Podcast #121 Show Notes: What You Need to Know About Self-Employment Taxes

Dealing with self employment taxes can be a little tricky. In this episode I discuss quarterly payments, or a way to avoid making them if you have W2 income as well, to avoid penalties by being in the safe harbor. Bear in mind, what you pay in advance or what is withheld, may have little to no relationship to how much tax you actually owe. So I discuss what we do in our monthly financial plan to ensure that we have adequate money to pay our tax bill come April 15th. Spoiler – investing the money set aside for taxes is a bad idea. You really don’t want to owe money to the IRS. They have a lot of rights that most lenders do not have, like being able to garnish your paychecks, take money out of your bank account, and send you to jail. We also discuss your term life insurance needs and how to invest that insurance money in the unfortunate event that you become the beneficiary of a term life insurance policy. Other questions we answer are about paying off debt vs investing, self directed IRAs, mutual funds vs ETFs and dealing individual stocks.

Today’s episode is sponsored by CommonBond. CommonBond has worked with thousands of doctors to help them refinance their student loans, save money, and get out of debt more quickly. And since your financial needs are unique, CommonBond has flexible plans along with award-winning customer service. CommonBond also offers best-in-class borrower protections, like up to 24 months of forbearance – just in case you run into any financial difficulties and need to press pause on your monthly payments. Best of all, listeners of this podcast will receive a $550 cash bonus when refinancing with CommonBond. Head over to CommonBond to see your new rate and claim your $550 bonus.

Conferences

I wanted to make you aware of a couple of conferences coming up that you might be interested in. Peter Kim at Passive Income M.D. is putting on a conference called Financial Freedom through Investing in Real Estate. It is in LA in October. I will be speaking at it. Early bird pricing ends on September 8th so check it out today.

A friend of mine from a mastermind group I’m participating in is holding a Financial Independence Summit for you FIRE people. It is put on by 2 Frugal Dudes and you can find more information here.

Quote of the Day

I missed the quote of the day in the last few episodes. But I will try to remember to do them each time. This one comes from Morgan Housel, who said,

“Few things matter more with money than understanding your own time horizon and not being persuaded by the actions and behaviors of people playing different games.”

Totally agree with that and I’m excited to meet Morgan Housel in person. He’s going to be speaking at WCICon 2.

Correction

I have to make a correction. I made a mistake in a podcast #116 and it is time to own up to it. I was talking about ETFs and mutual funds, and, at E*TRADE, I said it’s cheaper to buy the ETF than the mutual fund because the commissions are higher. That’s actually not true at E*TRADE. Vanguard Mutual Funds, at least the ones that you would use in a typical Boglehead-type index fund portfolio are part of their no-load transaction fee category. They only charge you redemption fees in the event of short-term trading. They don’t charge a typical fee for each time you buy and sell. I apologize for that. That is not true for all brokerages though as we’ll discuss later in this podcast.

Millionaire Doctors

A couple of things coming up this fall that I want you to know about. We are going to be putting on a physician millionaire episode. We are looking at having 5 or 6 people on the podcast to talk about their financial success. I’m looking for financially successful doctors, minimum of a million dollars net worth, who will come on and answer questions like, “What’s your net worth? What was your income over the course of your career? Why do you think you became financially successful and many of your peers did not?”

We’re going to put together a whole episode of that to run later this fall. If you’re interested that, email [email protected] and we’ll arrange for a time to record that segment with you and put them all together into one podcast.

Back to Broke

We are going to do another podcast aimed at people a little earlier in their career too. I want to bring on people that paid off their student loans, especially huge student loan burdens, in less than five years out of their residency or fellowship. So, if you’re one of those people and you’re willing to come on and talk for 5 or 10 minutes about your experience and how you did it, email [email protected], and we will set up a recording time with you.

What You Need to Know About Self-Employment Taxes

A listener, Audrey, started a locums 1099 side gig this year and had some questions about self employment taxes.

“I already maxed out a 401K at my W2, so I’m currently setting aside 20% of my 1099 profits in a high-yield savings account, as my accountant suggested, since I won’t know the exact number to take 20% of until I file my 2019 taxes. Is this a good strategy or should I invest monthly as I go and make any necessary adjustments when I file my 2019 taxes? Second question is, I know the general advice is to open a solo 401K because it enables you to do a backdoor Roth IRA, but what if I have a bit too much in my IRA to afford the tax hit? I currently own real estate in my self-directed IRA and I’m wondering if a SEP IRA would be an acceptable, if not a better option, since it’s a bit cheaper and slightly less complex to administer than a solo 401K. “

If you are self employed you should be setting aside money to pay your taxes but don’t invest that money. Let me tell you what I do with my taxes. I’m completely self-employed now. I don’t have any employee income, no W2 income at all, other than what I’m paying myself from the business I own. I pay my taxes in two ways. One, and the main way, is quarterly estimated payments, and these are due April 15th, June 15th, September 15th and January 15th. It’s kind of interesting, but that’s the way the IRS does it. You only get two months for the second quarter and you get four months for the last quarter. The idea is you pay enough in taxes that you don’t get any penalties as the year goes on.

This listener mentioned that she was putting away 20%. Maybe that’s enough for her. It’s not enough for me. I’m paying, right now, about 34% of my income in taxes, so each month, I take 34% of the money I make and put it into a savings account, just an online savings account or a money market fund. I keep piling that up month after month, and when I go to write a check in April or June or whenever the payments are due, I write it out of that account. That is my tax account. If I’m a little bit behind in what I owe the IRS come next April, I make up the difference out of that account because the money is there, I took it out each time I made the money. The worse thing you can do is spend the money and not pay the quarterly estimated taxes if you need to. So, that’s the most important thing to do if you’re self-employed.

Now, if you also have an employee gig, there’s an opportunity to maybe minimize or eliminate having to write those checks. What you can do is just have more money withheld from your employee paychecks. You can basically set your exemptions there on your W4 down to zero and just have a whole bunch of money withheld from that gig. If you don’t make too much in your self-employment, then that will cover the tax bill.

Between what is withheld by the employer and what you pay in quarterly estimated payments, you need to make sure you get into the safe harbor. That means for high income folks like us either paying 100% of what you owe or more or 110% of what you owed last year. Because my income has been rising over the years I pay 110% of what I owed the previous year. I just take what I owed last year, multiply it by a 110%, divide it by four and that is the check I write every quarter as my quarterly estimated payments.

In addition, we’re an S Corp now. White Coat Investor has been an S Corp for the last couple of years. So, I actually have to pull income and payroll taxes out every time we pay ourselves. We do that about once a quarter. Technically, you can probably do it once a year, but you’re going to have to fill out a federal and probably state forms once a quarter whether you pay yourself or not. So, we just thought we’ll make it easy and pay ourselves each quarter. The goal here with these methods of paying tax, as a self-employed person, is to make sure you have the money to pay the taxes. Don’t spend that money or you’re really going to be hosed come next April. And avoid any penalties by getting into the safe harbor.

Bear in mind, what you pay in advance or what is withheld, may have little to no relationship to how much tax you actually owe. In the past, I have written a check for $200,000 come April because I did not have to have that much withheld based on the previous year. I did not have to pay that much in quarterly estimated taxes to stay in the safe harbor, but I still owed the taxes in the end. So, you want to make sure you’re keeping that money around and using it to pay those taxes. If you’re going to need this money in three months to make a quarterly estimated payment or you’re going to need it in six months to finish paying your taxes for the year, this is not money that should be invested in stocks or real estate or maybe even bonds. This is money to keep in cash. Try to get a yield out of it. Try to make two percent out of it or something by going to a high-yield savings account like Ally Bank or by going to a Vanguard Money Market Mutual Fund to make two percent on it instead of one percent in your checking account. But this isn’t money you’re trying to make money off of. You’re trying to just preserve the principal, so it’s there to pay the taxes. You really don’t want to owe money to the IRS.

