so by doing the Roth conversion you would be able to get around paying the 10 percent penalty, which obviously would be tapping it before you got to age 59 and a half, and so that’s why they have to have the five year rule in there, so you can’t just do that.

Jim:
It just would allow you to get around the IRA withdrawal penalty. Same thing if this person completed this conversion, they waited five years, and if you are at that point only 45 years old then your five year conversion rule keeps you from dodging the early withdrawal penalty from the IRA, although it does allow you to potentially gain access before age 59 and a half. You just have to wait the five year period.
Jim:
The gains, of course, on that conversion, would still be taxable, and that’s basically how the five year rule works, so for a conversion you’ve got to wait five years before you can tap that principal, but principal you can take out at any time without having to pay a penalty. It’s only earnings on a Roth IRA that you have to pay penalty on if you take them out before age 59 and a half.
Jim:
In general, the strategy is to start the clock as soon as you can so you can get your money tax free and penalty free as early as possible. This sort of planning is really important for FIRE types, right? Financially independent, retire early. Someone who’s going to retire in their 30s or 40s or maybe even early 50s, but as you get close to age 59 and a half retirement, this becomes much less of an issue.

Jim:
At that point you’ve probably got other resources you’re going to be tapping before you get into your Roth IRAs, you can use the substantially equal periodic payment rule to get to your money before age 59 and a half without paying any penalties. It’s really only the really early retirees that mess with this sort of planning.
Jim:
Let’s get to the question, though. The question was not necessarily about IRAs but about 401ks, so when a designated Roth account from an employer retirement account is rolled into a Roth IRA, the years in the Roth employer account do not count toward the five year rule. You get your own five year rule once it goes into the Roth IRA. All that counts is that original five year rule for the Roth IRA.
Jim:
If there was no existing Roth IRA and the rollover from the Roth 401k created the account for the first time, that starts a new five year clock for the IRA even if the old Roth 401k had satisfied its own five year rule. They just don’t carry over. Basically, in answer to the question, your friend is right. If this matters to you because you’re going to fire soon, and you plan to use that money long before age 59 and a half, you should go through the hassle of doing the Roth IRA rollovers like your friend is doing.

Jim:
But for many, many people this just doesn’t matter because they’re either not going to retire early or they have other funds to spend first rather than their Roth IRA principal. I mean, that would be one of the last things I would be wanting to spend in retirement. I would be going through my taxable money and any 457 plan money I had and any of that stuff before trying to go after my Roth IRA money.
Jim:
If that’s your situation, then you’re right, too, so both you and your friend are right depending on what your situations are for getting money out of there. He actually called back and left this message.
Phil:
Hi, Jim. This is Phil again and I just have a couple of followup details from my last question in case they’d be useful. I called Fidelity to try to get an answer on this and they gave me on that surprised me. They said that when the conversion is done, either to the Roth IRA or to the Roth 401k, if there were any earnings and therefore taxes due on them, then there is also a five year waiting period, but if there weren’t any earnings then there isn’t.

Phil:
And since the automatic feature always runs before earnings can accrue, then there is never a five year period, and that answer surprised me. I didn’t know what to make of it. The other aspect that’s interesting is that in addition to being able to roll over to a Roth IRA and the Roth 401k, there is also the ability to do a split rollover where you send the contributions to a Roth IRA and the earnings to a traditional IRA, if there are any, and so maybe that option has different tax consequences, or if all three are different.
Phil:
The other thing I thought was interesting was that at my last employer the setup was identical to this one, except that we also had the ability to send money from the Roth 401k to a Roth IRA at any time. Obviously, only converted money had this feature, not direct Roth contributions, and I thought that was interesting, and I asked the Fidelity rep why the old employer had it and the new one did not, and he said that Fidelity charges a lot of money for that feature, and my new employer wasn’t ponying up, so I thought that was funny.
Phil:
It’s weird to think of how some of these procedures have costs associated with them and some don’t. Thanks again for all that you do, and for answering my question.

