Podcast #127 Show Notes: Understanding the Mega Backdoor Roth IRA

In this episode, I discuss the difference between the backdoor Roth IRA and the Mega Backdoor Roth IRA. The mega backdoor Roth IRA allows you to contribute an additional amount into a Roth IRA due to the fact that some employer 401k plans allow after-tax contributions. Listen to this episode to see if and how you can take advantage of this opportunity. Not all plans offer it but the mega backdoor Roth IRA is an incredible opportunity if your plan allows it. Katie and I started to do mega backdoor Roth IRA contributions this year but for a totally separate reason that I discuss in this episode, that may be applicable to you as a business owner. We also discuss making sure you get your 401k match, separate brokerage accounts for asset protection reasons, using margin in a portfolio, Vanguard international bond fund and municipal market fund, if index funds are in a bubble, and other listener questions.

Our podcast today is sponsored by one of my favorite partner companies, Earnest. Save money on your student loans by refinancing with Earnest. The cool thing about Earnest is that you can choose custom terms to fit your budget. You can pick your exact monthly payment. You can select fixed or variable rates. You can even choose your custom term. The shorter the term, the lower the interest rate. They are not going to pass you off to a third party servicer, nor penalize you for making any of your payments early. Your family is always protected with loan forgiveness in the event of your death. You can refinance anything from $5,000 to $500,000, a much wider range than most of these companies offer. Check out Earnest today and get $500 cashback when you refinance.

Quote of the Day

Our quote of the day today comes from George Soros who said,

“If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring.”

I agree with that. After a while, this stuff should be pretty much on autopilot. If you’re on a financial plan and you’re working towards your financial goals there shouldn’t be something new to learn every month. This stuff eventually should be pretty autopilot for you.

Understanding the Mega Backdoor Roth IRA

I had Aaron Milledge from Targeted Wealth Solutions, one of our financial advisor partners, on the podcast this episode to answer questions. We tackled the question of mega backdoor Roth IRAs. Who is eligible for these? What are the advantages?

Hopefully, you’re already familiar with a Backdoor Roth IRA. This is where you put money into your traditional IRA, $6,000 a year, and then convert it the next day or the next week or whenever to a Roth IRA. That’s the Backdoor Roth IRA. Now a Mega Backdoor Roth IRA has to do with a 401k plan. Basically, in your 401k, you’re allowed to put in an employee contribution if you’re under 50 of up to $19,000 per year. Now the total of your employee contributions and any employer contributions into that plan can be $56,000 a year. So if you get a big fat match, then maybe you can get to $56,000 but there’s a lot of people that don’t get that much of a match and so they’re just not able to get anywhere near that $56,000 limit.

But there are some plans that, the way they’re written, they allow you to make after-tax contributions to the 401k. This is money that has already been taxed. You’re not getting that upfront tax break like you are with the employee contribution to the 401k. It’s just after-tax money. When it comes out eventually, you won’t pay taxes on it, but the earnings will all be fully taxed at your ordinary income tax rate when it’s pulled out of the account. That is not super attractive unless there is one other provision in it. And that provision either has to allow you to pull money out of the plan despite not leaving the employer, this is an in-service distribution, or allow you to convert it inside the plan into a Roth 401k account. And then that becomes a Mega Backdoor Roth IRA because you put in all this after-tax money and then you convert it right away into a Roth IRA and then the earnings are tax-free forever.

The mega backdoor Roth IRA is an incredible opportunity if your plan allows it. It is not a guarantee to all 401k plans, though. Your plan needs to allow after-tax contributions. From the plans that Aaron sees as he sets up workplace retirement plans, depending on the industry and size of the business, only about 50% of the plans allow after-tax contributions; even fewer allow in-service distributions to Roth. The first level of diligence that needs to be executed is to understand what is available in your plan.

Katie and I started doing a mega backdoor Roth IRA this year, but kind of for a different reason. We were able to put in $56,000 in tax-deferred money if we wanted to. But the issue was, as business owners, the owners of the White Coat Investor, it was lowering our 199A deduction, with all the money we were putting in there as employer contributions. We decided to stop doing that and just do Mega Backdoor Roth IRA contributions. But we had to leave our Vanguard individual solo 401k because their boilerplate plan document didn’t allow this. We went and got a customized one that did allow it and basically that’s what we’re doing for our contributions this year. But lots of people through their 401k at the hospital or their practice or whatever, they can do these Mega Backdoor Roth IRAs.

You just have to make sure the plan, number one, lets you contribute money after-tax, and number two, lets you either convert it inside the plan or pull it out of the plan despite not leaving the employer and convert it yourself into a Roth IRA.

A listener asked an additional question that was part of this,  “what do you think about after-tax employee contributions that aren’t converted to a Roth IRA?” So the plan allows you to put in that money after-tax but doesn’t allow you to do an in-service distribution, doesn’t allow you to do an in-plan conversion. Is it still worth making or should you just invest in a taxable account?

If you’re leaving in a year or two, there’s a pretty good argument to make the contributions. If you think you’re going to be there for 30 years, maybe you’re better off in a taxable account, without getting that upfront tax break that you usually get with a retirement account. So you’re weighing a few things there. Most of the time it’s hard to say if it’s worth it without really getting into the details.

Reader and Listener Q&As

Getting Your 401K Match

“I’m a PGY 3 and I had a question about 401ks. Currently in my residency I have a 401k that offers Roth and pre-tax contributions with no match. After I finish my PGY 3 year, I’ll be joining a primary care practice in August of 2020. They do offer a match, and I guess my question primarily is from January to June in residency, should I be contributing to my 401k as a resident trying to get as much into Roth as I can or should I wait until I’m employed by my new employer in August to start contributing to my 401k. I don’t want to miss out on any potential extra income from getting the match with my new employer, but also want to take advantage of all the Roth contributions that I can make, while contributing to my Roth as a resident. I realize that I can only contribute 19,000 in a year, so just trying to figure out where best to allocate that 19,000.”

Aaron points out that many 401K plans limit employees from contributing to them for the first 6-12 months of employment. Before making any decision, this listener needs to get ahold of the plan document and see what the waiting period is. You can also take this into consideration as you negotiate your contract. Aaron said,

“If there is a waiting period, obviously, and depending on how tight the labor market is and your willingness to negotiate, I would say put that on the table as far as talking to your employers. Say ‘your plan excludes participation for the first six months. That’s costing me X amount of dollars in employer match. How can we kind of create an equitable solution from an all-in compensation perspective to make up for this poor plan design, for lack of a better term.'”

I love his idea of taking that to the negotiating table and using it to negotiate a little bit better offer because it’s not unusual at all. A lot of people don’t realize this. If they never had a retirement plan, like lots of doctors coming out of training, they’ve never used any sort of retirement plan. They don’t realize that when you start a new job, a lot of times the way the 401k documents are written, is you can’t contribute for six months or a year. If you’re coming out of training in July thinking, “Okay, I’m going to max out my new 401k”, they may tell you “No, you can’t contribute at all until next January or we’re not going to match you at all.”

So I think the bottom line is, before you decide what to do with your old resident 401K for that year you leave residency, figure out what’s going on with the new one before you leave. Get the document or call HR and ask if you are able to contribute and get the match. If there’s no match at either one, you might as well put it into your residency one, it doesn’t matter for that year. But if you’re going to get some match, if you put money in there in September and October and November, but you wouldn’t be able to contribute because you already maxed out your employee contribution in the first half of the year, well, you just left money on the table. I think the key is just to get the information before you leave residency so you know what to do. Once you have that information, it should be a pretty easy decision as far as how much you contribute.

I think another thing a lot of people don’t realize is that they’re still in a pretty good tax bracket that year they leave residency. Yes, it’s going to be higher than a full year of residency. But most of them are leaving in July, and so they have a half a year of resident income and half a year of attending income and the next year is going to be all attending income. So it’s likely going to be a higher bracket. That’s a great year to do Roth contributions. If you had a tax-deferred retirement account, maybe even do a Roth conversion of that in that year. It is probably your last year in a long time of not being in your peak earnings tax bracket.

 

Separate Brokerage Accounts for Asset Protection

“My wife and I are both doctors and so have maybe more than average asset protection concerns. Does it make sense for us to have separate taxable brokerage investing accounts for asset protection purposes?”

Will this make a difference in asset protection? Not much depending on the state you live in. You can title assets tenants by the entirety (TBE) in some states. Basically that says you own the whole account and your spouse owns the whole account. So mostly people are thinking about this with their house, but it can be applied to investment accounts as well, such that basically if someone brings suit against you, let’s say it’s a malpractice suit, and for some crazy reason, they get an above policy limits judgment that isn’t reduced on appeal to policy limits, the idea is, if you own the retirement account or you own the taxable investing account as tenants by the entirety with your spouse, they can’t take it. Because your spouse owns the entire thing and they’re not suing your spouse for malpractice, they’re only suing you. So this may help if your state allows assets to be titled tenants by entirety.

But when a lot of people start worrying about asset protection, they forget that their biggest risk is probably their spouse, anyway. So if your biggest risk is your spouse in a divorce, which even though physicians, dual physician couples, have lower divorce rates than the general population, it’s still way higher than the chances of an above policy limits malpractice judgment. And so putting half your taxable account or all your taxable account,  your boat, your cars, or your house in your spouse’s name, is probably going to cause you more problems in the event of your largest risk, a divorce happening.

Using Margin in a Portfolio

“My family is pretty early in its investing career and I am interested in exploring the idea of using margin to essentially borrow to fund our future financial independence. I know interactive brokers have relatively low broker margin interest rates. I was wondering if you had any experience with this? And what your experience has been like. What do you think is a safe total proportion of margin loan to have a portfolio? 10% 20% 30%?”

Most people, especially early in their career, are already very highly leveraged. If you look at a typical 35-year-old doctor, they may have $400,000 in student loans, a $500,000 mortgage, and $500,000 in a practice loan. They already have a ton of leverage in their life and now we’re talking about adding more into their life? I don’t think I’d really encourage that sort of behavior. Then later in life, hopefully, you’ve kind of taken care of this debt issue, now you really don’t need to take that risk to meet your financial goals. Most doctors don’t have to use margin. You just carve 20% out of your high income, invest it in some reasonable manner and you’re going to be financially independent in not that long.