[Update after the podcast was recorded: Apparently I didn’t actually answer the question asked (that’s what happens when I listen to the question a week before recording the podcast.) Yes, it’s fine to just leave that money in a high yield savings account until you know exactly how much to contribute to the retirement account. Alternatively, if cash flow allows, that money can be invested elsewhere and new money can be used to make the retirement account contribution. Money is fungible and you just have to make enough to cover the transaction, it doesn’t actually have to be the same physical dollars. And obviously no,  a SEP-IRA isn’t going to work very well because it screws up the pro-rata calculation for the Backdoor Roth IRA. In this case, with a self-directed IRA holding real estate, I’d try to just do a Roth conversion of the self-directed IRA to facilitate future Backdoor Roth IRAs, but if that was too hard, I’d just not do the Backdoor Roth IRAs. ]

Another listener, Matthew, had another question about 1099 income from moonlighting,

“Can you please discuss deductions on a tax return for 1099 income. Is there a limit? Let’s say I make $1,000 in 1099 income from moonlighting. Can I deduct $3,000 of expenses, such as DEA license, board examination fee, home office, etc.? Also, I know colleagues who have established a business for their 1099 work. Instead of the 1099 being addressed to John Smith, it is addressed to John Smith, Inc. What’s the benefit of creating a business for 1099 income? Does this help with additional retirement account options?”

He is basically asking, “Can I deduct more than I made.” Well, you actually can. When you’re running a business, if you’re a sole proprietor and you’re filling out Schedule C, you can have a loss in your business. In fact, I think you can have a loss for two of the previous five years and the IRS still believes you’re trying to make a profit, but if you claim a loss year after year after year, the IRS is going to say that’s not a business, that’s a hobby. You can’t deduct your expenses from a hobby like you can from a business.

Matthew was also wondering if he should incorporate. Here is the deal with incorporation. A lot of doctors think it is going to automatically save them all kinds of taxes and prevent them from being sued for malpractice. But malpractice is always personal. Just incorporating as a physician is not going to save you from any malpractice risk.  Maybe if you have employees or some other business associated risk, it could help you in that sort of asset protection scenario, but not for malpractice, which is really the only risk which most independent contracting doctors have. There’s just not really all these great retirement options that you can have when you’re incorporated, but not when you’re a sole proprietor. So, there is not really a huge point to incorporating for most people that are just doing a little bit of moonlighting.

Now, if almost all of your income is self-employment income, you might want to incorporate to save a little bit in payroll taxes because when you are filing your taxes as an S Corp, you can declare part of your income as salary and part of your income as a distribution. On the salary, you pay the full payroll taxes: social security tax and Medicare tax. On the distribution, you still pay your full income taxes, but you don’t pay any payroll taxes. What that means for most docs is that they save the Medicare tax, which is 2.9%. By incorporating, if you can declare a big chunk of your income as a distribution and still be paying yourself a reasonable salary, according to the IRS, then you can save 2.9%. So, if you declared $100,000 as distribution instead of salary, you save $2,900 in taxes. Now part of that is deductible, so it’s actually a little bit less than that.

That is kind of my general guideline. If you’re not going to save at least a couple thousand dollars in Medicare taxes, it’s probably not worth the hassle of incorporating because either you or someone you hire is going to have to file a whole bunch of extra tax forms each year if you want to file taxes as an S Corp.

Reader and Listener Q&A

We brought on another one of our financial advisor partners in this episode to answer your questions with me. Clint Gossage, at CMG Financial Consulting is a CFA, CFP and a CPA and happens to be married to a surgical oncologist for the last 15 years. He has experienced, first-hand, the ups and downs of the journey from undergrad to becoming an attending, and realized, after helping friends in medical school, residency and fellowship with their finances, that he wanted to focus on advising doctors. He really likes giving physicians back their time, our most scarce resource in life. If you are in need of a financial advisor Clint is a great one to reach out to. We answered the next three listener questions together.

Paying off Debt versus Investing

“My wife and I are currently deciding what to do moving forward with our financial plan. We’re both 27, have a combined annual income of around $160,000 and still owe $220,000 in student loans, which I recently refinanced with Laurel Road at 4.25% and had my wife’s loans, about $50,000 of that, at 3.2% fixed. We currently rent for $920 a month and keep our expenses fairly low at around $36,000. I contribute the max to my employer-sponsored 401K, plus profit sharing for nearly $35,000 a year into the 401K. My wife contributes the max for her employer-matched of around $3,000 a year for her 401K. I do have an HSA, as well, but only my employer is contributing to it. I have not yet opened a Roth IRA. My question is, do you think it would be worth it to max out my HSA and Roth IRA contributions and allow that money to grow or to take that same $9,500 a year and put it towards our student loans?”

It seems wiser to max out their retirement accounts, but I hate looking at the interest he is paying on student loans. I asked Clint how he would advise this listener.

“I know this is a common question for you and it’s probably the most common question I see, as well, which is essentially, “Should I prioritize paying off debt or investing?” In this case, they have already refinanced their student loans at lower rates, which definitely gives them some more options.”

Clint goes on to give them a priority list.

  1. Taking advantage of any employer-match on their 401K, which they are already doing.
  2. Prioritize any of their investment accounts that are getting tax benefits. That’s going to include their Roths and their HSAs.
  3. Pay off debt

Looking at their highest and best use of their money, with tax advantage accounts we are hoping, over the long-term, will earn seven to eight percent and they are going to be growing tax-free over that period. Compare that to potential payback on a student loan, which is earning three and a quarter, four and a quarter.

I get this reputation as being totally anti-debt, and I’m not a big fan of debt, by any means, but I’m also a huge fan of tax advantage investing accounts. It’s one thing to be comparing paying off a 4% something debt versus your taxable account. It’s entirely different in your Roth IRA or HSA, something that’s probably never going to be taxed again. So, I think you need a little bit higher barrier there. That doesn’t mean carry around debt at 10 or 15 percent in order to max out your Roth IRA, but at three or four percent, that’s not a bad gamble.

Mutual Funds  versus ETF fees

“Hey Jim, quick question for you regarding mutual fund versus ETF fees. I commonly use the TD Ameritrade website to compare perspective investments. I’ve noticed when comparing different share classes of the same investment, the hypothetical fees that TD Ameritrade quotes will vary substantially despite a nearly identical expense ratio. For example, take the comparison between VTSAX and VTI, which, as you know, are different share classes of the same Vanguard Total Market Index Fund. The VTSAX expense ratio is 0.04% and the VTI’s 0.03%. This different would theoretically translate to a yearly fee difference of $1 per $10,000 invested. When you compare these funds on the TD Ameritrade website, however, they give a five-year total fee estimate of 1.41% for VTSAX and 0.28% for VTI. They calculate these hypothetical fees using the same initial investment, yearly investments, and rate of return over five years for both funds. Is there something missing here? Are there hidden fees in the mutual fund share class that aren’t reflected in the expense ratio? Is there an error on the TD Ameritrade website?”

Clint said, “on TD Ameritrade’s site, they include commissions in the way they do their fee comparison when you’re comparing mutual funds and ETFs. TD’s using their commission schedule to make that comparison. TD charges $6.95 per ETF trade and $49.99 per trade on the mutual fund, which is quite a bit higher. So, that’s why you’re seeing that big disparity there.  If you’re not using TD as your brokerage, and you’re buying them at Vanguard, you can basically look at the expense ratio as the same on both of them.  If you are looking to buy them at TD, obviously, VTI or the ETF is going to make a lot more sense.”