Jim:
Okay. I think it’s hard to tell, right? All I have is a snippet of information here, but I think the Fidelity rep is probably wrong about the conversion five year rule, i.e. that the converted earnings are treated the same as converted contributions, but he might be talking about the other five year rule, the one that applies to Roth contributions. That five year rule is about whether the earnings can come out tax free, not about whether the principal can come out penalty free.
Jim:
But again, all of this is pretty easily avoided. As a general rule, you want to be burning through your taxable money and your 457 money as an early retiree, and save your retirement account money, especially Roth money, to be used later in retirement. In my case, I’ll bet my taxable portfolio right now makes up about 60 percent of my portfolio. Tax deferred is probably 30 percent, and Roth money is probably 10 percent, and I’ll be those ratios are pretty similar for most FIRE types.
Jim:
You’re just saving too much money to be able to save it all inside retirement accounts, and so I think if you’re an early retirement kind of person this probably is a non-issue for you. You’re probably not going after your Roth money anyway in retirement. Do you still have student loans at way too high of an interest rate? If you’re going to be paying them off yourself you might as well refinance them and get a lower rate.
Jim:
Check out Whitecoatinvestor.com/splash today to see how much lower of a rate Splash Financial can offer you. If you refinance through them, after getting there through that link, they’ll give you 500 dollars cash back as a bonus. No application or pre-payment fees. Again, Whitecoatinvestor.com/splash.
Jim:
All right, our next question comes from an anonymous listener.

Speaker 7:
Hi, Dr. Daly. Thanks for everything you do for us and giving us the information we need to take control of our finances and become financially independent. It is much appreciated and it’s made a big difference. My question today relates to 401ks. In my situation, I am currently set up as an S corporation. I currently work at a few different offices, and I have an individual 401k that I took out last year, I started contributing to, and maxed out.
Speaker 7:
Now, this summer, in about six months, I will have the opportunity to buy into one of those offices that I’ve been working at and I’m planning to do so. Now, it’s my understanding that once I buy in I cannot contribute to my individual 401k as I will have to contribute to the company, or that practice’s 401k that’s available to all employees. Am I still able, for these first six months before I buy in, am I still able to max out my individual 401k or come as close to maxing it out as possible?

Speaker 7:
If I am, I would love to do that. Also, once I have bought into that practice, I will still have other 1099 income from other practices. Can I use that income to contribute to my solo 401k and contribute to that in many years to come? I would love your insights there. I’m planning on meeting with an accountant to talk about this with, but I would love to hear what you have to say. Thanks again.
Jim:
Okay, so sounds like we’ve got somebody that’s buying into a practice and now can’t use his individual 401k. I can’t tell exactly what’s going on here but it sounds like you are currently an independent contractor and you’re becoming a partner in a multi-partner group, while still functioning as an independent contractor for at least some of your income, so you’ll soon be able to use two 401ks, since those two employers are totally unrelated.

Jim:
That gives you two 57,000 dollar per year maximum for the employee plus employer contribution limits. One for each 401k, as dictated by the rules of each 401k, but between the two of them you only get one 19,500 dollar employee contribution, so use that one wisely. The way most people in this situation use it is they max out the employer 401k employee contribution, or at least put in enough to max out the match, and then just put 20 percent of their self-employed earnings into the individual 401k.
Jim:
If you didn’t use your whole employee contribution in your employer’s 401k, you can put that into your individual 401k, but usually you only do that if your employer’s 401k is really terrible and you’re just trying to get the match out of it and that’s it. I hope that helps.
Jim:
All right, our next question comes in via email. I was wondering if you could do a podcast about defined benefit plans. My accountant states this type of plan would be beneficial for me. I’m paid around 430,000 dollars yearly as a 1099 contractor. I have an S corp with a solo 401k which I max out each year. I also max out my backdoor Roth IRA. According to my accountant, I’m able to put away 134,000 dollars a year into a defined benefit pension plan.
Jim:
A little background about me. I’m 37 and my husband is a physician and W2 employee. He makes about 375,000 dollars a year and maxes out his retirement plans, a KIO plan, and a backdoor Roth. We have no student loans. We paid 550,000 dollars in three and a half years. Congratulations on that, very well done. And have a home that is less than 1X our income and no other debt.