If you do choose to do margin, you’re limited to 50% of your portfolio. That’s the most you can borrow against. But I wouldn’t get anywhere near that because that’s where you start seeing margin calls as assets start dropping. You hit a 2008 kind of scenario and you’re going to have some serious margin calls. And if you had enough money to meet those margin calls, maybe you should have just invested that in the first place instead of holding it in cash. But if you’re really want to leverage up, I think the place to do it is the non callable stuff. Your refinanced student loans, your mortgage, a home equity line of credit, that sort of stuff. Rather than going to interactive brokers and taking out a margin loan, although they’ll give you a relatively low interest rate, I think they are 2 or 3 or 4%, something like that. You do face the possibility of a margin call.

Before I did something like this though, I would encourage you to go back and read a thread. This is kind of a classic thread on the Bogleheads Forum. It was started in September of 2007 and if you know your financial history you can kind of know what’s coming. This was a fellow by the name of Market Timer as his avatar on the forum and he was a graduate economics student who called this thread A Different Approach to Asset Allocation. Basically his idea was to mortgage your retirement, borrow all this money early in your career, and then gradually deleverage throughout your career. Well, this attempt at using leverage in his portfolio blew up spectacularly a year later and it’s all documented in real-time as this thread goes on.

I would encourage anyone who was even considering adding a significant amount of margin to their portfolio to really read what it looks like when it goes bad. Because when it goes bad, it’s pretty ugly. Luckily, this guy was smart enough and hardworking enough that he eventually recovered from his huge mistake of trying to mortgage his retirement, but it wasn’t before losing several hundred thousand dollars that he really did not have. And he’s humble enough and into it enough and anonymous enough probably, that he kind of shared all the gory details. It is worth a read if you’re really considering adding leverage to your portfolio. It’s not something I’ve ever really done and I just don’t think that a typical doctor needs to do this to meet their goals.

ETF Authorized Participants Taking Lowest Basis Shares

“I’ve been reading about how ETFs work and I was curious about the authorized participant’s role in flushing out capital gains. Why would an authorize participant be willing to accept shares with the lowest basis? Wouldn’t the capital gains taxes they would have to pay, negate any ability for them to arbitrage and make money?”

So why would ETF authorized participants be willing to take the lowest basis shares when ETF units are liquidated? Well, I’m not sure they actually get a choice. I think they’ve just got to take what they’re given. Yeah, probably this reduces the returns, but these are smart people with very powerful computers. I’m sure they can calculate out whether it makes sense for them to liquidate that ETF, if there’s an arbitrage there or not. Remember these authorized participants are able to form these ETF shares and disform them, and they’re the only authorized people able to do that. When they see an arbitrage opportunity between the prices of their securities and the prices of the ETF shares, they can swap them out, basically, and take the shares and sell them. For most of us, that would be very unwieldy to do and this really benefits us because it keeps the market very liquid and priced appropriately and so it’s a benefit to all of us to have people doing this.

But as far as answering your questions, I don’t think they get a choice. I don’t think they’re able to ask for the shares they want. And so the company can use this mechanism to flush the lowest basis shares out of the ETF and make the ETF, and in Vanguard’s case, the ETF and the traditional mutual fund shares, a little bit more tax efficient. That’s a great question though. If I ever meet one of those authorized participants, I’ll try to remember to ask them that question.

 

Equity Glide Paths

“I followed your discussion of equity glide paths by which equity positions increased during retirement, but you start at 30% equities on day one of retirement. I’m now at 60% equities, 20% of which is in retirement accounts. Would you really make a dramatic and tax inefficient move to lower my equity position on day one before I retire?”

Basically we’re talking about bond tents here. A bond tent is this idea that was kind of made popular, I think, mostly by Wade Pfau in the last couple of years, that to reduce your sequence of returns risk, the period of time that matters the most is the 5 years before you’re retiring and the 5 years afterward. That is actually when your asset allocation should be the least risky. With an extra amount of bonds in your portfolio, this bond tent is in case terrible returns in your 30 year retirement period show up in the first 5 years. That’s what it protects you from. And then the idea is that after those 5 years or so after you retire, you start increasing your equity percentage in your portfolio. And so the bond tent is this period of time around the date of retirement in which you have a less risky portfolio.

In the case of this question, he’s talking about going from 70% stocks to 30% stocks. I think what most people do is, rather than making a dramatic shift, which obviously introduces some elements of market timing, they do it more gradually over a 5 or 10 year period. If you want to be at 30% stocks for 5 years before and after your retirement date, I wouldn’t recommend going there all in one year. I’d tried to get down to there over a course of 5 or 10 years. And I think that’s probably the way to do it rather than a dramatic shift.

High Dividend Equities

A listener asked what I thought about high dividend equities or funds. I’m not a big fan of this approach to getting a value tilt. Now there are people out there that swear by dividends. They just think dividends are the cat’s meow. Even though in reality, you know, as far as from an accounting point of view or a taxation point of view, a dividend is nothing more than selling shares at a longterm capital gain. It’s like a forced sale of your shares when you may not even want the cash. And so it’s not necessarily ideal to declare a dividend, because it’s costing your investors some taxes if they really didn’t want the dividend.

The idea, though, that these dividend investors have is that if company management has to pay dividends, then they’ll manage the company better. And if they look back over the historical records, they see these companies that paid dividends have better returns than the overall market, but in reality, what that is, is just a manifestation of the value factor. This idea that value stocks over the long run had better returns than growth stocks, and that’s likely because the companies are a little bit riskier, although there are some behavioral aspects to that. But it turns out if you want a value tilt in your portfolio that a dividend tilt is not necessarily the best way to get that. It’s not a terrible way to get that. If you want to tilt your portfolio toward dividend-producing stocks, that’s okay. I mean, I tilt my portfolio toward value stocks, but it may not be the very best way to do it.

I’m not a huge fan of it. I certainly don’t think there’s something magic about dividends, like a lot of these kinds of dividend diehards you’ll see out there. I mean there’s a thousand blogs on the internet dedicated to dividend stock investing. Most of them don’t understand the concept of uncompensated risk of individual equities, but just realize that there’s a lot of behavioral and psychological aspects to this.

Vanguard’s Total International Bond Fund

“What do you think about Vanguard’s Total International Bond Fund? Should we use it for relatively short term savings goals? Should my mom use it in her retirement account?”

Vanguard likes it. No surprises. It is their fund. They use it in their target retirement funds. I’ve never actually owned that particular fund. There are dozens of asset classes out there. You don’t have to invest in them all. There are no called strikes in investing. Certainly, international bonds are a reasonable asset class to include in your portfolio, but here’s the deal with bonds. If bonds are only 10 or 20 or 25% of your portfolio, you probably don’t have to have a very complex bond holding. Maybe you only own one bond fund. If you’ve got 50 to 80% of your portfolio in bonds, you probably want to break it up into a few different bond asset classes and maybe that’s the type of place where international bonds or treasury inflation-protected securities (tips) bonds are appropriate to include in the portfolio.

But the whole key to building a portfolio, building your asset allocation is to pick something reasonable and stick with it. If you like international bonds, it’s okay to put them in your portfolio, set them to 5 or 10 or whatever percentage of your portfolio that you want them to be, rebalance it periodically and go forward with it and stick with it. They will have their day in the sun just like every other asset class does, but I don’t find the argument hugely compelling for those of us early in the accumulation phase to add this fund to a total bond market fund, just for completeness sake, so you have all of the bonds in the world. I don’t know the bonds necessarily need to be diversified quite that much like stocks do. I’d be much more likely to add an international stock fund to my portfolio than I would an international bond fund.

Non-Qualified Deferred Compensation

“I have a question regarding non-qualified deferred compensation. My new employer is offering non-qualified deferred compensation where I can contribute up to $50,000 a year, but in spite of that, my tax bracket will still remain the highest when I do married filing jointly due to our combined high physician salaries. My question is that should I still contribute to non-qualified deferred compensation at all as it is non-qualified and risking, though my employer currently is very stable? I have been maxing out my other retirement contribution and Roth contributions every year along with a brokerage account. But my new employer will be contributing $17,200 every year to my deferred compensation account irrespective of my contribution. So I think that could be a substantial amount accumulate until the time I go to distribution or there is a termination.”

Okay, so this is about a deferred compensation account. Should you use it? Well, these are basically the same as a 457B. That means the money still belongs to your employer. So the number one consideration is whether that employer is stable. If the employer goes under you could lose the money. It’s asset protected from your creditors but not their creditors. You also want to make sure it has reasonable fees, reasonable investment options and reasonable distribution options. If you have to take all the money out the year you leave, that’s not reasonable. If you put $200,000 in there and now you have to take that all out the year you leave employment, that sucks because that’s basically going to be an extra $200,000 in taxable income on that money. And you may end up paying a higher tax rate on it coming out than you did going in.

But if you can spread that out over 5 or 10 years or longer, or you can roll it into an IRA, like a lot of governmental 457 plans, then it can make a lot of sense to use that 457 plan. Likewise, if all the investments are terrible or there’s some type of weird insurance product, maybe you’d rather just use a taxable account than that deferred compensation account. But the most common issue is that the distribution options just aren’t very good. So make sure you understand how that money comes out of the account before you put the money into the account. There is no standard out there. Every plan is different. Read the document and really understand what’s going on and make a smart decision.

Just remember, even if the plan isn’t perfect, you may want to put some money in there even if you don’t max it out. Maybe you don’t max out every year for 10 years. Maybe you max it out for a year or two or maybe you just put $5,000 a year in there. It’s not an all or nothing decision. You can always go halfsies and put half of the extra money you have to invest in that and half in a taxable account.

Vanguard Municipal Market Fund

“I read in your financial bootcamp book that maybe a good idea for high-income professionals is to use the Vanguard Municipal Market Fund, money market fund as a savings account, especially if you live in a tax free state such as Florida. I just wanted to confirm that I interpreted that correctly. I was planning on putting an excess cash into the Vanguard Municipal Money Market Fund after I’ve maxed out all my tax exempt retirement accounts and Backdoor Roth. In addition, I have a 2.3% high yield savings account at a bank.”

The key with these cash equivalents, these money market funds, these high yield savings accounts is to do a calculation. That calculation is you take the yield of the taxable account and you multiply it by 1 minus your marginal tax rate. So if you’re in 37% tax bracket, you take the yield of the taxable account, multiply it by 1 minus 37% or 0.63 and that tells you the equivalent yield on an after tax basis. So you then compare that to what the municipal money market fund is yielding. And if it’s the municipal money market fund is yielding more, like it usually does for those in the highest tax brackets, then you put your cash in there. If it’s yielding less on an after tax basis, then you just keep it in the taxable account and you pay the taxes.

Lately, the last couple of months has been a little bit wonky. Those of us in the highest tax bracket, sometimes it has actually worked out better to just be in a taxable money market fund or a taxable high yield savings account. So periodically you might want to recheck that. Occasionally the yields of munies versus taxable bonds and money market funds does change a little bit, so keep an eye on it. But the key is to do that calculation.