This has happened to me a lot, actually, in my career with various 401Ks. Like my 401Ks at Schwab, I buy the ETFs because the commissions are lower and that is the only reason. Whereas, when I’m buying them at Vanguard, even in my taxable account, a lot of time I just use the mutual fund version because I happen to prefer mutual funds rather than dealing with having to put in the trade orders during the day. If you’re going to charge me 50 bucks every time I do a transaction, well, shoot, I’ll deal with the hassle and I’ll just buy the ETFs. I think that’s the difference that they’re seeing here.

It’s interesting, though, every broker is a little bit different in this respect as I mentioned earlier in the show notes.  E*TRADE has the Vanguard Mutual Funds on their no transaction fee list. So, you could have used either one there at E*TRADE, but at TD Ameritrade, they’re not super happy with Vanguard right now or vice versa. I’m not sure exactly what’s going on, but they took the Vanguard ETFs off their commission-free list, and, obviously, they’re charging the full price for the mutual funds.

Unrealized Gains in Individual Stocks

“I have about 1.6 million dollars in a brokerage taxable account and another $300,000 or so in a Roth TSP account between my wife and I. The brokerage account is up approximately $600,000 in unrealized gains. Most of the holdings within the brokerage account are individual stocks. Many of these were purchased well before I started listening to your podcast. I’m wondering if there’s a tax-efficient way to transfer some of the individual stocks into index funds, bonds, ETFs, other various less risky investments.”

He has done a great job saving up a good chunk of money in individual stocks at this point and it’s really a question of looking to reduce risk. There are several different options to look at when trying to diversify.  It’s somewhat going to depend upon the specifics, probably on the number of individual stocks. If he has 40 or 50, it’s going to be a little different than if he has five or six, but the more holdings he has, the closer he is to a well-diversified portfolio.

Clint had some suggestions:

  1. Turn off any automatic dividend re-investments, so, that way, he’s not adding to his individual stock portfolio each month or each quarter.
  2. Harvest any losses. That’s going to involve selling any of the stocks that have losses. He probably wants to look at even the individual lot level, meaning, if he had bought some Apple stock every year, some of it might have a loss while other shares of it might have a long-term gain. By doing that then, he’ll generate some losses that he can potentially use to off-set some of the long-term capital gains that he’s built up.
  3. Sell any holdings that have smaller gains and start building up a cash pile that he can use to start the process of diversifying away from his current individual stocks.
  4. If he is charitably inclined, he may want to give away some of the appreciated stock, so he can deduct that at full market value and doesn’t have to pay any of the gains. That’s a great option, or, if he has an estate plan, and wants to leave, potentially, an amount to an heir or heirs, then he can get a step-up in basis on his taxes once he finally decides to go through that process.

If all those options have been exhausted,  he is probably in the 15% long-term capital gains tax bracket, so it wouldn’t be the biggest deal to sell, at least up to the point that he’s not going to trigger going up and paying 18.8 after the Medicare surtax. As long as he’s still within that 15% AGI threshold, Clint would look at starting to sell off a portion and generating some of those long-term capital gains as part of his year-end tax planning, but he probably wants to coordinate that with a CPA.

When I began helping my parents with their portfolio, they had a whole bunch of individual stocks that somebody had been picking for them. They were terribly underperforming index funds. Most important thing for their portfolio, was to get into good investments as soon as possible, but they were lucky. All their money was in an IRA, so I could just sell them all. I put in all the sell orders, then, by the end of the day, I had bought index funds with them. It was very very straightforward because there were no tax consequences. But that isn’t the case for this doctor.  It’s a lot more complicated. It’s easy to turn off the dividends. It’s easy to sell all the losers. It’s easy to sell everything with minimum gains. Then you’re stuck looking at it going, “Do I build my portfolio around this thing with a large capital gain or do I bite the bullet and pay the taxes now instead of paying even more taxes later?” I think it’s a difficult dilemma for people.

But Clint made a good point. “Don’t let the taxes drive the whole decision there, just because there’s so much risk in individual stocks. A stock can lose all of its value in a given year, so it’s pretty easy to make up for a 15 to 20 percent tax loss in one bad earnings month for individual stock.” The risk is significant and you can’t let the tax tail wag the investment dog.

Self Directed IRA

“What should I do for retirement plan, given that I have a self-directed IRA?”

There’s really only two good options here. Because it’s self-directed, it’s presumably invested in something that you can’t invest in your 401K. Maybe it’s bitcoin or maybe it’s a real estate property.  You can’t just roll this thing into your 401K and clear out the pro rata issue with the backdoor Roth IRA. What you need to do is one of these three thing:

  1. Not do a backdoor Roth IRA. There are people that it just doesn’t make sense for. Like people that have a simple IRA at work that they are continually contributing to. A backdoor IRA just isn’t going to work great for that person.
  2. Or, what I’d probably do, in this case, is try to pay for a Roth conversion of that entire self-directed IRA and make it a self-directed Roth IRA. Then you’re clear from the pro rata rule and you can continue doing backdoor Roth IRAs going forward.
  3. You could open a self-directed individual 401K. That would allow you to invest in whatever alternative investment you want to invest in and you could roll the self-directed IRA in there. In order to open an individual 401K, of course, you need self-employment income.

Student Loan vs Roth IRA

“I’m a second-year veterinary student. For my first year and for the other upcoming years of that school, I plan to be very frugal. I’ve taken very minimum amount of loans and kept my cost of living low. However, once I graduate, my loans will be about $250,000. What can I do at this time while I’m at school to prepare for the future? Also, I’ve been hustling and having side gigs, accumulating about $6,000 during the summer and during the school year. What should I do with that lump of sum? Should I put it into my Roth IRA? Should I save it for a rainy day? Or should I slowly pay off my loans while I’m in school?”

The most important thing when you’re a student is to minimize your debt. That means going to schools that are as cheap as you can get into, trying to live very very frugally and not rack up a bunch of expenses. In her case, she’s actually working, so she’s got $6,000. Because that’s earned income, it can go into a Roth IRA and start compounding for retirement. In general, when you’re a student, I think your best investment is in yourself and just minimizing how much student loans you’re taking out. So, that’s probably what I’d do with it. If I could make $6,000 extra in medical school or in veterinary school or in dental school, I would probably just use that to take out less loans, so I owed less when I came out. That’s almost always a great investment.

I don’t see a point in having a huge emergency fund when you are taking out all kinds of loans every year anyway. Just borrow more money if you have an emergency, rather than having thousands of dollars sitting around as an emergency fund, making nothing, when in reality you’re paying 6% to have that money sitting there on the side because you’re taking out more loans at 6%.

Life Insurance

“One of my physician friends recently died in a road accident. He leaves behind a physician wife and a five-year-old son. His wife is about to receive about $1,000,000 in insurance, $500,000 from his term insurance, and $500,000 from his employer provided term insurance, which is twice his annual income, and his wife would like to know how to invest that money.”

I’m certainly sorry to hear about this. I don’t like hearing about bad things happening to anybody, especially, a physician, but physicians are not immortal. They die just like anyone else. The first lesson here is to realize that, and, if you have people depending on you, even if your spouse is a physician, you probably ought to have some term life insurance. It doesn’t cost a lot of money and you can get a lot of benefit for very little cash, especially if you’re young and healthy. Most doctors probably ought to be carrying two-five million dollars, not a half million dollars. This doctor might have been lucky that the employer also chipped in quite a bit of life insurance, but I would have like to have this question being, “How should I invest $4,000,000, not how should I be investing $1,000,000? At any rate, $1,000,000 is better than nothing.