Jim:
We’re trying to save as much pre-tax money as possible, given our large dual-physician income. Yes, it is a large income, but it was also a large debt, so very, very well done, and I’m happy to see you saving so much money. You’re going to become wealthy very quickly doing so.
Jim:
But 134,000 dollars a year into a defined benefit cash balance plan seems awfully high for a 37 year old. I’m a little bit skeptical, but if that’s what the actuary says it works out to be, I suppose it could be true. Certainly, I know docs in their 50s that can put up to 200,000 dollars or so into a defined benefit cash balance plan.
Jim:
Unfortunately, my stupid plan only lets me put in 17,500 dollars as a 44 year old. That used to be 30,000 dollars a year, but now it just kind of goes up every five years as you go older, but it’s really not until you’re in your 50s that you get to put a big chunk of money in there, so I’m a little bit jealous if you really can put quite that much money into a defined benefit plan.
Jim:
Given your goal to put away more tax deferred money, it sounds like it would be a good idea for you to do it. Even if you can only put in 20,000 dollars a year, which is kind of what I expected you to say, I’d still go for it. I think that’s probably, given your goals, a good idea. Are you doing your own taxes? If you are, use the software that I use, TurboTax. They’re the industry leader for a reason.
Jim:
Check out Whitecoatinvestor.com/turbotax, and if you need more help than that, check out our list of recommended tax preparers and strategists at Whitecoatinvestor.com/taxes. All right, our next question comes from Iyal. Let’s take a listen.
Iyal:
Hi, Dr. Dahle. I’m an emergency medicine resident in Washington. D.C. I’m a new listener to your podcast and keep hearing that keeping too much money as cash in the bank is not a great idea because it’s not doing anything for you. My question is how much money should you keep cash in the bank, and how much is too much? 1,000, 5,000, 10,000? At what point after saving it would you consider moving it to investments? Thank you very much.

Jim:
All right. How much money should you keep in cash in the bank, how much is too much? Is 1,000 too much? Is 10,000 too much? It’s really difficult for me to answer this situation because I’m in such a different situation than most doctors these days. We keep much, much more money than that in cash and it’s mostly just for cashflow needs. We’ve got payroll to make, and we’ve got business expenses coming out, and we’ve got to make out 401k contributions, and all that kind of stuff, and so we end up with lots of money in cash compared to those amounts that you’re talking about in this.
Jim:
How much is too much? Well, I think most people try to keep an emergency fund of three to six months of expenses placed away somewhere, whether that’s in a short term bond fund, or whether that’s in I-bonds, or whether that is in a high yield savings account, or a money market fund, or CDs, or whatever. You know, I think that’s really all you have to keep in cash.
Jim:
Above and beyond that, I think it’s mostly just for your own cashflow needs, and if your cashflow needs aren’t very significant then you don’t have to keep very much in cash, but if you’re spending 15,000 dollars a month, well, you might need 15,000 dollars in the checking account just to keep from bouncing checks, keep from bouncing your automatic credit card payments, and that sort of a thing.

Jim:
It really depends on how closely you’re going to watch that account and be moving money in and out knowing when the expenses are coming in and going out. If you just don’t want to deal with that, you tend to do what I do and just leave more cash in there. If you are willing to watch it really closely, you can obviously earn a little bit more money on that cash.
Jim:
And so it’s a constant weighing game of hassle versus a little bit of extra interest, and depending on how much that interest is worth to you you might be willing to deal with the hassle a little bit more. All right, our next question comes via email. I’m a dentist six years out of school. I’ve paid off all of my wife and my student loans which were 350,000 dollars.
Jim:
Now that we are debt free I maxed out my employer 401k and opened a backdoor Roth. I make 300,000 dollars as a general dentist but not get a lot of enjoyment at my job. I would love to go back to residency for orthodontics, but residency for three years costs 300,000 dollars.
Jim:
Yes, that’s different for you physicians who aren’t aware of this, but residency for many dental specialties, you still have to pay tuition. You’re not even getting the salary. I’m not sure how much more I would make as an orthodontist, but I would enjoy the job more. Am I committing financial suicide by going back into student debt to be an orthodontist?
Jim:
Well, it sounds like it’s time to do some more research, to decide whether the investment is worth it or not. For example, I know an orthodontist making 225,000 dollars a year, and I know orthodontists making seven figures. If it’s going to make you happier and it’s going to make you enough additional money to justify the investment of time and money, I’d go for it. If not, well I’d just figure out ways to optimize your practice to get you to FIRE as soon as possible.