How Much to Spend on Vacation

“I’m fresh out of training. Our family likes to travel. I was wondering how much should I spend each year on vacations. Is there a formula like 5 to 10% of post-tax income?”

Well, first of all, you’re fresh out of training, so you’re supposed to be in your live like a resident period. So it’s okay to go on a vacation if it’s a kind of vacation that a resident can afford. Oftentimes that means driving on a road trip or staying with family or doing it on the cheap or using airline miles to pay for it, that sort of a thing. And then generally after your live like a resident period, my recommendation is that you save 20% of your gross income for retirement. Save enough for your kids college and to have your house paid off by retirement, and then you can spend the rest guilt free. There’s no magic number of 5% for vacations or whatever.  5% sounds reasonable to me at the stage I’m at in life, but there are periods of time in my financial life where 5% would’ve been way more than I should have been spending on vacations, so you just have to look at your overall budget, make sure you’re working towards your goals and then decide how much you’re willing to spend on vacation.

Index Funds in a Bubble

While I was gone recently on a trip, I got a couple of emails from people asking about an interview that Michael Burry did. Michael Burry is the doctor who left medicine and went and ran a hedge fund and resisted all of his investors’ calls to stop doing what he was doing and made a big call, right in 2008, made gazillions of dollars for himself and his investors.

In this article, basically he talks about things like index funds are a bubble and those sorts of things and gives some warnings about that. People asked me what I thought about that. Well, I’m not a guru. Maybe Michael Burry is a guru, but here’s what I’ve learned. Nobody knows what’s going to happen in the future. Michael Burry’s crystal ball is just as cloudy as everybody else’s. Just because he made one call right in 2008 does not mean that he knows the future about everything going forward from here. So I take anything people say with a grain of salt. Try to have a plan that doesn’t require you to be able to predict the future in order to meet your longterm goals.

I really don’t buy this index funds are in a bubble argument. The reason why is, yes a significant portion of the market is indexed, but a significant portion of the trades in the market are not indexed. They are being made by active managers. They are determining as they go along what they think a company is worth. And those people who are making the trades are the ones who are determining what the value of the security is. Not the people who are buying and holding it for 30 years. They’re not making any contribution to what the value of that security is on a given day is and so I am not worried until a much larger percentage of the market is in index funds that it is somehow going to cause the market to be less efficient.

There will always be people like Michael Barry out there trying to find the stocks that are under priced and buy those instead. I just don’t see this scenario where index funds are going to go down and the overall market is not, or that somehow index funds are gonna drop more than the market. I don’t buy it. If the stock market goes down, your index funds are going to go down.

Maybe your tracking area error gets a little bit larger, but it is so tight right now. It could triple, and you wouldn’t even notice it. That’s much less of an issue anyway for a longterm investor like me than it is for someone running a hedge fund like Michael Burry. But anyway, I stopped believing in anybody’s ability to predict the future well enough to provide actionable information a long time ago. I suggest you do the same.

Ending

I hope you find these Q&A episodes helpful. Don’t forget to leave your questions at the speakpipe.  Can you share this podcast episode with a colleague? Word of mouth is an effective way to spread the message of the White Coat Investor.

Full Transcription

Intro Speaker: 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.

WCI: This is White Coat Investor podcast number 127, Mega Backdoor Roth IRAs. I’ve been hanging out in the white coat investor private Facebook group. You can find that at facebook.com/groups/whitecoatinvestors. And trying to figure out why something happens in there that doesn’t happen necessarily elsewhere in some of our other communities like our subreddit. For those of you who are into Reddit, that’s a great place to check out a community of like-minded individuals or on the WCI forum that we host on our website itself. And the reason why I couldn’t figure it out for a while is because I access the Facebook group through my laptop. I go to Facebook, I click on the group, and I go in there and I see all the questions that people are asking together. I go from one to the next to the next.

WCI: But I think I’ve realized that most of the people in the Facebook group don’t access it that way and the questions and the topics that come up and they just show up in their feeds. So they’re between aunt Millie’s cat pictures and whatever else you happen to be a member of or what your friends are posting on Facebook. And so they just come up randomly. Cause sometimes some of the questions we see as well as the answers that are given in that group are less than ideal. Let us say perhaps less than I would expect from a financially literate population. And so I’ve been trying to do a few things to improve that. The first thing is I signed up all the people in the group whose email addresses we had for the white coat investor newsletter, which gives them Financial Bootcamp, that 12 step email series that you get emailed to you once a week for 12 weeks.

WCI: And I think that helps bring people up to speed that are just finding the blog. And I’m hoping what it will do is bring the people in the Facebook group up to speed so they kind of have the basics of financial literacy and can then talk about the esoteric because they want to talk about in there. Because I often see questions in there where people are asking about investments and all of a sudden people are chiming in, tell them to buy individual stocks and Bitcoin or whatever crazy thing they’re finding the investment dejure. So what I want to ask you to do is to help me in this effort to actually go to the Facebook group and answer people’s questions in a financially literate way. There are the typical questions people ask about their investments and their retirement accounts and their disability insurance and asset protection and those kinds of things.

WCI: We tend to talk about the same 50 or 100 questions all the time in these online communities, but if you can help in that community, I would appreciate that. Again, you can find that at facebook.com/groups/whitecoatinvestors. Also, I have put in a plug for the subreddit and the WCI forum. Also great places to discuss personal finance for doctors and other high income professionals.

WCI: Our quote of the day today comes from George Soros who said, “If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring,” and I agree with that. After a while, this stuff should be pretty much on autopilot. If you’re on a financial plan and you’re working towards your financial goals there should be something new to learn every month, something new to understand every month. This stuff eventually should be pretty autopilot for you.

WCI: Our sponsor today is Earnest, one of the student loan refinancing companies. Save money on your student loans by refinancing with Earnest. Choose custom terms to fit your budget like pricing your exact monthly payment or selecting fixed and variable rates. Earnest precision pricing matches your custom term with a custom interest rate. Saving you even more money when refinancing. You won’t be passed off to a third party servicer nor penalized for making payments early.
WCI: Your family has always protected with loan forgiveness in cases of death and dismemberment. The minimum amounts of refinance is $5,000 and the maximum is $500,000. So the chances of you being outside those two limits is pretty low. That’s pretty broad as these companies go. But there’s more.
WCI: If you sign up to refinance your loans and actually complete a refinance after going through this link, whitecoatinvestor.com/refi, that R.E.F.I, you will get $500 cash back. I would encourage you to take that $500 put it toward your loans and pay him down a little bit faster. So refinance your loans today with Earnest whitecoatinvestor.com/refi, R.E.F.I.

WCI: Thanks so much for what you do. Every day you go into work and you do something difficult. That’s why you get paid so well. You’re high income professional, whether you’re a physician or a dentist, podiatrist, maybe you’re an APC. I don’t know what you do for a living, but chances are it’s difficult and that’s why you get paid so much. And that’s why you’re listening to this podcast. Try to stop doing dumb stuff with your money. So I want to thank you for what you’re doing and it’s hard. And the years of preparation you put into it. I had a difficult shift yesterday where it seemed like every patient that came in had some sort of psychiatric problem that I had to deal with. For example, I had this lady that had been brought in by the police because she was walking around naked all over the place.

WCI: And so they brought her in and she continued to walk around naked around my emergency department. So I’ve got the kids and my other patients totally being scarred by this elderly lady walking around, butt naked. And you know what? Most jobs don’t have to deal with that stuff. And maybe that’s why we get paid so much because we do. So thanks for what you do. I know the paycheck is nice, but it’s not always enough. And after a while especially, I have to become financially independent. We’re not really doing it for the paycheck and so I appreciate what you do. I know your patients do as well and their families, even if sometimes they forget to tell you, by the way, if you need a financial advisor, I want you to check out our new revamped recommended financial advisers page. If you need a financial planner or if you need ongoing investment management, that’s where you can find people that can help you.

WCI: There are also people there that can help you with implementing retirement plans for your practice and so we’ve been featuring some of these folks on the podcast for bringing them on one at a time of our 10 featured advisors there and let you get to know them a little bit better, but the entire list is some great advisors that I’ve gone through the trouble to vet for you, look at their ADVII too. I’ve read through their applications that I make them fill out and I’ve taken feedback from White Coat Investors who have used their services and got back with me and let me know what their experience was like. And so this is a list of some of the best of the best financial advisors out there. These aren’t people that are not going to hose you and sell your crummy stuff you don’t need. There are people who are going to give you the advice you need at a fair price.

WCI: So if you need an advisor, that’s perfectly fine. Do you use an advisor? Just make sure you’re getting good advice at a fair price. And the easiest way to do that is to go to the White Coat Investor recommendation page.

WCI: We have a guest today on the podcast. He is one of our featured financial advisor partners. It is Aaron Milledge from Targeted Wealth Solutions. Targeted Wealth Solutions is an independent fee-only financial planning and investment management firm founded by former US Air Force pilots. Their goal is to build the financial latitude in your life so you can pursue your passions. As fighter pilots, they served alongside some of the best flight surgeons in the military and saw how being in a demanding career with a large number of peripheral responsibilities caused stress over the lack of time available to spend on professional and personal pursuits that really mattered to their flight surgeons. They started Targeted Wealth Solutions to shoulder financial and business planning burdens so that their clients could get back to doing the things they were most passionate about. They can be reached at [email protected] or at their website targetedwealthsolutions.com or by phone at (303) 800-8179.
WCI: So Aaron, welcome to the white coat investor podcast.
Aaron Milledge: Thanks for having me.

WCI: So let’s start with just a little bit about you and your firm. Why did you become a financial advisor? What was the story there?
Aaron Milledge: I’ll be the first to tell you that the financial advisory career found me and I think that most advisors would tell you; “I got into this job because I love numbers.” And I think for the most part, that is a necessary condition. And certainly I could go on about a passion for finance. They kind of developed over the course of my MBA. But I don’t think that’s sufficient in answering the question of why do we this? What rose us out of bed in the morning and how do we translate numeric literacy to the value you had to clients. And so when I look back at my own life and kind of reduce it down. Two elements really standing out, the first was when our middle daughter was born.

Aaron Milledge: She has some significant special needs and it was at the time, kind of the peak operational tempo of my air force career. And so as a family we wanted to figure out how do you take financial resources? How do you plan around that? How do you develop this action of stewardship? Where do you take these resources? Did you plant them in such a way that expresses what’s most important to you as a family? How we wanted to spend more time together? How do we want it to be able to supports and services and education for our daughter? It was really the first time that we took pencil to paper and went through the deliberate process. This is what we have as a financial resource, how can we use it to express our values?