The truth is you invest that money just like the rest of your money. You have an investing plan for the money you have been saving for retirement. You just added a million dollars to it. Now, it’s a little bit more complicated than that, especially in a scenario where your income went dramatically down because you just lost a high earning spouse. So, it might make sense to reduce risk a little bit. Maybe invest a little less aggressively. If you were 75% stock before, maybe you’re 50% stock now. Maybe pay off some debt. Obviously, not the student loans of the person who just died, but maybe pay off the mortgage and the car, if you have a car, and the credit cards. Wipe out those kinds of debts. You’re reduce that leverage risk from your life.

In this case, the surviving wife is also a physician, so, hopefully, still has a great income, and will continue to earn and contribute toward retirement. Basically, she just got a million dollars closer to retirement. Obviously, not a good swap for your working spouse, either financially or emotionally, but that should help her reach financial independence a little bit earlier than she would have been able to if he did not have term life insurance.

Ending

If you find the WCI podcast helpful, tell a colleague about it today. You can help spread the message of financial literacy one person at at time.

Full Transcription

Intro: This is The White Coat Investor Podcast where we help those who wear the white coat get a fair shake on Wall Street. We have 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 121: What to do With Taxes When Self-employed. First, though, before we get started, I want to thank you for what you’re doing out there. I know you’re working hard. I know you put in a lot of sacrifice and sometimes we forgot just how big of a deal it is. If nobody’s saying thank you to you, I wanted to make sure I was the person today.

WCI: It’s interesting. I had a really interesting case this week. I had a 13-year-old who came in in cardiac arrest. It was, obviously, always a terrible moment when any child comes in in cardiac arrest, but this transplant patient, after we worked on her for an hour and a half, coded her for an hour and a half, got her pulse back and sent her on to a higher level of care. I just wanted to thank all of you who spent time and effort in your lives to be able to help somebody like that in their hour of greatest need. It was really wonderful to be able to be a part of that and I know each of you are parts of similar miracles that happen each day. So, thank you for doing that. It’s not easy. It’s not necessarily the thing that pays the best in the world, but it is important.

WCI: Hey, I wanted to ask you a favor as well. A little bit of a call to action if you will. Most of the people who have heard about the White Coat Investor Podcast do so through one of two ways. One, a friend tells them about it. So, thank you so much to those of you who have been telling your friends and colleagues about the White Coat Investor Podcast, especially people who love podcasts or have long commutes anyway where it’s just a no-brainer, as a medium to become financially literate. So, thank you to those of you doing that. To those of you who are not, please suggest it to your friends. It’s really helpful.

WCI: The second thing you can do to help get this information into the hands of your friends and colleagues is to leave us a nice five-star rating on iTunes or on Apple Podcast, rather. What that does is it moves the podcast up in the ranking, so people are more likely to see it when they search for other podcasts, and so, that very helpful. We have had a lot of great reviews. I think, Cindy said, we had 930 on there, but the more there are, the more people are likely to find out about the podcast and get this critical information. So, thanks to those of you who have left podcasts. I see a few of them on here.

WCI: This one from Laura, I think it is: “Got the book. Loved it and listened to the podcast. I have been learning so much about finances and I started out with no knowledge at all. I’m about to start medical school and feel much more confident about loans, paying off loans and what to expect later down the road.” This one “Went through all the podcast over the last month and a half.” That’s quite a binge. “Bought and read the book. I feel like I already know more about finances than many of my attendants as a PGY2. Highly recommend.” Yeah, that’s probably the case. “First year medical student. I can’t get enough of Dr. Dahle’s podcast. Thanks for such engaging, fun and easy to digest format.” I don’t think I’ve ever been called fun before, so that’s great. This one from Ben “Informative, well-organized, good quality podcast.”

WCI: This one from Tiger Fan 153: “Dr. Dahle is the man. He’s obviously very knowledgeable in all things finance and investing, but what sets him apart is his down-to-earth approach. While there are more entertaining podcasts out there, this one is hard to top in terms of bang for your buck. I learned a great deal about a wide range of investing principles through this podcast.” He obviously doesn’t think I’m as fun as the last one, but if he’s getting the important information, that’s the important part. Finally, from Tag 80: “Dahle has a knack for explaining the financial topics that are pretty dry in a concise manner. This is high-yield information if you’re in his target niche, physician or other high income young professional. He cuts out a lot of the extraneous financial topics that don’t really apply to you. I learned a lot from his blog and book. Podcast is a great format for people who want to learn personal finance during their commute or at the gym.” So, if you can leave us a great review, we would appreciate it. That does help spread the word.

WCI: Today’s episode is sponsored by CommonBond. CommonBond has worked with thousands of doctors to help them refinance their student loans, save money and get out of debt more quickly. Since your financial needs are unique, CommonBond has flexible plans along with award-winning customer service. CommonBond also offers best-in-class borrower protections, like up to 24 months of forbearance, just in case you run into any financial difficulties and need to press pause on your monthly payments. Best of all, listeners of this podcast will receive a $550 cash bonus when refinancing with CommonBond. Head to commonbond.co/wci. Commondbond.co, not .com, .co/wci to see your new rate and claim your $550 bonus.

WCI: A couple of other things I wanted to let you know about. Peter Kim, who is in The White Coat Investor Blogging Network, he blogs as Passive Income M.D., is putting on this sweet conference. I am going to go out in October to L.A. and speak at it. It is on a Saturday. It’s a one-day conference on Saturday, October 26th in L.A. He’s calling it the Financial Freedom Through Investing in Real Estate Conference. He’s got all kinds of speakers there. I’m going to speak. Peter’s going to speak, Parikh is going to speak, Letizia Alto, who will also be speaking at WCI Con 2020 next year, will be speaking there, Kenji Asakura, AdaPia d’Errico, Trevor McGregor, Victor Mangona and Eric Tait are going to be there. You may know them from the Facebook groups. Toby Mathis and Aaron Kaplan are also going to be there. So, lots of great people are going to be at the conference.

WCI: If you’re interested in learning more about real estate and you’re a doc… even if you’re not a doc, but, especially if you’re a doc, this is a great conference to go to, especially if you’re already out in California. So, it starts at 7:30 with registration and it ends at 4:30, but then there’s a cocktail reception and networking. If you buy the VIP registration, there’s a dinner for you where you get to meet all the speakers, as well, personally. So, just went on sale on Tuesday the 20th. I don’t know if the VIP tickets, which are going for $697, are still going to be available by the time you hear this podcast, but they may be. At any rate, I don’t know if it’s going to be sold out for the regular general admission ones, which are being sold at an early bird price of $397.

WCI: So, if you’re interested in that, be sure to check that out. You can do so at passiveincomemd.com. He’s got a prominent link there and you can register for the conference and I hope to see you there. I’ve got lots of friends on the Internet; a lot of whom put on conferences, but this one looks particularly good.

WCI: Just to mention another one, though. A friend of mine from a mastermind… they call themselves 2 Frugal Dudes, are putting on a Financial Independence Summit. It’s about the same time period, last week of October. It’s a much less expensive conference. It’s only going for $59, but if you want to check that out, you can see fisummit.2frugaldudes.com and meet some of the people that are big in the FI community, like JL Collins and Mrs. Frugalwoods.

WCI: Let do our quote of the day. I think we missed a few of these in the last few episodes, so we’ll try to remember to do them each time. This one comes from Morgan Housel, who said, “Few things matter more with money than understanding your own time horizon and not being persuaded by the actions and behaviors of people playing different games.” Totally agree with that and I’m excited to meet Morgan Housel in person. He’s going to be speaking at WCI Con 2 as well.