Jim:
But I think those are the decisions to make. If you expect you’re going to go into a half time practice in a tiny town that doesn’t have very many patients to do orthodontics, well, it’s probably not worth paying 300,000 dollars, not to mention the opportunity cost in order to do that.
Jim:
But if you’re really committed that you’re going to do this for 20 or 30 years, and you have a pretty good business mind, and you’re going to open a practice, and you’re going to run it as efficiently as my kids’ orthodontist, you’re going to make a killing, and so it would be a good financial move.
Jim:
But the truth is you only get one life, and if being an orthodontist is going to make you happy and being a general dentist is not making you happy, maybe it’s worth it even if it doesn’t work out perfectly well financially. Certainly, most orthodontists are not going to have trouble knocking down an extra 300,000 dollars in student loans.
Jim:
They generally make enough, more than a typical dentist, to be able to take care of that. That assumes you do a good job, and get a nice, high income as an orthodontist. All right, next question, also via email. I love the blog. I just had a quick question about my backdoor Roth IRA. I opened it in January 2019, contributed to my traditional IRA for 2018 and 2019, and did the conversion to my Roth IRA the same month through Vanguard.

Jim:
I’m going to fill out my form 80606 for my 2019 taxes as per your tutorial, which you can find just by googling backdoor Roth IRA tutorial for late contributions. My 2019 1099R for Vanguard says my contributions are 11,500, as it should, but TurboTax is saying I contributed 5,500 excess to my IRA for 2019, resulting in a six percent penalty until it is corrected.
Jim:
Since this was for my 2018 contribution, I don’t think it was correct and I am in excess, will filling my form 8606 correctly resolve this issue? Well, remember when you do late contributions, meaning you’re contributing for 2018 in calendar year 2019, or you’re contributing from 2019 in calendar year 2020, that the contribution goes on the 8606 for the tax year, so it would go if it was a 2018 contribution made in 2019 it goes on your 2018 8606.
Jim:
And the conversion goes on the tax form for the calendar year that you did the conversion in, so if you made a contribution in January of 2019 for 2018, and then converted it in 2019, the contribution would go in your 2018 8606, and the conversion would go in your 2019 8606, and if you keep that straight usually the paperwork won’t be screwed up.
Jim:
This is why it’s so much easier to just do the contribution conversion during the same calendar year, but that’s basically what the problem is. If you go back and you realize that you didn’t file a 2018 8606, or you filled it out wrong, you need to go back and correct that, file a 1040X with it, and then it should be correct for this year.
Jim:
Do you still need disability insurance? Get a policy from an experienced independent agent at Whitecoatinvestor.com/doctordisability. All right, our next question, also via email. I’ve been listening to your podcast for 1.5 years. I’m a physician graduate in 2006 and working as a psychiatrist in the Southwest. I own two triple net properties worth 3.5 million with a corporate tenant, a 15 year triple net lease with around 15 percent return per year with depreciation.