Aaron Milledge: And then second to that, I grew up in a small business family. My dad literally built a business around the kitchen table when he was laid off from the gas company. He was the junior stake holder in this company that would eventually become a significantly large company and in the middle market, regionally speaking. And so I was going through the MBA and was able to see this transaction occur where a private equity firm came in and acquired my father’s company and that was neat, right there at face value. “Hey look, it’s a case study, a real life case study that I know all the players watching the valuation and the deal terms and the diligence”. But as I took a step back, nobody was actually sitting on the side of the table with my parents, right?

Aaron Milledge: And so nobody was answering the question of how do we add in covenants so that ownership doesn’t get diluted as this company takes on new capital and grows. How do you navigate this liquidity event in a tax efficient manner? What does this do to longterm goals? What does this do to your kind of life? Nobody was there answering this questions, which is interesting because it seems like everybody has a guy. The guy that solves your insurance, a guy that does your taxes or a guy who does your investments. But that person didn’t exist to our parents. And so philosophically I think that those two elements are something very personal and near and dear to my heart at how as a family we use our finances to pursue what’s important to us.

Aaron Milledge: And then seeing that dearth of kind of trusted advisors that are out there to help clients in navigating complex situations are really the…those are the sufficient conditions.They kind of take this well, “Yeah I love numbers.” But what’s the next step? What lens do you look through? That kind of paved the way really for the financial advisory career to arrive on my doorstep, so to speak.

WCI: So let’s talk a little bit about your firm, Targeted Wealth Solutions. What do you view as being unique about your firm compared to others?
Aaron Milledge: I think that most people would say, “Oh, you guys flew fighters in the air force, that’s neat.” And I don’t want to be dismissive of the intangible qualities that that military officership brings to an industry that is often looked at with a skeptical eye and probably with good reason. But as clients start to work with us, I think really what stands out are three things and it’s kind of broken down into structure and scope and approach.
Aaron Milledge: Structurally, we’ve always worked as ensemble. And so the other co-founder Brandon LaValley and I have always worked as a team in every client relationship. And so if a prospective client goes to the website and they schedule a complimentary consult, they’re going to need to talk to Brandon or me. And so we were kind of the de facto persona in that relationship. But behind the scenes, we’re both working in and tackling that financial plan. I’m a big believer in… and I think that the true antidotes of hubrises is a dissenting opinion from a colleague.

Aaron Milledge: And so I think that the way that we approach planning investment management as an ensemble allows us to attack assumptions and analyze the plan from all angles and it kind of results in a robust outcome for clients along the same lines, the scope of what we do. But because we targeted on really this kind of notion of entrepreneurial spirit, we don’t just say that, well you’ve gotta be a business owner. It’s no, it’s anybody who really wants to take their finances and build optionality into their lives in order to pursue some passion or express some value. That opens up a whole world of domain expertise that we touch on.

Aaron Milledge: So this ownership to tax strategies to managing variable income in a business to get your cash conversion cycle under control to everything in between. The kind of normal personal financial advisor touches on. That’s the extent of our scope. And so it’s broad and it’s deep and you’re not have the answers off the top of our heads. But I think we’re the folks who are going to roll up our sleeves and run that question to the ground to get the answer to build it into the plan.

Aaron Milledge: And the third element is really the approach, which is just a kind of a knock on effect of the scope. So in combat aviation, you live and die by the planning that you do. And so it’s this continuous cycle of, you plan ignition and you brief the mission and then execute the mission. You debrief what you’ve learned, both success and failure and that feeds right back into the next iteration of the planning cycle. It’s wonderfully kind of systematic in the way that it looks at how to generate effects or desired instates at the most cost efficient or risk limiting way.

Aaron Milledge: And so it’s a framework that’s easily applied to financial planning. But I think that the current state of financial planning efforts kind of missed out on. The output of the normal financial plan produces more of a report card of, “Hey, you get an A plus in retirement savings, you get a C in your risk management or insurance.” Our approach to planning adds a little more dynamic element certainly in the areas of contingency planning and addressing issues before they actually become issues.
WCI: Now you two have likely got some special insight into the lives of military physicians. What do you see as being unique about the lives of a military doctor compared to other doctors?

Aaron Milledge: I think that’s it… And so our special insight, I don’t know is that special, but I will say that it was an incredible relationship to have in a flying unit because every flying unit has a flight surgeon assigned to that unit, it’s on your Manning document. And so you’re working, you’re briefing, you’re deploying, you’re going on temporary duty assignments with your flight docs. And if you’re fortunate enough to fly in an aircraft with multiple seats, your flight docs reports along with you. You build this where your ethos with these physicians. And I say that it was an incredible opportunity to kind of form those relationships. And certainly through those relationships we learned that not only that military physicians are under the same difficulty of translating the military lexicon to civilian life and they get transition.

Aaron Milledge: And so there’s a quantitative element to that end and there’s a qualitative element. A quantitative element is the fact that obviously as a military position, you’re probably most likely, underpaid relative to your market rate compensation in the real world. But at the same time you have these benefits that some are tax free, some are location dependent. Obviously you have a present value of a pension is your factory. And when you kind of look at, “Okay, well I want to leave the military transitioning to the civilian world, how do I make those apples to apples comparisons when I look at my financial lives?” And then from a qualitative or intangible side, I think it’s super unique, the life of a military physician where you’re not only be an officer first, and also you’re responsible for the air force, equipping and training these younger airman underneath you.

Aaron Milledge: But again you’re building this… where your ethos alongside your professional capacity, you’re deploying, you’re put in positions where the definition of first do no harm is put to the test right. I mean, I think you run into any military doctor who served at a deployed operating base and just the scope of our current military operations and they have a story of where they were treating an American service member right next to an enemy combatant. Those sorts of elements of a military profession are very difficult I think to make that transition from military service to civilian service. And so that’s a point, that’s a talking point when we talk to our military physician clients about, “Hey, this is what the outside looks like. Have you considered this?”

Aaron Milledge: It may not touch on your financial life, but it’s something definitely to consider that unique to military positions.
WCI: Yeah. Tell us about the fee structure, Targeted Wealth Solutions and why you guys decided to do it that way.
Aaron Milledge: Well I’ll be the first to tell you that sometimes we… or I should say the regulator tail wags the fee structure dog in the way that our state regulators view verbiage and they go through these periods of liking certain words and disliking other words. And what we’ve found is really if we give the client, “Hey, this is what we’re doing for you, this is how many hours on a yearly basis or this project is going to take. And this is kind of the aggregate total of that fee.” It’s really irrelevant to us how we express it in terms of percentage of AUM or a flat fee or a non-recurring project fee, that’s really kind of up to the client of what makes sense to them.
Aaron Milledge: And so we have an AUM scale where we can do flat fee, we can do again project or hourly fee. But at the end of the day it really comes down to… Our value is largely the fees associated or are largely determined by the amount of work that we do for the client. It’s just often times easier to explain to that directly to the client versus trying to capture that in the ADV or disclosure document in a way that satisfies the regulator and what words they want to see. But that’s a long way to say that we could tackle that multiple ways in our fee structure is flexible because we’re independent and this just makes it easier when you’re expressing the cost in terms of the work or the output per hour that we’re doing for a client.

WCI: And so it sounds like, looking at your ADV 2 how you expressed it to the regulators, you can do financial planning and consulting for 150 an hour and then ongoing wealth management for an AUM fee that starts at 1%, but starting at $400,000 drops to as low as 0.4% per year depending on the level of assets. Is that still the scale you’re mostly working with?

Aaron Milledge: Yeah, and I throw in the caveat to that. Because we’re finding that, for instance, in Colorado where we’re domiciled and regulated. The term retainer is sort of curious, mixed feelings, but I think we’re seeing a shift in our own practice new towards a flat fee. Again, it’s simpler. I think it’s a little more transparent and that’s not to say that you can’t reconcile an AUM structure with a flat fee, but I think that’s on an industry whole that’s where you’re going. And certainly how you arrive at that fee. I think that the fairest and most transparent ways is to use that hourly rate. Say, “Hey, this is what we’re doing on your behalf for the year. This is the hourly rate or go, here’s the fee as expressed.” However, it is much comfortable to the client. And then obviously the ultimate caveat is that everything is negotiable based on the complexity and the kind of unique situation that everybody brings to the table.

WCI: For those just tuning in and we’re talking to Aaron Milledge from Targeted Wealth Solutions. Let’s get to some of your questions now. Our first questions coming in up to Speakpipe today. This is coming from an anonymous resident. Let’s listen to it now.

Speaker 4: Hey Dr. Dahle, thanks for everything that you do. I’m a PGY 3 and I had a question about 401ks. Currently, in my residency I have a 401k that offers Roth and pre-tax contributions with no match. After I finished my PGY 3 year, I’ll be joining a primary care practice in August of 2020. They do offer a match and I guess my question primarily is when I have from January to June in residency, should I be contributing to my 401k as a resident trying to get as much into Roth as I can or should I wait until I’m employed by my new employer in August to start contributing to my 401k. I don’t want to miss out on any potential extra income from getting the match with mine new employer, but also want to take advantage of all the Roth contributions that I can make, while contributing to my Roth as resident, let’s say $1,000 a month prevent me from getting the full match. I realized that I can only contribute 19,000 in a year, so just trying to figure out where best to allocate that 19,000, thanks.
WCI: So basically Aaron, sounds like they’re asking, “Should I hold off on making 401k contributions the year I leave training in hopes of getting a match from my new employer?” What would you say to that client?

Aaron Milledge: Obviously I’d probably the first thing that comes to mind and in most folks as well, that I could create a closed form solution to this problem if I know how much I’m going to make. That, however, is inadequate, because every plan is maturely different. Even you know the language in the summary plan description may look fairly boilerplate across the landscape. Your ability to participate in the plan may be limited based on the waiting period. And so employment may start on January 1st but you can’t actually participate in the plan and receive the employer match until six months down the road.