WCI: All right, I gotta make a correction here. I made a mistake in a previous podcast and it’s time to own up to it. So, in podcast 116, which was about five podcasts ago, toward the beginning, I was talking about ETFs and mutual funds, and, at E*TRADE, I said it’s cheaper to buy the ETF than the mutual fund because the commissions are higher. That’s actually not true at E*TRADE. Vanguard Mutual Funds, at least the ones that you would use in a typical Boglehead-type index fund portfolio are part of their NTF or no-load transaction fee category. They only charge you redemption fee in the event of short-term trading. They don’t charge a typical fee for each time you buy and sell. My bad there. Apologize for that. That’s not for all brokerages as we’ll discuss later in the podcast today, though.

WCI: A couple of things coming up this fall that I want you to know about as well. We are going to be putting on a physician millionaire episode. What I want for this is I want five or six people that we’re going to bring on the podcast and talk about your financial success. So, I’m looking for financially successful docs, minimum of a million dollars net worth, who will come on and answer questions like, “What’s your net worth? What was your income over the course of your career? Why do you think you became financially successful and many of your peers did not?” We’re going to put together a whole episode of that. It’ll run later this fall. So, if you’re interested that, email [email protected] and we’ll arrange for a time to record that segment with you and put them all together into one podcast.

WCI: We’re going to do one other podcast aimed at people a little earlier in their career and I want to bring on people that paid off their student loans, especially big, huge student loan burdens in less than five years out of their residency or fellowship. So, if you’re one of those people and you’re willing to come on and talk just for 5 or 10 minutes about your experience and how you did it, email [email protected] and volunteer to come on that episode and we will record you for that. Cindy is my assistant with this podcast and she just got back from Podcast Movement, which is a big podcasting conference. We learned all kinds of great things about how we’re supposed to be doing this. So, hopefully, you’re notice some improvements in the podcast as time goes on.

WCI: We’re also going to be talking just for a few minutes towards the beginning of this podcast with Clint Gossage, who is one of our financial advisors. Let’s bring him on now. On this podcast, we’ve got a special guest, one of our partners, a financial advisor partner of The White Coast Investor here, Clint Gossage, who is a CFA, CFP and a CPA and happens to be married to a surgical oncologist for the last 15 years. So, he’s experienced, first-hand, the ups and downs from the journey from undergrad to becoming an attending, and realized, after helping friends in medical school, residency and fellowship with their finances, he left a high paying job where he was managing investments at a multi-billion dollar family office to basically start advising docs. He’s been helping docs and other medical professionals ever since to get out of student loan debt and save money and invest in tax efficient strategy and manage and protect their assets.

WCI: What he really likes doing, though, is giving them back their time, which is really our most scarce resource in life. He’s actually local to Scottsdale, Arizona, but like all of our recommended advisors that you can find at The White Coat Investor, he will work with you all over the country via phone, email or video conference. You can find him at cmgfin.com or just email him at [email protected] or call him at 480-695-8004.

WCI: Clint, welcome to The White Coat Investor Podcast.

Clint Gossage: Well, thank you for having me. It’s a pleasure to be here.

WCI: It’s great to have you on. We’re going to do a few things. We’re just going to talk for a minute about your practice and then we’re going to take some reader questions together and just have this be a short segment as part of our podcast today. So, what was it that drove you to become a financial advisor in the first place.
Clint Gossage: I was always the type of kid that liked numbers and was into math competitions and things like that, and, going to college, I was looking for a way to put those skills to use. So, I ruled out engineering, finance and accounting made a lot of sense to me, but it wasn’t really interested in personal finance or financial planning at all until finance became personal to me, I guess. So, I’ll leave out some of the details of this story, because I’m sure my mom will want to post a link to this episode on her Facebook page, but growing up, I never felt the pressures of money within our family.

Clint Gossage: Grew up in a small town in Kansas with two brothers and a sister on 10 acres of land. We always had plenty of food on the table, but it wasn’t luxurious lifestyle by any means. We had a saying in our family, “Once a car hits 100,000 miles, it still has two-thirds of its life left.” It definitely wasn’t a childhood where we ever worried about money. Once I graduated college, though, I realized it was the big stressor in my parents’ lives, and something that my parents fell asleep worrying about, woke up worrying about. It was at that point that I realized that finance wasn’t just percentages and spreadsheets, but it really impacts people’s lives. That’s when I decided I could use this to make a difference. In my early 20s, my parents kind of became my first planning clients.

WCI: That’s pretty cool. It obviously means more when it’s somebody you obviously care very much about. Now, you have some impressive financial designations. Not only a CFP, which lots of advisors have, but also a CFA, a Chartered Financial Analyst, and you’re a Certified Public Accountant. Do you think those were worth getting? Should people be using advisors that don’t have all those credentials? What do you think the value that’s been to you and your practice?

Clint Gossage: It’s definitely been worth it to me as far as having an education level there and an education base there. There’s a lot of time that goes into studying for those, particularly, the three CFA exams, but it’s still nothing really compared to the time that goes into medical school or residency or something like that. So, I don’t want to sit here and pat myself on the back too much, but I’m the type of person who doesn’t feel comfortable giving evidence on a topic until I’ve researched it to death, which is good when I’m doing a deep dive into student loan analysis, but maybe not as great when my wife just wants me to pick out a washer and dryer.

Clint Gossage: Should people use advisors who don’t have these? I think you wrote a good article on this a few years ago about the big problem in our industry and that it’s not very regulated as far as the barrier to entry. So, you don’t need a college education to get into being an advisor and most can pass a series of seven exams within a week of studying. For that reason, I’d say it’s a good rule of thumb that an advisor have at least one of the three because, ultimately, the reason to use an advisor is for the advice, so, while certification alone don’t guarantee a good advisor, if an advisor has one of the big three, at least you know they put in some work to education themselves first.
WCI: What do you see that unique about your company, your practice?

Clint Gossage: I’ve never been the type of person that could be a good salesman. I remember when I launched my firm, I tried the sales act with a potential prospect. I came away from it hating the meeting and could tell the prospect was really turned off as well and I decided at that time that I would never try something like that again. That was kind of a period of reflection when I looked back and realized the whole reason I started this firm was as a favor to help our friends out with student loans and tax issues while my wife was in residency. That’s something I try to stay centered on carryover in everything that we do. It’s not really about selling. It’s about starting from a place of adding value and making a difference and truly doing what’s in the best interest of our clients and help eliminate the issues that are causing them stress.
WCI: Now, what’s your fee structure and how do you decide on that?

Clint Gossage: So, that’s a good question. I don’t think there’s a perfect fee structure out there, but, ultimately, I wanted our fee to be fair to clients and easy to understand. That’s why I ended up using a flat fee structure. It has three different tiers which is probably a little more complex than I would like, but it’s easy to understand because you’re paying a flat monthly amount that’s transparent. You’re paying it using a credit card or debit card. It’s not just getting deducted from your account and you don’t even know what kind of fee you’re paying and it doesn’t keep increasing forever, like that typical AU1 fee would.

WCI: All right. Let’s take a few questions from the listeners. First, this one comes in by email from a physician assistant. He actually asked for this to be answered on the podcast, but didn’t mention if he wanted to stay anonymous or not. So, I’m just going to leave him anonymous. It’s actually one of the most common questions I ever get about paying off debt versus investing.

WCI: He says, “I’m a current emergency medicine PA. Although I’m not an MDDO, I have gained a great perspective on managing my finances, so thank you. My wife and I are currently deciding what to do moving forward with our financial plans. We’re both 27, have a combined annual income of around $160,000 and still owe $220,000 in student loans, which I recently refinanced with Laurel Road at 4.25% and had my wife’s loans, about $50,000 of that, at 3.2 fixed. We currently rent for $920 a month and keep our expenses fairly low at around $36,000. I contribute the max to my employer-sponsored 401K, plus profit sharing for nearly $35,000 a year into the 401K. My wife contributes the max for her employer-matched of around $3,000 a year for her 401K. I do have an HSA, as well, but only my employer’s contributing to. I have not yet opened a Roth IRA. My question is, do you think it would be worth it to max out my HSA and Roth IRA contributions and allow that money to grow or to take that same $9,500 a year and put it towards our student loans?”