Jim:
I’ve never heard any of your guests talking about the benefit of triple net properties. With the piece of mind and still being able to build up your real estate with no overhead expenses, as long as you have the right corporate tenant like Dollar General or Starbucks. One drawback is I have a two million dollar loan on it which might be not to everyone’s like.
Jim:
Some of this position on this form, I have cashflow to buy this property for cash and fix rent for those timelines, and still this tenant has four options to renew for five years each with a rent increase. I hope this topic can be added to one of your podcasts, as a question from Anonymous.
Jim:
Well, a triple net lease is not a specific asset class or an investment. It’s just the way the rental contract is written. A triple net property is net of taxes, net of maintenance costs, and net of insurance, so the landlord doesn’t pay any of that stuff. The tenant does. You’re transferring some risk from the landlord to the tenant in exchange for a lower rent.
Jim:
Lots of landlords like this because it’s a little bit decreased risk and a little bit decreased hassle, but it’s not some sort of extra special investment. It’s just basically a different type of contract to put in place on the property. I suppose you could do it on a residential property, but almost always these are commercial, especially retail and industrial properties in which the tenant’s responsible for all that sort of stuff.
Jim:
But if you’re looking for even less hassle in direct real estate ownership, a triple net lease can be a way to do that. If that sounds like too much hassle to you, you might try taking some physician surveys from Curizon. They’re especially looking for oncologists, neurologists, and rheumatologists, and you can find more information on that at Whitecoatinvestor.com/curizon, C-U-R-I-Z-O-N. Our next question’s coming off the speak pipe. Let’s take a listen.

Speaker 9:
Dr. Dahle, thanks for all that you do. I’ve been a longtime listener of the podcast. I have a question about the timing of when to contribute to a traditional IRA versus doing a backdoor Roth IRA. Currently, my wife and I have only been doing backdoor Roths. We’re both in our early 30s but we have a marginal tax rate of 35 percent. I’m a private practice urologist and she’s a CRNA, and I understand the advantage of doing the traditional IRA contribution for the pretax write off, but my issue is the fact that we are still in our early to mid 30s, and we are not going to touch this money until we are at least 59 and a half, and hopefully much later.
Speaker 9:
Would it be wiser to take advantage of the longterm gains with the Roth IRA being tax free versus taking the pretax break right now? I understand that later in our career when the money doesn’t have as long to compound it would make sense to do it traditional. Just curious on your thoughts on this, and about what age would you definitely start switching to traditional contributions in your peak earning years? I appreciate all that you do again, and I definitely don’t think you’re boring. Thanks.
Jim:
Okay. Well, most urologists and CRNAs have a retirement plan at work, and they make too much money so they cannot deduct traditional IRA contributions at all. They also cannot contribute directly to a Roth IRA, so their only option there as far as their IRA accounts goes is a backdoor Roth IRA. Regarding a Roth versus a tax deferred 401k, it’s a lot more complicated question. The usual answer is tax deferred during your peak earnings years and Roth at all other times, but there are lots of exceptions.
Jim:
In your case, though, this is really straightforward. A backdoor Roth IRA is what you ought to do. If you are interested in Airbnb, we have a partner that has put together a course that teaches you everything you need to know to run a profitable Airbnb. Some doctors have found this to be an exceptionally good side hustle, especially if they can put their spouse or partner in charge of it, but if you’re interested in learning about that, Whitecoatinvestor.com/airbnb.

Jim:
In fact, we have about almost a dozen courses put together by ourselves or by our partners there that you can find under the courses menu at Whitecoatinvestor.com, or just go in directly to Whitecoatinvestor.com/onlinecourses. All kinds of stuff that you can learn from these courses. Real estate stuff, billing stuff, financial management and planning, all kinds of courses there that you probably ought to check out if you like learning stuff from online courses.
Jim:
Next question comes from Denny off the speak pipe.
Denny:
Hi, Dr. Dahle. I had a quick question about people with individual LLCs. I am in the process of trying to start a solo 401k versus a SEP IRA for 2020, and the question I had is what is the difference between a self directed solo 401k versus a not self directed? I know the versatility is a little bit more for the self directed, and to my understanding you can invest in honestly whatever you want, with some limitations, so why aren’t every solo 401k and SEP IRA self directed, then? Thank you so much for your guidance, and I look forward to hearing back from you.
Jim:
Okay. I often hear lots of questions about solo 401ks versus SEP IRAs, but the question here is really what is the difference between a self directed 401k and a regular one? Why aren’t they all self directed, is really the question? Well, it’s a little bit more of a hassle to be self directed, and the classic example of a self directed 401k or IRA is a checkbook account, where basically you can write a check and invest it in any allowed investment, and usually, this means real estate.