Aaron Milledge: And so before you know I’d say anything, to hold off on making contributions or whatever to get ahold of the plan document, if able take a look if that’s even an option of a first day of employment and are you eligible to enroll and participate in the plan and then understand how that kind of factors the decision calculus from there. If there is a waiting period obviously and depending on how tight the labor market is and your willingness to negotiate, I would say put that on the table as far as Hey, talking to your employers say your plan excludes participation for the first six months that’s costing the X amount of dollars in employee match or employee your match rather, how can we kind of create an equitable solution from an all in compensation perspective to kind of make up for this poor plan design for lack of a better term.
WCI: Yeah, I think that’s exactly right. I love your idea of taking that to the negotiating table as well and using it to negotiate a little bit better offer because it’s not unusual at all. A lot of people don’t realize this. If they never had a retirement plan, like lots of docs coming out of training, they’ve never used any sort of retirement plan. They don’t realize that when you started a new job, a lot of times the way the 401k documents are written, is you can’t contribute for six months or a year. So if you’re coming out of training in July thinking, okay, I’m going to max out my new 401k, they may tell you no, you can’t contribute at all until next January or we’re not going to match you at all. So I think the bottom line is before you decide what to do with your old resident 401K for that year, you leave residency, is figuring out what’s going on with the new one before you leave.
WCI: You just got to get the document or you got to talk to the employer or call HR or whatever and just say, “Hey, am I even going to be able to contribute to this and is the plan any good and is a match”, and cause all that stuff matters, right? If there’s no match at either one, you might as well put it into your residency one, it doesn’t matter for that year. But if you’re going to get some match, if you put money in there in September and October and November, but you wouldn’t be able to contribute because you already maxed out your employee contribution in the first half of the year. Well you just left money on the table. And so I think the key is just to get the information before you leave residency so you know what to do. Once you have that information, it should be a pretty easy decision as far as how much you contribute.

WCI: I think another thing a lot of people don’t realize is that they’re still in a pretty good tax bracket that year they leave residency. Yes, it’s going to be higher than a full year of residency. But most of them are leaving in July and so they’ve got a year of resident income and a year of attending income and the next year is going to be all attending income. So it’s likely going to be a higher bracket. And so that’s a great year to do Roth contributions. If you had a tax deferred retirement account, maybe even do a Roth conversion of that in that year is kind of your last year for a long time of not being in the top bracket and not being in your, well not necessarily the top bracket but your peak earnings bracket, if you will.

WCI: And I think that’s a really key planning point for a lot of people. It’s not quite as good as those people that come back to med school from another career. I mean med school is a great time for Roth conversions, cause you have no income. You could do huge Roth conversions and pay nothing for them as a med student. But still even those years of residency or the year you leave residency or fellowship, there’s some opportunities there.
WCI: All right, let’s take our next question. I think we’ve got two here and I’m going to have a couple more later in the podcast from Tim from San Francisco. So Tim from San Francisco. Thank you so much for coming on the Speakpipe and leaving us questions for the podcast. We’re really going to be featuring you today. But listen to this first question here.

Speaker 5: Hi Jim. This is Tim calling from San Francisco. I had a question because my wife and I are both doctors and so have maybe more than average asset protection concerns. Does it make sense for us to meet separate taxable brokerage investing accounts for asset protection purposes? Thanks.
WCI: Okay, so this is an interesting idea. Tim is talking about having separate taxable accounts, one in his name, one in his wife’s name to try to maximize asset protection. What would you say to Tim when he brings this idea to you to boost his asset protection?
Aaron Milledge: It’s in a similar vein as the previous question, there is incredible amount of leg work and diligence to be done. Because asset protection, it’s all or nothing and so really the kind of a better way to look at it is three legs to a stool or whatever support. The first is looking at it through the lens of risk transference. And so I want to understand what insurance I have? What that it covers? What it doesn’t cover? To identify the gaps, identify the assumptions built into the coverage there, make sure that my policy limits are adequate for my situation and certainly the amount of assets that I have to protect.

Aaron Milledge: The second pillar or leg to that stool is we’re kind of getting into the operation of law here. I never want to rely on operation of law to keep a creditor away or saw my asset protection plan in its entirety. I don’t want to rely on something that a lawyer wrote for the benefit of another lawyer to protect whatever I own. And so to that end, I think that’s the point where you understand your insurance, you understand how we’re going to transfer risks, then we go to an attorney and bring in… this is where the financial team kind of gathers and says, “Hey, the advisor says this is what’s at risk. Is this the total net worth.” The CPA says, “Hey, we need to create a tax neutral, a strategy here.” And the attorney says, “Okay, based off of what state we’re in, based on case law and precedent-based off of judgment limits, this is the structure that I recommend, be it irrevocable trust or onshore, offshore structuring titles the right way”. That’s where the professionals get involved.
Aaron Milledge: And then finally the third leg. I think it’s more of something you owe yourself from a thought experiment is, if you don’t understand how a lawyer would bring a suit against you, regardless of the merit of the claim, if you don’t understand how contingent fee lawyers work or what their decision calculus is when they decide to take a case against you, I think it’s worth understanding. Understanding in yourself specifically what the history is kind of the land’s legal landscape of results arena, judges of contingency lawyers, and just what that looks like. Because again, I think the more information you know and what you’re armed with you, you kind of round out this effort of truly going through the diligence of asset protection.

WCI: So from those three perspectives, what do you think about the idea, as part of that plan obviously being to separate your taxable account, your taxable investing account into two and put some in your spouse’s name, some in your name. Do you think that would add much?
Aaron Milledge: Not much depending on the state. So TBE is limited by 15 States, which basically says that unless the votes spouses are encumbered by the same creditor, that the creditor can only can’t touch the other spouses account. Well that’s not the case in your state. And by the way, in a defensible position, TBE has kind of been put all on a by the wayside. I think Florida was like the most popular state for TBE being used and in kind of an indefensible positions to protect assets. I don’t see the benefit here in Tim’s case, given where he’s located at and just the kind of the lack of efficacy and TBE as a one stop shop for asset protection. And I do think it adds unnecessary burden and complexity from a household perspective.
WCI: Yeah, now he’s talking about TBE. So you mean means tenants by the entirety. This is how you title your assets in some States such that basically it says you own the whole account and your spouse owns the whole account. So mostly people are thinking about this with their house, but it can be applied to investment accounts as well, such that basically if someone brings suit against you, let’s say it’s a malpractice suit and it’s for some crazy reason, they get above policy limits judgment that isn’t reduced on appeal to policy limits, they’ve actually got a valid judgment against you. And the idea is if you own the retirement or you own the taxable investing account as tenants by the entirety with your spouse, they can’t take it. Because your spouse owns the entire thing and they’re not suing your spouse for malpractice they’re only suing you. Unfortunately, California is not a tenants by the entirety state. So this isn’t going to work for Tim in San Francisco.

WCI: But what a lot of people start worrying about asset protection. They forget that their biggest risk is probably their spouse anyway. So if your biggest risk is your spouse in a divorce, which even though physicians, dual physicians couples have lower divorce rates in the general population, it’s still way higher than the chances of an above policy limits malpractice judgment. And so putting half your taxable account or all your taxable account or your taxable account, your boat and your cars and your house and your spouse’s name, is probably going to cause you more problems in the event of your largest risk a divorce happening.
WCI: I had a subscriber the other day who unsubscribed from my newsletter and I often ask when people do, “Hey, how come you decided to?” And this person said, “Well, I’m going through divorce and it is too painful right now to be hearing about money every day in my email box because I realize all these great tips I put into place listening to you are just making my ex spouse much richer.” And so you going to realize that is a really big asset protection risk.
WCI: So I suppose if there was this is very rare above policy limits judgment against this doc, and maybe this could theoretically help, maybe it would protect half that taxable account because it isn’t owned by the doc. I haven’t gone to the trouble to do this. Have you had any clients do this in the past?
Aaron Milledge: No, not TBE. And again, I think it’s once you go to an attorney, I think they’re going to steer you away from this as a viable solution. There are better ways to protect yourself from this, this kind of hypothetical case of above policy limits judgment than just solely relying on title and maybe part of the equation, but I think it’s fallen out of favor as an exclusive solution.

WCI: Okay. So let’s take Tim’s next question here. Let’s listen to that.
Speaker 5: Hey Jim, this is Tim in San Francisco. My family is pretty early in its investing career and I am interested in exploring the idea of using margin to essentially borrow to fund our future financial independence. I know interactive brokers have relatively low broker margin interest rates. I was wondering if you had any experience with this? And what your experience has been like. What do you think is a safe total proportion of margin loan to have a portfolio? 10% 20% 30%? Thanks so much. Bye.
WCI: Okay, so here he’s talking about margin and really asking how much margin is a good idea to have in a portfolio? What would you tell them on that question?
Aaron Milledge: I think that’s probably the wrong question to start with it. And so, we liken things probably because we have simple minds back to the things we learned as fighter pilots. And one of the first things you learn is that if you ever show up to a fair fight, you’ve done something incredibly wrong. You should never show up to a situation where the odds are not stacked in your favor.
Aaron Milledge: Immediately when you start levering up, you stack things against you, unless you can create a situation where you do have an unfair advantage. And I think that you can create an unfair advantage in certain situations where there is an information asymmetry where you may have an insight into a particular geography as far as real estate is concerned or maybe a particular industry or private markets. But before we even get to creating that edge, so to speak with where it makes margin or leverage a sensible plan of action; the first… and we’ve got to look at your debt ratios in aggregate.

Aaron Milledge: If you’re looking at your personal finances, you need to understand all of the debt ratios that a corporation would do. And so learn to run your personal finances like a business. You got to understand your willingness and your ability to accept risks, which may be more mutually exclusive than people realize. You’ve got to understand what are you are using this margin or leverage for and how does that tie into longer term goals? What are the risks associated with that, that may derail the plan? And then from there, you could establish, “What information asymmetry can I exploit that would put me back into an unfair fight with the odds stacked in my favor.
Aaron Milledge: I think you mentioned here the no margin calls and I completely agree. If something is a liquid and there’s no Mark to Market on it, no one’s answering the question that no one wants to ask of what’s the true value of this. And so no one’s calling you on your margins. And so I think that before even getting to this, how much margin is a good idea to have in a portfolio, there’s a whole litany of questions we need to answer before then.
WCI: Yeah and most people, especially early in their career, there are already very highly leveraged. If you look at a typical 35-year-old doc, they’ve got 2 or 3 or $400,000 in student loans already. Maybe they have a practice loan for a half a million dollars, maybe they’ve got a half a million dollar mortgage. They’ve already got a ton of leverage in their life and now we’re talking about adding more into their life? I don’t think I’d really encourage that sort of behavior. Then later in life hopefully you’ve kind of taken care of this debt issue. You really don’t need to take that risk to meet your financial goals. Most docs don’t have to use margin. You just carve 20% out of your high income, invest it in some reasonable manner and you’re going to be financially independent in not that long.