WCI: It seems wiser to max out their retirement accounts, but I hate looking at the interest on paying my student loans. What do you think? What would you advise this PA?
Clint Gossage: I know this is a common question for you and it’s probably the most common question I see, as well, which is essentially, “Should I prioritize paying off debt or investing?” In this case, they have already refi their student loans at lower rates, which definitely gives them some more options. So, I think their priority list looks like this. Taking advantage of any employer-match on their 401K, which they are already doing and that’s great. Then, also, prioritize any of their investment accounts that are getting tax benefits. That’s going to include their Roths and their HSAs, as well. We’re really trying to understand what’s going to be their highest and best use of their money. So, with tax advantage accounts, we’re hoping over the long-term those are going to be earning seven to eight percent and they are going to be growing tax-free over that period. Compare that to potential payback on a student loan, which is earning three and a quarter, four and a quarter, then I think that’s a good trade-off.
WCI: I agree with you. I get this reputation as being totally anti-debt, and I’m not a big fan of debt, by any means, but I’m also a huge fan of tax advantage investing accounts. It’s one thing to be comparing off a 4% something debt versus your taxable account. It’s entirely different in your Roth IRA or HSA, something that’s probably never going to be taxed again. So, I think you need a little bit higher barrier there. That doesn’t mean carry around debt at 10 or 15 percent in order to max out your Roth IRA, but at three or four percent, that’s not a bad gamble there.

WCI: All right, let’s take a couple of questions off the SpeakPipe. Remember, you can record questions for us the SpeakPipe at www.speakpipe.com/whitecoatinvestor. You can be as anonymous as you want on those. This is our first question. This one coming from an anonymous listener.

Speaker 4: Hey Jim, quick question for you regarding mutual fund versus ETF fees. I commonly use the TD Ameritrade website to compare perspective investments. I’ve noticed when comparing different share classes of the same investment, the hypothetical fees that TD Ameritrade quotes will vary substantially despite a nearly identical expense ratio. For example, take the comparison between VTSAX and VTI, which, as you know, are different share classes of the same Vanguard Total Market Index Fund. The VTSAX expense ratio is 0.04% and the VTI’s 0.03%. This different would theoretically translate to a yearly fee difference of $1 per $10,000 invested. When you compare these funds on the TD Ameritrade website, however, they give a five-year total fee estimate of 1.41% for VTSAX and 0.28% for VTI. They calculate these hypothetical fees using the same initial investment, yearly investments, and rate of return over five years for both funds. Is there something missing here? Are there hidden fees in the mutual fund share class that aren’t reflected in the expense ratio? Is there an error on the TD Ameritrade website? Thanks so much for your input on this.
WCI: They are basically asking why are the fees different for the mutual fund version of the Vanguard Total Stock Market Index Fund VTSAX versus the ETF version, which is VTI at TD Ameritrade. You want to take that one Clint?

Clint Gossage: Sure. That’s a good question. So, on TD Ameritrade’s site, they include commissions in the way they do their fee comparison when you’re comparing mutual funds and ETFs. TD’s using their commission schedule to make that comparison. How TD charges their ETFs, they do $6.95 per trade and they charge $49.99 per trade on the mutual fund, which is quite a bit higher. So, that’s why you’re seeing that big disparity there. When looking at that and trying to really compare their fees… If you’re not using TD as your brokerage, and you’re buying them at Vanguard, or something like that, you can basically look at the expense ratio on the two of them. If you are looking to buy them at TD, obviously, VTI or the ETF is going to make a lot more sense.

WCI: This has happened to me a lot, actually, in my career with various 401Ks and whatever. Like my 401Ks at Schwab. I basically have brokerage window there and I buy the ETFs because the commissions are lower and that the only reason. Whereas, when I’m buying them at Vanguard, even in my taxable account, a lot of time I just user the mutual fund version because I happen to prefer mutual funds rather than dealing with having to put in the trade orders during the day. If you’re going to charge me 50 bucks every time I do a transaction, well, shoot, I’ll deal with the hassle and I’ll just buy the ETFs. I think that’s the difference that they’re seeing here.
WCI: It’s interesting, though, is every broker is a little bit different in this respect. I was actually corrected recently on… I had mentioned that there were higher transaction fees at E*TRADE, as well, for Vanguard Mutual Funds, and I was wrong about that. It wasn’t true. They actually have the Vanguard Mutual Funds on their no transaction fee list. So, you could have used either one there at E*TRADE, but at TD Ameritrade, they’re not super happy with Vanguard right now or vice versa. I’m not sure exactly what’s going on, but, in 2017, they took the Vanguard ETFs off their commission-free list, and, obviously, they’re charging the full price for the mutual funds, as well, probably, because Vanguard won’t pay to play with them.

WCI: All right, our next question comes from Caleb, a military dentist, who’s got large unrealized gains in his individual stocks. Let’s listen to that question.
Caleb: Hello, I’m a military dentist who graduated dental school in 2006. I have about 1.6 million dollars in a brokerage taxable account and another $300,000 or so in a Roth TSP account between my wife and I. The brokerage account is up approximately $600,000 in unrealized gains. Most of the holdings within the brokerage account are individual stocks. Many of these were purchased well before I started listening to your podcast. I’m wondering if there’s a tax-efficient way to transfer some of the individual stocks into index funds, bonds, ETFs, other various less risky investments. Thank you and have a great day.

WCI: So, he’s basically asking how to move from all these individual stocks to index funds in a tax-efficient way. What would you advise him in that sort of scenario?
Clint Gossage: He’s done a great job saving up a good chunk of money in individual stocks at this point and it’s really a question of looking to reduce risk. There are several different options to look at when trying to diversify away. It’s somewhat going to depend upon the specifics, probably on the number of individual stocks if he has 40 or 50. It’s going to be a little different than if he has five or six, but the more holdings he has, the closer he is to a well-diversified portfolio.
Clint Gossage: First thing I’d do is turn off any automatic dividend re-investments, so, that way, he’s not adding to his individual stock portfolio each month or each quarter. Secondly, harvest any losses. That’s going to involve selling any of the stocks that have losses. He probably wants to look at even the individual lot level, meaning, if he had bought some Apple stock every year, some of it might have a loss while other shares of it might have a long-term gain. By doing that then, he’ll generate some losses that he can potentially use to off-set some of the long-term capital gains that he’s built up. Also, want to sell any holdings that have smaller gains and start building up a cash pile that he can start using to start the process of diversifying away from his current individual stocks.

Clint Gossage: The other thing to consider is if he’s charitably inclined. He may want to give away some of the appreciated stock, so he can deduct that at full market value and doesn’t have to pay any of the gains. That’s a great option, or, if he has an estate plan, and wants to leave, potentially, an amount to an heir or heirs, then he can get a step-up in basis on his taxes once he finally decides to go through that process.
Clint Gossage: Really, what we’re looking at, if all those options have been exhausted, as a military dentist, I don’t exactly know what he makes, but I’m guessing he’s in the 15% long-term capital gains tax bracket, so it wouldn’t be the biggest deal to sell, at least up to the point that he’s not going to trigger going up and paying 18.8 after the Medicare surtax. As long as he’s still within that 15% AGI threshold, I would look at starting to sell off a portion and generating some of those long-term capital gains as part of his year-end tax planning, but he probably wants to coordinate that with a CPA.