Jim:
You know, you can write a check out of this, and you can put it into a private real estate fund, or a syndication, or something like that, and use that 401k or IRA money in order to invest in that sort of thing, but there’s a little bit more of a hassle to running the account. Someone’s got to keep track of the checks. They’ve got to provide you checks to start with, and so it’s usually the big brokerage houses, the big mutual fund houses don’t have this feature.
Jim:
You usually have to go to a separate company, usually a smaller company like one of our partners that you can find at Whitecoatinvestor.com/mysolo401k, or Whitecoatinvestor.com/rocketdollar, and they will help you set up an account like this. What’s it going to cost you? It’s going to cost you a few hundred dollars in fees to set up, and then 100 or 200 dollars a year to maintain it.
Jim:
And so it costs more than going to E-Trade or going to Vanguard or going to Fidelity and just opening a solo 401k and investing in mutual funds there, but you won’t have quite as many investment choices. There’s not a right answer or a wrong answer. I’ve had a standard solo 401k at Vanguard. I’ve had a self directed 401k, and they both have their pluses and minuses. It’s just a matter of whether you’re wiling to pay a little bit more in fees in order to have some other investment options.
Jim:
Okay, I got some feedback via email. Here it is. I wanted to provide some feedback, since you often ask for it on the blog and podcast. I refinanced my 275,000 dollar medical school loans through your link with Sofi, and per their email response below they’re not honoring their referral credit. Apparently, I should’ve requested the credit within 30 days of refinancing my loan. I was not aware of this timeframe and assume many other readers or listeners are not either. I just wanted to make you aware to potentially prevent this from happening to others.

Jim:
That’s not exactly the way it works. If you went through the links on the site or in the podcast show notes, you get these cashback bonuses automatically. You don’t need to request it specifically, but you can’t just go to Sofi.com and refinance and then months later ask them to send you a few hundred dollars. They’re not going to do it. If that were allowed, they might have to pay me for customers that I didn’t even bring them, which is obviously not great for them.
Jim:
I mean, I can always ask for exceptions there if you’re just caught in some sort of snafu, which does occasionally happen, about once a month. We have somebody that just for whatever reason didn’t get what they should’ve gotten, and we can always fix that up, so what I want to do in the podcast is emphasize the importance of actually going through the White Coat Investor links if you want those special White Coat Investor negotiated deals, and so I got a response on this email.

Jim:
I actually did use your link but I read the fine print at the very bottom and it says for new customers only. I forgot I had refinanced and then subsequently paid off a small private med school loan while in residency with Sofi, so I bet that’s why I didn’t get the bonus. Yeah, that’s why I didn’t get the bonus. They’re basically putting these deals together to try to get new people introduced to the business, so if you’ve refinanced 12 different loans at Sofi, you’re not going to get the cash bonus each time you do it.
Jim:
Now, if you go from one company to another to another, you could get additional bonuses, but at the same company you only get it one time. I’m sorry about that. I only get paid one time and you only get paid one time. That doesn’t mean it’s not worth refinancing if you can get a lower rate, but that’s the way the cash bonuses work.
Jim:
If you are interested in getting a cash bonus for refinancing your student loans, you can find out which companies are offering those at Whitecoatinvestor.com/student-loan-refinancing. All right, I think we’re getting long on the questions here, so let’s cut it off here and we’ll push our other questions out to the next podcast.
Jim:
Have you ever considered a different way of practicing medicine? Whether you’re burned out, need a change of pace, or want to see the world, Locum Tenens might be that option for you. If you’re not sure where to start, Locumstory.com is a place where you can get real, unbiased answers to your questions, and 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.
Jim:
You can go to Whitecoatinvestor.com/locumstory and get the answers. If you need help with your taxes during this tax season, be sure to check out our recommended strategists page. Thank you for leaving us a five star review and for telling your friends about the podcast. Keep your head up, your shoulders back; you’ve got this, we can help. We’ll see you next time on the White Coat Investor Podcast.
Disclaimer:
My dad, your host, Dr. Daly, is a practicing emergency physician, blogger, author, and podcaster. He is 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.