WCI: If you do choose to do margin, you’re limited to 50% of your portfolio. That’s the most you can borrow against. But I wouldn’t get anywhere near that because that’s where you start seeing margin calls as assets start dropping. You hit a 2008 kind of scenario and you’re going to have some serious margin calls. And if you had enough money to meet those margin calls or maybe you should have just invested that in the first place instead of holding it in cash. But if you’re really want to leverage up, I think the place to do it, again as you mentioned, is the non callable stuff. Your refinanced student loans, your mortgage, a home equity line of credit, that sort of stuff. Rather than going to interactive brokers and taking out a margin loan, although they’ll give you a relatively low interest rate, I think there are 2 or 3 or 4% something like that. You do face the possibility of a margin call.
WCI: Before I did something like this though, I would encourage you to go back and read a thread. This is kind of a classic thread on the Bogleheads Forum. It was started in September of 2007 and if you know your financial history you can kind of know what’s coming. This was a fellow by the name of Market Timer was his avatar on the forum and he was an economics student, a graduate student, I think as I recall, who called this threat A Different Approach to Asset Allocation. And basically his idea was to mortgage your retirement, borrow all this money early in your career, and then gradually deleverage throughout your career. Well this attempt at using leverage in his portfolio blew up spectacularly a year later and it’s all documented in real time as this thread goes on.

WCI: And so I would encourage anybody can even considering adding a significant amount of margin, their portfolio to really read what it looks like when it goes bad. Because when it goes bad, it’s pretty ugly. Luckily, this guy was smart enough and hardworking enough that he eventually recovered from his huge mistake of trying to mortgage his retirement, but it wasn’t before losing several hundred thousand dollars that he really did not have. And he’s humble enough and into it enough and anonymous enough probably that he kind of shared all the gory details, but it is worth a read if you’re really considering adding leverage to your portfolio. It’s not something I’ve ever really done and I just don’t think that a typical doctor needs to do this to meet their goals.
WCI: So. All right, let’s move on to the next question. This one is about Mega Backdoor Roth IRAs, which is what I titled this podcast as. Let’s listen to it.
Speaker 6: Hi Jim. Could you further discuss the Mega Backdoor Roth IRA, specifically who is eligible? What advantages does it provide? And any legal or tax documentation that needs to be completed in order to do a mega backdoor Roth IRA conversion properly.

Speaker 6: Could you also discuss the utility of after tax traditional 401k contributions? Even if a Mega Backdoor Roth IRA is not possible? For example, does after tax 401k contributions provide the same asset protection benefits that a pretax contribution would provide.
Speaker 6: Here is some additional background about myself. My wife and I are both W2 employed physicians and we are already maxing out our respective 401K and 403B accounts, Backdoor Roth IRA accounts and HSA accounts. My employer sponsored 401k does allow for in plan Roth conversions of after tax traditional 401k contributions. However, my wife’s 403B plan does not allow this. Thank you again for everything you do. You’ve really inspired my family and me to take control of our finances.
WCI: Okay, so it sounds like he wants to hear about, Mega Backdoor Ross who they’re helpful for? How to do them right? And then also a little bit about after tax employee contributions that aren’t converted to a Roth. You want to talk a little bit about that? What he’s talking about there with the mega backdoor contributions?

Aaron Milledge: Yeah. And it’s an incredible opportunity if the plan allows it. And so just before we start getting everybody excited about the Mega Backdoor Roth, it’s not a guarantee by any means to all 401k plans. Your plan needs to allow after tax contributions. And from what we see from being lesser 338 and 321 fiduciary is when we look at plans, depending on the industry and the size of the business about 50/50 of those that allow an after tax contributions, even less allow in service distributions to Roth even less than that. Some actually provide a systematic valuation to the Roth portion of the 401k.
Aaron Milledge: And so again we’re always going back to this first question of it’s a level of diligence that needs to be executed to understand what’s available to your plan? How it works? Because at the end of the day what you’re doing is you’re contributing after tax dollars and so you are trying to achieve the maximum 56,000 in 2019 of the qualified plan, obviously beyond 19,000 assuming you’re younger than 59 not playing a catchup game, you get the tax break on and then above and beyond that you don’t get any tax, there’s a pre-tax benefit so you’re paying taxes on it, but you’re contributing to the plan. Those contributions are going to grow tax undeferred until you can do something with them.

Aaron Milledge: And so that do something with them could be distributed to a Roth IRA, their after tax are eligible for rolling into a Roth IRA. The earnings portion of those dollars when you distribute those will end up in your traditional IRA.
Aaron Milledge: And so it’s a fantastic way to supercharge retirement savings. Is a fantastic way to… if you’re excluded from contributing to a Roth due to income, it’s a great way to square that corner. It just requires some understanding of what your plan allows, what it doesn’t allow, and then certainly knowing what it looks like from a tax perspective to get your 1099-R when you do make those distributions and how you report that and distribution rollover from the plan into the Roth IRA. So it’s requires some work in my opinion, if your plan allows it and certainly if it doesn’t create a liquidity crunch for you know cash crunch, you have the excess capital to to put into retirement savings back to our, our asset protection obviously at a lesser plan is a great place to protect assets.

Aaron Milledge: We could go on and on about the benefits of the Mega Backdoor Roth. There’s a little bit of work to be done ahead of time to understand… so that everyone understands when the plan allows it and to kind of your responsibility of keeping up with the tax state and tax forms that it will be ultimately reportable.
WCI: Now your firm sets a fair amount of retirement plans up cause you guys function as 338 fiduciaries on them. Did the plans you set up usually have this as an option for people who want to do a Mega Backdoor Roth IRA?
Aaron Milledge: We’ve seen the shift down market for plan providers to kind of replace your standard insurance companies and payroll providers that have been of typically put in plans for small businesses. That’s great because I think the pricing is better across the board, the issue is that in order to achieve that scale and reached down market, what you see are a lot of volume submitter packages and basically boilerplate language and to be honest, you don’t see a whole lot of in the small business space which of kind of where we work, you don’t see a whole lot of plans that right out of the door have these options built in.

Aaron Milledge: Now that being said, it is well worth investigating. When at any time to kind of go through a restatement of the plan or amend it, talking with your TPA record keeper hey if you restate the plan to add in the ability to accept after tax contributions in service distributions. Certainly if there’s no walk component to the plan that’s that’s low hanging fruit it is always worth asking the benefits that coordinator, or if you’re on the 401k committee those are conversations to have. Unfortunately in the small business space, we just don’t see that as kind of commonplace elements of these mass produced low costs 401Ks. That’s not to say that they’re not out there. It just you really have to go ask the questions when you go through the plan design phase.
WCI: Yeah, pretty much has to be a customized plan most of the time to get that in a small business plan. For those who are lost, they would totally got lost in the last two minutes on this podcast. Let me step back for a minute and explain what a Mega Backdoor Roth IRA is. Hopefully you’re already familiar with a Backdoor Roth IRA. This is where you put money into your traditional IRA, $6,000 a year and then converted the next day or the next week or whenever to a Roth IRA. That’s the Backdoor Roth IRA. Now a Mega Backdoor Roth IRA has to do with a 401k plan. Basically in your 401k, you’re allowed to put in an employee contribution if you’re under 50 of up to $19,000 per year. Now the total of your employee contributions and any employer contributions into that plan can be $56,000 a year. So if you get a big fat match, then maybe you can get to 56,000 but there’s a lot of people that don’t get that much of a match and so they’re just not able to get anywhere near that $56,000 limit.

WCI: But there are some plans that the way they’re written, they allow you to make after tax contributions to the 401k. This is money that has already been taxed. You’re not getting that upfront tax break like you are the employee contribution to the 401k. It’s just after tax money. When it comes out eventually you won’t pay taxes on it, but the earnings will all be fully taxed at your ordinary income tax rate when it’s pulled out of the account. And so that’s like, well that’s about super attractive unless there’s one other provision in it. And that provision either has to allow you to pull money out of the plan despite not leaving the employer, right? This is an inservice distribution or allow you to convert it inside the plan into a Roth 401k account. And then that thus becomes a Mega Backdoor Roth IRA because you put in all this after tax money and then you convert it right away into a Roth IRA and then the earnings are tax free forever and none of that ever gets taxed again.

WCI: And so that, that’s a pretty great deal if you’ve got it and a want to do that. So Katie and I started doing that this year, kind of for a different reason. We were able to put in $56,000 in tax deferred money if we wanted to. But the issue was as business owners, the owners of the White Coat Investor, it was lowering our 199A deduction. All that money we were putting in there as employer contributions. And so we decided we’d stop doing that and just do Mega Backdoor Roth IRA contributions. But we had to leave our Vanguard individual solo 401k because their boilerplate plan design, plan document, didn’t allow this. And so we went and got a customized one that did allow it and basically that’s what we’re doing for our contributions this year. But lots of people through their 401k at the hospital or their practice or whatever, they can do these Mega Backdoor Roth IRAs.
WCI: You just have to make sure the plan number one, lets you contribute money after tax, and number two, lets you either convert it inside the plan or pull it out of the plan despite not leaving the employer and converting yourself into a Roth IRA. That’s what we’re talking about is these Mega Backdoor Roth IRAs. But the other question that was part of this was what do you think about after tax employee contributions that aren’t converted to a Roth IRA? So the plan allows you to put in that money after tax but doesn’t allow you to do an in-service distribution, doesn’t allow you to do in-plan conversion. What do you think? Do you think those are worth making or should you just invest in a taxable account?

Aaron Milledge: You can always wait until you terminate employment and so now you’re playing the long game maybe. Or if you know that you have a different life plan over the next few years and you can take the distribution on termination or separation of employment, that’s something to consider. We just mentioned the fact that from an asset protection perspective, that certainly in a risk plan like a 401k is a great place to hide money, so to speak. And so in this tax environment, I’m always challenged to find a compelling argument against opportunities to get money into a Roth, right? Because when you look at it historically post war years as world war II years, most brackets are the lowest they’ve ever been.
Aaron Milledge: And so, when you start looking at structural requirements down the road as far as the demography of the United States and our liabilities, your taxes are probably going to increase. And so that makes the Roth even more attractive. And so there’s a little bit of a bias on my part that say, “Hey, this is still an attractive option if they don’t allow in-service distributions or valuations to go Roth element of the plan”. Just keep in mind that you do have to wait until separation or termination employment before you can effectively roll that into a Roth account.