WCI: I think that’s great advice. When I began helping my parents with their portfolio, they had a whole bunch of individual stocks that somebody had been picking for them. They were terribly underperforming index funds. Most important thing for their portfolio, was to get into good investments as soon as possible, but they were lucky. All their money was in an IRA, so I could just sell them all. I just put in all the sell orders, then, by the end of the day, I had bought index funds with them. It was very very straightforward because there were no tax consequences.

WCI: That’s not the case for Caleb, is it? It’s a lot more complicated. It’s easy to turn off the dividends. It’s easy to sell all the losers. It’s easy to sell everything with minimum gains. Then you’re stuck looking at it going, “Do I build my portfolio around this thing with a large capital gain or do I bite the bullet and pay the taxes now instead of paying even more taxes later?” So, I think it’s a difficult dilemma for people that have done this.
Clint Gossage: I think it is too and I think it’s… You don’t want to just let the taxes drive the whole decision there, just because there’s so much risk in individual stocks. A stock can lose all of its value in a given year, so it’s pretty easy to make up for a 15 to 20 percent tax loss in one bad earnings month for individual stock.
WCI: That’s a good point, for sure. The risk is significant and you can’t let the tax tail wag the investment dog.
Clint Gossage: For sure.

WCI: Well, thank you so much Clint, for being on the podcast. If you have further questions for him, you can find him at https://cmgfin.com and he can answer further questions that, or if you’re looking for a good financial advisor, he can certainly provide you good advice at a fair price. Thanks, again, Clint.
Clint Gossage: Thanks and thanks for having me on the podcast.

WCI: That was great having Clint on here. He’s one of the good guys in financial services. Let’s take some more questions here off the SpeakPipe. The next one comes from Audrey about her 1099 gig.

Audrey: Hi Dr. Dahle. I started a locums 1099 side gig this year and I have a couple of questions I’m hoping you can answer for me. I already maxed out a 401K at my W2, so I’m currently setting aside 20% of my 1099 profits in a high-yield savings account, as my accountant suggested, since I won’t know the exact number to take 20% of until I file my 2019 taxes. Is this a good strategy or should I invest monthly as I go and make any necessary adjustments when I file my 2019 taxes? Second question is, I know the general advice is to open a solo 401K because it enables you to do a backdoor Roth IRA, but what if I have a bit too much in my IRA to afford the tax hit? I currently own real estate in my self-directed IRA and I’m wondering if a SEP IRA would be an acceptable, if not a better option, since it’s a bit cheaper and slightly less complex to administer than a solo 401K. Thanks so much for all you do.

WCI: So, she’s mostly asking about taxes when you’re self-employed and should you invest those taxes as you go along. Well, let me tell you what I do with my taxes. I’m completely self-employed now. I don’t have any employee income, no W2 income at all, other than what I’m paying myself from the business I own. What I do is I pay my taxes in two ways. One, and the main way, is quarterly estimated payments, and these are due April 15th, June 15th, September 15th and January 15th. It’s kind of interesting, but that’s the way the IRS does it. You only get two months for the second quarter and you get four months for the last quarter, but that’s the way they do it. The idea there is, you have to pay enough in taxes that you don’t get any penalties as the year goes on.

WCI: Now, Audrey mentioned that she was putting away 20%. Maybe that’s enough for Audrey. It’s not enough for me. I’m paying, right now, about 34% of my income in taxes, so every time I make money each month, I take 34% of it and I put it into a savings account, just an online savings account or a money market fund, and I keep piling that up month after month, and when I go to write a check in April or June or whatever, I write it out of that account. So, that’s my tax account. If I’m a little bit behind come next April, I make up the difference out of that account because the money is there because I took it out each time I made the money. The worse thing you can do is spend the money and not pay the quarterly estimated taxes if you need to. So, that’s the most important thing to do if you’re self-employed.

WCI: Now, if you also have an employee gig, there’s an opportunity to maybe minimize or eliminate having to write those checks. What you can do is just have more money withheld from your employee paychecks. You can basically set your exemptions there on your W4 down to zero and just have a whole bunch of money withheld from that gig. If you don’t make too much in your side gig, in your 1099 employment, in your self-employment, then that will cover the tax bill. Between the two of those… between what is withheld by the employer and what you pay in quarterly estimated payments, you need to make sure you get into the safe harbor. That means either paying… for high income folks like us either paying 100% of what you owe or more or 110% of what you owed last year. That’s what I do each year because my income has been rising over the years. So, I just take what I owed last year, multiply it by a 110% divide it by four and that it the check I write every quarter, as my quarterly estimated payments.

WCI: In addition, we’re an S Corp now. White Coat Investor has been an S Corp for the last couple of years. So, I actually have to pull income and payroll taxes out every time we pay ourselves. We do that about once a quarter. Technically, you can probably do it once a year, but you’re going to have to fill out a federal and probably state forms once a quarter whether you pay yourself or not. So, we just thought we’ll make it easy and pay ourselves each quarter. The goal here with these methods of paying tax, as a self-employed person, is to make sure you have the money to pay the taxes. Number one, you want to make sure you’re not spending that money or you’re really going to be hosed come next April. And two, to avoid any penalties, so to get into the safe harbor.

WCI: Bear in mind, what you pay in advance or what is withheld, may have little to know relationship to how much tax you actually owe. In the past, I have written a check for $200,000 come April because I did not have to have that much withheld. I did not have to pay that much in quarterly estimated taxes to stay in the safe harbor, but I still owed the taxes in the end. So, you want to make sure you’re keeping that money around and using it to pay those taxes. If you’re going to need this money in three months to make a quarterly estimated payment or you’re going to need it in six months, in April, to finish paying your taxes for the year, this is not money that should be invested in stocks or real estate or maybe even bonds. This is money to keep in cash. Try to get a yield out of it. Try to make two percent out of it or something by going to a high-yield savings account like Ally Bank or by going to a Vanguard Money Market Mutual Fund and make two percent on it instead of one percent in your checking account.

WCI: Really, this isn’t money you’re trying to make money off of. You’re trying to just preserve the principal, so it’s there to pay the tax man. You really don’t want to owe money to the IRS. They have a lot of rights that most lenders do not have, like being able to garnish your paychecks and take money out of your bank account and send you to jail, those kinds of things.

WCI: Let’s take our next question. “What should I do for retirement plan, given that I have a self-directed IRA?” There’s really only two good options here. Because it’s self-directed, it’s presumably invested in something that you can’t invest in in your 401K. Maybe it’s bitcoin or maybe it’s a real estate property. I don’t know, but you probably can invest in it in your 401K. You can’t just roll this thing in your 401K and clear out the pro rata issue with the backdoor Roth IRA. What you’re need to do is one of two things.

WCI: The first one is not do a backdoor Roth IRA. There are so people that it just doesn’t make sense for. Like people that have a simple IRA at work that they are continually contributing to. A backdoor IRA just isn’t going to work great for that person. Or, what I’d probably do, in this case, is try to pay for a Roth conversion of that entire self-directed IRA and make it a self-directed Roth IRA. Then you’re clear from the pro rata rule and you can continue doing backdoor Roth IRAs going forward. So, that’s what I would do. I guess there’s one other option. You could open a self-directed individual 401K… I have one of those now… that would allow you to invest in whatever alternative investment you want to invest in and you could roll the self-directed IRA in there. In order to open an individual 401K, of course, you need self-employment income to do that.

WCI: Next question comes from Matthew.

Matthew: Dr. Dahle, thanks for your hard work and helpful information from The White Coat Investor. I have learned lots of helpful and practical information. I’m in fellowship training for an internal medicine subspecialty in Michigan. I have a question about 1099 income from moonlighting. Specifically, can you please discuss deductions on tax return for 1099 income. Is there a limit? Let’s say I make $1,000 in 1099 income from moonlighting. Can I deduct $3,000 of expenses, such as DEA license, board examination fee, home office, etc.? Also, I know colleagues who have established a business for their 1099 work. Instead of the 1099 being addressed to John Smith, it is addressed to John Smith, Inc. What’s the benefit of creating business for 1099 income? Does this help with additional retirement account options? Thanks for your help.

WCI: Matthew is talking about deductions on the tax return for 1099 income. So, we’re staying with our theme here. He’s asking, “Can I deduct more than I made.” Well, you actually can. When you’re running a business, you’re filling out… if you’re a sole proprietor and you’re filling out Schedule C, you can have a loss in your business. In fact, I think you can have a loss for two of the previous five years and the IRS still believes you’re trying to make a profit, but if you claim a loss year after year after year, the IRS is going to say that’s not a business, that’s a hobby. You can’t deduct your expenses from a hobby like you can from a business.

WCI: Matthew was also wondering if he should incorporate. Here’s the deal with incorporation. A lot of docs think it’s going to automatically save them all kinds of taxes, prevent them from being sued for malpractice and all this stuff. Well,, malpractice is always personal. Just incorporating as a physician is not going to save you from any malpractice risk. You’ve still got the malpractice risk. Maybe if you employees or some other business associated risk, it could help you in that sort of asset protection scenario, but not for malpractice, which is really the only risk which most sole proprietors, independent contractor doctors have. There’s just not really all these great retirement options that you can have when you’re incorporated, but not when you’re a sole proprietor. So, there’s not really a huge point to incorporating for most people that are just doing a little bit of moonlighting.

WCI: Now, if almost all of your income is self-employment income, you might want to incorporate to save a little bit in payroll taxes because when you are filing your taxes as an S Corp, you can declare part of your income as salary and part of your income as a distribution. On the salary, you pay the full payroll taxes: social security tax and Medicare tax. On the distribution, you still pay your full income taxes, but you don’t pay any payroll taxes. What that means for most docs is that they save the Medicare tax, which is 2.9%. By incorporating, if you can declare a big chunk of your income as a distribution and still be paying yourself a reasonable salary, according to the IRS, then you can save 2.9%. So, if you declared $100,000 as distribution instead of salary, you save 2,900 bucks in taxes. A part of that is deductible, so it’s actually a little bit less than that.

WCI: That’s kind of my general guideline. If you’re not going to save at least a couple thousand dollars in Medicare taxes, it’s probably not worth the hassle of incorporating because either you or someone you hire is going to have to file a whole bunch of extra tax forms each year if you want to file taxes as an S Corp.

WCI: All right. The next question comes from Tracy, the veterinarian.

Tracy: Hi Dr. Dahle. My name is Tracy. I’m a second-year veterinary student. For my first year and for the other upcoming years of that school, I’m planning to be very frugal. I’ve taken very minimum amount of loans and kept my cost of living low. However, once I graduate, my loans will be about $250,000. What can I do at this time while I’m at school to prepare for the future? Also, I’ve been hustling and having side gigs, accumulating about $6,000 during the summer and during the school year. What should I do with that lump of sum? Should I put it into my IRA Roth? Should I save it for a rainy day? Or should I slowly pay off my loans while I’m in school. Thanks.
WCI: So, Tracy is basically a vet student asking what can I do to prepare for the future. Well, the most important thing when you’re a student is to minimize your debt. That means going to schools that are as cheap as you can get into, trying to live very very frugally and not rack up a bunch of expenses. In her case, she’s actually working, so she’s got $6,000. Because that’s earned income, it can go into a Roth IRA and start compounding for retirement. In general, when you’re a student, I think your best investment is in yourself and just minimizing how much student loans you’re taking out. So, that’s probably what I’d do with it. If I could make $6,000 extra in medical school or in veterinary school or in dental school, I would probably just use that to take out less loans, so I owed less when I came out. That’s almost always a great investment.
WCI: I don’t see a huge point in having a huge emergency fund when you are taking out all kinds of loans every year anyway. Just borrow more money if you have an emergency, rather than having 5 or 10 or 15 or 20 thousand dollars sitting around as an emergency fund, making nothing, when in reality you’re paying 6% to have that money sitting there on the side because you’re taking out more loans at 6%.

WCI: The next question comes in by email. It says, “One of my physician friends recently died in a road accident. He leaves behind a physician wife and a five-year-old son. His wife is about to receive about $1,000,000 in insurance, $500,000 from his term insurance, and $500,000 from his employer provided term insurance, which is twice his annual income, and his wife would like to know how to invest that money.

WCI: Well, I’m certainly sorry to hear about this. I don’t like hearing about bad things happening to anybody, especially, a physician, but physicians are not immortal. They die just like anybody else. The first lesson here is to realize that, and, if you have people depending on you, even if your spouse is a physician, you probably ought to have some term life insurance. This stuff doesn’t cost a lot of money and you can get a lot of benefit for very little cash, especially if you’re young and healthy. Most docs probably ought to be carrying two, three, four, five million dollars, not a half million dollars. This doc might have been lucky that the employer also chipped in quite a bit of life insurance, but I would have like to have this question being, “How should I invest $4,000,000, not how should I be investing $1,000,000? At any rate, $1,000,000 is better than nothing.

WCI: The truth is, how do you invest that money? Well, you invest it just like the rest of your money. You’ve got an investing plan for the money you have been saving for retirement. Well, you just added a million dollars to it. Now, it’s a little bit more complicated than that, especially in a scenario where your income went dramatically down because you just lost a high earning spouse. So, it might make sense to reduce risk a little bit. Maybe invest a little less aggressively. If you were 75% stock before, maybe you’re 50% stock now. Maybe pay off some debt. Obviously, not the student loans of the person who just died, but maybe pay off the mortgage and the car, if you have a car, and the credit cards. Wipe out those kinds of debts. You’re reduce that leverage risk from your life.
WCI: In this case, the surviving wife is also a physician, so, hopefully, still has a great income, and will continue to earn and contribute toward retirement. Basically, she just got a million dollars closer to retirement. Obviously, not a good swap for your working spouse, either financially or emotionally and happiness wise, but that should help her reach financial independence a little bit earlier than she would have been able to if she did not have term life insurance. It’s hard to say a lot about how someone should invest with only a couple of lines about them, though. Of course, it’s always helpful to know a little bit more about in order to address those issues.

WCI: All right. Our sponsor today for this podcast is CommonBond. They have worked with thousands of doctors to help them refinance their student loans, save money and get out of debt more quickly. Since your financial needs are unique, CommonBond has flexible plans along with award-winning customer service and best-in-class borrower protections, like up to 24 months of forbearance in case you run into any financial difficulties and just need to press pause on your monthly payments. Listeners of The White Coat Investor Podcast receive a $550 cash bonus when refinancing with CommonBond through this link: commonbond.co/wci. You can go there today to see your new rate and claim your $550 bonus.

WCI: Be sure to check out the Passive Income M.D. conference on real estate investing. If you need an advisor, check out Clint Gossage that we had on earlier today. He’s at cmgfin.com. Be sure to give us a five-star review on the podcast and tell all your friends about it.

WCI: Head up, shoulders back. You’ve got this and we can help. We’ll see you the next time on The White Coat Investor where I’ll be interviewing Disha Spath, M.D.
Disclaimer: My dad, your host, Dr. Dahle, is a practicing emergency physician, blogger, author and podcaster. He’s not a licensed accountant, attorney or financial advisor. So, this podcast is for your entertainment and information only. It should not be considered official personalized financial advice.