WCI: Yeah, certainly if you’re leaving in a year or two, there’s a pretty good argument to make the contributions. If you think you’re going to be there for 30 years, maybe you’re better off in taxable account because the person is your attorney earnings it could be longterm capital gains into ordinary income. And without getting that upfront tax break that you usually get with a retirement account. So you’re weighing a few things there. Most of the time it’s hard to say if it’s worth it without really getting into the details. So for those just tuning in, I’ve had Aaron Millage on here he is with Targeted Wealth Solutions. You can learn more about him and ask him more questions at targetedwealthsolutions.com. You can email at [email protected] or give him a call at (303) 800-8179. Aaron, thanks for being on the White Coat Investor podcast.
Aaron Milledge: My pleasure. Thanks for having me.
WCI: All right, I’ve got another question from Tim here. This is great Tim, you’re really feeding our podcast today. It’s great also that he left a name and where he’s from. So if you don’t mind, do that on the Speakpipe questions. I know a lot of you like to remain anonymous, but it does add a little bit more personality to the show and you leave your name and where you’re from. So let’s listen to his next question.

Speaker 5: Hi Jim, this is Tim in San Francisco. I’ve been reading about how ETFs work and I was curious about the authorized participant’s role in flushing out capital gains. Why would an authorize participant be willing to accept shares with the lowest basis? Wouldn’t the capital gains taxes they would have to pay, negate any ability for them to arbitrage and make money. Thanks.
WCI: So why would ETF authorized participants be willing to take the lowest basis shares when ETF units are liquidated? Well, I’m not sure they actually get a choice. I think there’s just got to take what they’re given. Yeah, probably the reduces the returns, but these are smart people with very powerful computers. I’m sure they can calculate out whether it makes sense for them to liquidate that ETF. If there’s an arbitrage there or not. Remember these authorized participants are able to form these ETF shares and disform them, and they’re the only authorized people able to do that. And so when they see an arbitrage opportunity between the prices of their securities and the prices of the ETF shares, they can swap them out basically and take the shares and sell them. For most of us, that would be very unwieldy to do and this really benefits us because it keeps the market very liquid and priced appropriately and so it’s a benefit to all of us to have people doing this.

WCI: But as far as answering your questions, I don’t think they get a choice. I don’t think they’re able to ask for the shares they want. And so the company can use this mechanism to flush out the lowest basis shares out of the ETF and make the ETF, and in Vanguard’s case, the ETF and the traditional mutual fund shares a little bit more tax efficient. That’s a great question though. If I ever meet one of those authorized participants, I’ll try to remember to ask them that question. All right. The next few questions we’re going to do here were actually aimed at my discussion with Michael Kitschies a few weeks ago. We weren’t able to get them in. As you may have noticed, Michael is a little bit talkative and we certainly didn’t get all the questions you guys wanted us to get on that podcast. So I’m gonna try to answer these to myself. Here’s the first one.
Speaker 7: Love both your podcasts. I’m a 62-year-old physician retiring in 5 years. Michael, I followed your discussion of equity glide paths by which equity positions increased during retirement, but you start at 30% equities on day one of retirement. I’m now at 60% equities, 20% of which is in retirement accounts. Would you really make a dramatic and tax inefficient move to lower my equity position on day one before I retire? Hey, thank you.

WCI: Okay. Basically we’re talking about bond tents here. What a bond tent is, is this idea that was kind of made popular, I think mostly by Wade Pfau in the last couple of years, that to reduce your sequence of returns risk, the period of time that matters the most is the 5 years before you’re retiring the 5 years afterward. And so that’s actually when your asset allocation should be the least risky, right? Mostly bonds, is extra amount of bonds in your portfolio. This bond tent in case terrible returns in your 30 year retirement period show up in the first 5 years. That’s what it protects you from. And then the idea is that after those 5 years or so after you retire, you start increasing your equity percentage in your portfolio. And so the bond tent is this period of time around the date of retirement in which you have a less risky portfolio.
WCI: So in the case of this question, he’s talking about going from 70% stocks to 30% stocks. I think what most people do is rather than making a dramatic shift, which obviously introduces some elements of market timing, is they do it more gradually over a 5 or 10 year period. If you want to be at 30% stocks for 5 years before and after your retirement date, I wouldn’t recommend going there all in one year. I’d tried to get down to there over a course of 5 or 10 years. And I think that’s probably the way to do it rather than a dramatic shift. All right, let’s take the second question.
Speaker 8: Michael. You’re such a clear thinker. Many talk about high dividend paying equities or funds as being superior in retirement because they generate income. They don’t consider that selling appreciated. Diverse stock funds is an option, but the tax rates are basically the same. What’s your view on dividend investing for retirement? Thank you.

WCI: Okay, so what do you think about high dividend equities or funds? I’m not a big fan of this approach to getting a value tilt. Now there are people out there that swear by dividends. They just think dividends are the cat’s meow. Even though in reality, you know, as far as from an accounting point of view or a taxation point of view, a dividend is nothing more than selling shares at a longterm capital gain. It’s like a forced sale of your shares when you may not even want the cash. And so it’s not necessarily ideal to declare a dividend, because it’s costing your investors some taxes if they really didn’t want the dividend.
WCI: The idea though that these dividend investors have is that if company management has to pay dividends, then they’ll manage the company better. And if they look back over the historical records, they see these companies that paid dividends have better returns than the overall market, but in reality, what that is, is that is just a manifestation of the value factor. This idea that value stocks over the long run at better returns than growth stocks, and that’s likely because the companies are a little bit riskier, although there are some behavioral aspects to that. But it turns out if you want a value tilt in your portfolio that a dividend tilt is not necessarily the best way to get that. It’s not a terrible way to get that. If you want to tilt your portfolio toward dividend producing stocks, that’s okay. I mean, I tilt my portfolio toward value stocks, but it may not be the very best way to do it.

WCI: So I’m not a huge fan of it. I certainly don’t think there’s something magic about dividends, like a lot of these kinds of dividend diehards you’ll see out there. I mean there’s a thousand blogs on the internet dedicated to dividend stock investing. Most of them don’t understand the concept of uncompensated risk of individual equities, but just realize that there’s a lot of behavioral and psychological aspects to this. All right, let’s take our next, this one’s not so much a question as a comment on the Speakpipe and let’s listen to it.
Speaker 9: I would just like to make a comment on one of your latest episodes where you’re interviewing the pulmonary critical care physician and kind of going into her finances. I absolutely loved that episode. It was so enlightening. It’s great to hear you just talk to someone like me who’s a physician and kind of go through their entire portfolio, their entire life in terms of their finances and then kind of diagnose what she needs to do. So I feel like more episodes of that would be awesome. For example, if you did at the very least, maybe an episode a month of just talking to a normal person and kind of going through that. I would love to be a volunteer, but just in general, just wanted to let you know. I absolutely love that episode. It was very informative and if you could continue to do those types of episodes, I would be very grateful. Thank you for everything that you do and thank you.

WCI: Okay, this here is the episode we had a few years… a few weeks ago, excuse me, where we brought somebody on and kind of did a deep dive into their finances. I got tons of great feedback on that episode. Everybody loves him. Unfortunately, nobody really volunteers to come on and talk about their mistakes and be M and M in front of 25,000 docs. Nobody seems to want to do it. I get a few people that want to come in and talk about all the success they’ve had in their life, but that’s not really what you guys want to listen to. You want to listen to the mistakes people made, which are just like your mistakes and just like my mistakes and talk through them. So if you’ve made a few mistakes in your life and you feel like that would make a good episode to do a deep dive into your finances and you have some questions about it, well shoot us an email.
WCI: We do put those episodes on and people love them. So let’s do a few more of them. Alright, next couple of questions came in by email. These are two questions from the same doc. The first one, I’ve got $32,000 in a rollover IRA. My expected income in 2019 is 175,000. Is it worth rolling by $32,000 in a rollover IRA into a solo 401k in order to do a Backdoor Roth IRA? I know I can convert the entire thing, but the taxes would be high because I’m a California resident and converting would only help me for the 2019 year because I’m going to be using a simple IRA as my employer provided retirement account going forward.

WCI: I’m not a big fan of simple IRAs. I understand it’s the right thing for some small practices, some small businesses to use a simple IRA. But a simple IRA does not have a very high contribution amount, you’ve got to leave the money in there for two years before you can do a rollover or a transfer and it is counted in the pro-rata calculation or a Backdoor Roth IRA. And so they’re not great. And so I feel bad for those docs who are forced to use them. The truth is, if your main retirement account going forward is going to be a simple IRA, a Backdoor Roth IRA probably is not in the cards for you, it’s probably not worth the hassle. If you’re only going to be there for a couple of years, sure do the contribution step and just don’t do the conversion step for Backdoor Roth IRA.

WCI: But for the most part, this is your longterm plan. Maybe you’re just not one of those people that are going to use a backdoor Roth IRA as far as this $32,000. It can be converted and you can just pay the taxes, maybe you’ll pay 10 grand in taxes on that. If you can afford that, that would be fine to do and then of course you’d be able to put $6,000 into a Backdoor Roth IRA that year. But that’s probably it. Given that you’re going to be using a simple IRA going forward.
WCI: And so I may not bother with it. I may just hold on to it as a rollover IRA for now and just resign myself to the fact that I wouldn’t be able to do a Backdoor Roth IRA going forward. Remember of course that IRA stands for individual retirement arrangement, right? It’s individual. That means even if you can’t do one because of a simple IRA, that doesn’t mean you can’t do a spousal IRA for your spouse. So if your spouse is a stay at home parent or if they do whatever their work and you can still fund a Backdoor Roth IRA for them, even if you have a simple IRA at work.

WCI: And remember when I’m saying simple IRA, I’m not talking about your basic traditional IRA. A Simple IRA is a separate type of retirement account that the self-employed use, that employers use for their employees. It’s called a Simple IRA and it’s always capitalized. S I M P L E stands for something. I can’t remember off the top of my head what it stands for today, but that’s not just a traditional IRA.
WCI: Okay. The second part of the question, as a resident and fellow, I maxed out my Roth IRA every year. The only issue going forward is that my new employer only offers a simple IRA including a 2% salary match. I know that simple IRAs prevent rollovers for two years from the initial contribution of funds, which would not allow me to do Backdoor Roth IRAs because the pro rata rule, what do you recommend I do? Well, I probably just wouldn’t do Backdoor Roth IRAs going forward as I mentioned. Okay. Another question from Tim from San Francisco.
Speaker 5: Hi Jim. It’s Tim in San Francisco. What do you think about Vanguard’s Total International Bond Fund? Should we use it for relatively short term savings goals? Should my mom use it in her retirement account? Thanks.

WCI: Okay. What do I think of the Vanguard Total International Bond Fund? Should I use it? Should my mom use it, et cetera. Okay. Vanguard likes it. No surprises. They’re fun. They use it in their target retirement funds. I’ve never actually owned that particular fund. There are dozens of asset classes out there. You don’t have to invest in them all. There are no called strikes in investing. Certainly international bonds are a reasonable asset class to include in your portfolio, but here’s the deal with bonds. If bonds are only 10 or 20 or 25% of your portfolio, you probably don’t have to have a very complex bond holding. Maybe you only own one bond fund, a total bond market under an intermediate bond market index fund or something like that. If you’ve got 50 to 80% of your portfolio in bonds, you probably want to break it up into a few different bond asset classes and maybe that’s the type of place where international bonds or treasury inflation protected securities tips, bonds are appropriate to include in the portfolio, et cetera.
WCI: But the whole key to building a portfolio, building your asset allocation is to pick something reasonable and stick with it. If you like international bonds, it’s okay to put them in your portfolio, set them to 5 or 10 or whatever percentage of your portfolio that you want them to be, rebalance it periodically and go forward with it and stick with it. They will have their day in the sun just like every other asset class does, but I don’t find the argument hugely compelling for those of us early in the accumulation phase to add this fund to a total bond market fund, just for completeness sake, so you have all of the bonds in the world. I don’t know the bonds necessarily need to be diversified quite that much like stocks do. I’d be much more likely to add an international stock fund to my portfolio than I would an international bond fund. All right. Next question.
Speaker 10: Thank you very much for all your financial wisdom and financial polls. I have a question regarding non-qualified deferred compensation. My new employer is offering non-qualified deferred compensation where I can contribute up to $50,000 a year, but in spite of that, my tax bracket will still remain the highest when I do married filing jointly due to our combined high physician salaries. My question is that should I still contribute to non-qualified deferred compensation at all as it is non-qualified and risking the future though my employer currently is very stable? I have been maxing out my other retirement contribution and Roth contributions every year along with… I also have brokerage account. But my new employer will be contributing $17,200 every year to my deferred compensation account irrespective of my contribution. So I think that could be a substantial amount accumulate until the time I go to distribution or there is a termination.

Speaker 10: Can you please give me the details of a non-qualified deferred compensation plan? I did read that it is largely illiquid. The terms that an irrevocable one as it is set is risky not to put creditors. I do know that I don’t pay income tax but pay FICA in future tax year the year I defer compensation, but is it that I can only access it after retirement or I can keep a term of 5 years or 10 years? Is there anything else I’m missing about deferred compensation and should I defer any amount of my gross salary in deferred compensation? And the funds and then deferred compensation or Vanguard funds. Thank you again.
WCI: Okay, so this is about a deferred compensation account. Should you use it? Well, these are basically the same as a 457B is deferred compensation. That means the money still belongs to your employer. So the number one consideration is whether that employer is stable. If the employer goes under you could lose the money. It’s asset protected from your creditors but not their creditors. You also want to make sure it has reasonable fees, reasonable investment options and reasonable distribution options. If you have to take all the money out the year you leave, that’s not reasonable, right? And if you put $200,000 in there and now you got to take that all out the year you leave employment, that sucks because that’s basically going to be an extra $200,000 in taxable income on that money. And you may end up paying a higher tax rate on it coming out than you did going in.

WCI: But if you can spread that out over 5 or 10 years or longer, or you can roll it into an IRA, like a lot of governmental 457 plans, then it can make a lot of sense to use that 457 plan. Likewise, if all the investments are terrible or there’s some type of weird insurance product, maybe you’d rather just use a taxable account than that deferred compensation account. But the most common issue is that the distribution options just aren’t very good. So make sure you understand how that money comes out of the account before you put the money into the account. There is no standard out there. Every plan is different. Read the document and really understand what’s going on and make a smart decision.
WCI: Just remember, even if the plan isn’t perfect, you may want to put some money in there even if you don’t max it out. Maybe you don’t max out every year for 10 years. Maybe you max it out for a year or two or maybe you just put $5,000 a year in there. It’s not an all or nothing decision. You can always go halfsies and put half of the extra money you have to invest in that and happen a taxable account.

WCI: Okay. I got this question by email and another one a little bit about savings accounts. They say, I read in your Financial Bootcamp book and maybe a good idea for high-income professionals to use the Vanguard Municipal Market Fund, money market fund as a savings account, especially if you live in a tax free state such as Florida. I just wanted to confirm that I interpreted that correctly. I was planning on putting excess cash into the Vanguard Municipal Money Market Fund after I’ve maxed out all my tax exempt retirement accounts and Backdoor Roth. In addition, I have a 2.3% high yield savings account at a bank. Thanks for your input.
WCI: Well, the key with these cash equivalents, these money market funds, these high yield savings accounts is to do a calculation. And that calculation is you take the yield of the taxable account and you multiply it by 1 minus your marginal tax rate. So if you’re in 37% tax bracket, you take the yield of the taxable account, multiply it by 1 minus 37% or 0.63 and that tells you the equivalent yield on an after tax basis. So you then compare that to what the municipal money market fund is yielding. And if it’s the municipal money market fund is yielding more like it usually does for those in the highest tax brackets, then you put your cash in there. If it’s yielding less on an after tax basis, then you just keep it in the taxable account and you pay the taxes.

WCI: Lately, the last couple of months has been a little bit wonky. Those of us in the highest tax bracket, sometimes it has actually worked out better to just be in a taxable money market fund or a taxable high yield savings account. So periodically you might want to recheck that. Occasionally the yields of munies versus taxable bonds and money market funds does change a little bit, so keep an eye on it. But the key is to do that calculation.
WCI: All right, here’s another question that comes out of the Facebook group. I’m fresh out of training. Our family likes to travel. I was wondering how much should I spend each year on vacations. Is there a formula like 5 to 10% of post-tax income. Well, first of all, you’re fresh out of training, right? So you’re supposed to be in your live like a resident period. So it’s okay to go on a vacation if it’s a kind of vacation that a resident can afford.
WCI: Oftentimes that means driving on a road trip or staying with family or doing it on the cheap or using airline miles to pay for it, that sort of a thing. And then generally after your live like a resident period, my recommendation is that you save 20% of your gross income for retirement. Save enough for your kids college and up to have your house paid off by retirement, and then you can spend the rest guilt free. There’s no magic number of 5% for vacations or whatever. If you’re a car guy, go spend the extra on a fancy car. Maserati or whatever you car guys are into these days. If you love to travel, we’ll spend it on vacations. So what if you spend 15 or 20 or 30% of your gross income on vacations? If that’s your thing and you want to live in a shack and drive a beater, but go on these awesome vacations, then do that, right? But you got to balance everything else out and make sure you’re taking care of business.

WCI: 5% sounds reasonable to me at the stage I’m at in life, but there are periods of time in my financial life where 5% would’ve been way more than I should have been spending on vacations, so you just have to look at your overall budget, make sure you’re working towards your goals and then decide how much you’re willing to spend on vacation.
WCI: Okay. Another one from the Facebook group, I’m holding a Vanguard total bond market ETF and my taxable account, I want to exchange it for something more tax efficient such as a municipal bond ETF. Okay, that seems reasonable to do. That’s not a bad idea. If you are going to try to have a little bit more tax efficient portfolio. You can also simply take your bonds and invest in them in your tax protected accounts and put stocks. A total stock market index fund, total international stock market index fund, that sort of a thing into your taxable account as well.

WCI: This question also asks if I identify a loss and do this exchange does that count as tax loss harvesting? So yeah, that’s great if you can sell something… but you’re going to sell anyway and get a loss out of it, then you can use that to offset up to $3,000 a year of your ordinary income and beyond that, any capital gains you may have.
WCI: Okay, so while I was gone recently on a trip, I got a couple of emails of people asking about an interview that Michael Burry did. Michael Burry is the guy in the big short, he’s the doctor who’s left medicine and went and ran a hedge fund and resisted all of his investors calls to stop doing what he was doing and made a big call, right in 2008 made gazillions of dollars for himself and his investors.
WCI: And so in this article, basically he talks about things like the index funds are a bubble and those sorts of things and give some warnings about that. And people asked me what I thought about that. Well, I’m not a guru. Maybe Michael Burry is a guru, but here’s what I’ve learned. Nobody knows what’s going to happen in the future. Michael Burry’s crystal ball is just as cloudy as everybody else’s, right? Just because he made one call right in 2008 does not mean that he knows the future about everything going forward from here. So I take anything everybody says with a grain of salt, right? And try to have a plan that doesn’t require you to be able to predict the future in order to meet your longterm goals.

WCI: I really don’t buy this index funds are in a bubble argument. And the reason why, is yes a significant portion of the market is indexed, but a significant portion of the trades in the market are not index. They are being made by active managers who are trying to do price discovery and discovery with the value of the various securities are. And so they are determining as they go along what they think a company is worth. And those people who are making the trades are the ones who are determining what the value of the security is. Not the people who are buying and holding it for 30 years. They’re not making any contribution to what the value of that security on a given day is and so I am not worried until a much larger percentage of the market is in index funds that is somehow going to cause the market to be less efficient.
WCI: There will always be people like Michael Barry out there trying to find the stocks that are under priced and buy those instead. I just don’t see this scenario where index funds are going to go down and the overall market is not, or that somehow index funds are gonna drop more than the market or that a significant percentage of the market being index funds to some are going to inflate stock prices.I don’t buy it. If the stock market goes down, your index funds are going to go down.

WCI: Maybe you’re tracking area error gets a little bit larger, but it is so tight right now. It could triple and you wouldn’t even notice it. That’s much less of an issue anyway for a longterm investor like me than it is for someone running a hedge fund like Michael Burry. But anyway, I stopped believing in anybody’s ability to predict the future well enough to provide actionable information a long time ago. And I suggest you do the same. So our sponsor for this episode was Earnest. Earnest is really great because you can choose custom terms to fit your budget. So you can pick your exact monthly payment or you can select your interest rate or you can select the term, which is what most people do is they decide how long they want to pay and then Earnest tells you what the interest rate for that term is going to be.

WCI: You can get fixed and variable rates, they don’t pass you off to third party servicers. They don’t penalize you for making payments early. They protect your family and the event of your death or disability. And the minimum out to refinance is super low, 5,000 and the maximum out is pretty high, 500,000. So if you have debt between five and 500,000 you can refinance with Earnest. If you go through the link I’m about to give you, you can get $500 cash back as well, and please put that towards your and pay them off even faster. That link is whitecoatinvestor.com/refi, R.E.F.I. Refinance today with Ernest.
WCI: You sure you sign up for our email list? You can find that a whitecoatinvestor.com/email also give us a five star review on the podcast. Tell all your friends about it. Head up, 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. Dahle, 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.