Why Mixing Insurance and Investing Causes So Many Problems

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

Dr. Jim Dahle:
This is White Coat Investor podcast number 329 – Why mixing insurance and investing causes so many problems.

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QUOTE OF THE DAY

All right, our quote today comes from index fund champion Rick Ferry who said “The longer an index portfolio is held, the better its performance relative to an actively managed portfolio.”

And that is the truth, especially after tax. And that's because the advantage of an index fund is that it beats most of the actively managed funds each year and that effect gets multiplied year after year after year after year until once you've been in the investment for 20 or 30 years, you beat now 90% plus of the actively managed funds. But that doesn't happen in the first year. In the first year you might only beat 55% of them. The advantage really shows up over time though.

All right, let's talk about a sale. We told you about this last week, now you got one day left. This is only for you, it's only for the podcast listeners. We're not telling anybody else about this. Don't go on Instagram and tell everybody about this great sale. The code is PODCAST200. What it gets you is $200 off any WCI online course. Tomorrow is the last day though. It ends August 25th, so make sure you use that. If you've been waiting for a discount on a White Coat Investor course, this is your chance.

Let's get into your questions, your feedback, what you're interested in talking about. Remember, this is your podcast really, as much as it is mine. We want to talk about what you're interested in talking about. We've been getting some emails lately about some insurance products and some problems with those insurance products. So, we're going to be talking about some of these more controversial insurance products today on podcast.

ANNUTIEIS QUESTION

Let's start with an email that came in about annuities. This is a fellow who's given me some negative feedback who says, “You said once that email negative feedback is gold. So, here's some on the off chance it's useful. One extreme, there's Dave Ramsey who just repeats that it's really stupid to use credit cards, buy whole life, use non Roth accounts, vote Democrat, et cetera, but provides very little objective education to apply to your personal situation or they can age well as the world changes. The other extreme is maybe Wade Pfau, who is so agnostic and didactic. You might miss what's weird and what's standard.

My perception is your coverage of annuities is drifting a little too far towards Dave. Even if it's wrong for everyone, it's still nice to get some objective education. For example, when answering the QLAC question recently, you didn't mention the Secure Act 2.0 increased the maximum to $200,000 index to inflation, which is pretty low for solving an RMD problem.

Likewise, for the Speak Pipe question with a bad bond fund plus a 0.6% fee in a 401(k). Why not mention that inside a low cost variable annuity such as at Fidelity, a total bond fund index fund is 0.39% as an expense ratio, a 0.25 annuity fee plus a 0.14 expense ratio.

If someone lives in a state that protects annuities and if his bonds total over a million, making the total expense ratio of 0.24% it starts to creep into reasonable territory. Sorry, that was really specific, but just saying it seemed like an oddly perfect chance to objectively mention a variable annuity.

By the way, your negativity about the Fidelity variable annuity stopped me from buying it a while back, and I'm happy about that. Your raw opinion is appreciated. I enjoy all your content and hope this feedback was worth the time reading it.”

Well, okay, it sounds to me the feedback is more information. I can give you more information, we can do that, but I think it's also important to hear my opinion on stuff. So, let's start with talking about annuities. Let's start with the opinion for those of you who won't listen to everything else.

Almost nobody needs to buy an annuity, okay? That's the truth of the matter. This is a superfluous financial product and many, many, many annuities are terrible financial products, products designed to be sold and not bought.

That's the general mindset you should start with when we start talking about annuities. Now, of course, as I get into the information, you might come up with some bizarre reason why you might actually want an annuity.

And it's not that every annuity out there is a bad annuity, but you need to understand what they are. They come in many, many different flavors, but all of them are an insurance product with some sort of an investment characteristic.

At its most basic level, an annuity is just a pension that you purchase from an insurance company. You give the company a lump sum of money and in return it pays you a guaranteed amount every month or every year until you die.

And as an insurance product, the company generally pays a commission to the agent selling it to you. The agent of course, often masquerades as a financial advisor, but at least when they're selling you that annuity, they're functioning as a salesperson and not an unbiased advisor.

The annuity is backed by the insurance company. If the insurance company goes away, so does the annuity except as provided for by a state insurance guarantee organization. Those are not the state, they're all the insurance companies in the state. Very different.

Now it generally works out okay, but they only protect a limited amount of an annuity's value. So, you can only put a certain amount into an annuity and have any protection behind it besides that insurance company.

Think about annuities in general as a way to spend your money, not a way to invest your money. And the reason why is because the investment returns are usually not that good. The reason you're buying it is because you find the guarantees provided by the annuity to be valuable.

For example, if you were buying that classic annuity I mentioned, also known as a single premium immediate annuity, you find the guarantee that you'll never run out of money to be valuable and you're willing to give up potentially better return you could get with more standard investments in order to have that guarantee.

Annuities are taxable for the most part. Now it's important to understand how they're taxed. How it's taxed depends on whether it's inside or outside of a retirement account. If it's inside a retirement account, there's no taxation due except on what comes out of the retirement account. And then of course, every dime that comes out of that retirement account is taxed at ordinary income tax rates.

Now, if it's a Roth account, that's not the case. But inside a tax deferred account that is the case. If the entire IRA is invested in an annuity, the entire annuity payout takes the place of any required minimum distribution that you're required to take, starting at various ages, soon to be age 75 for everybody.

Outside of a retirement account, an annuity has its own unique taxation. In this classic scenario where you're buying a pension from an insurance company, part of the monthly payout is interest that's payable, taxable rather, at ordinary income tax rates. And part of that is just a return of your principle, which of course is tax free.

This ratio of principle payout to total payout which is the principle plus the interest is the exclusion ratio. And the exclusion ratio varies according to how much principle is used to purchase it, how long you've had it, and the interest rate on the annuity. So it's calculated to spread out the principal withdrawals over your remaining life expectancy. That's the way the tax works.

If you withdraw money from an annuity like a partial surrender of a cash value life insurance, the interest comes out first. That's very different than cash value life insurance where you take out the principle first in a partial surrender situation. When you partially cash out an annuity, you get the interest first. So it's not a very tax efficient thing to do.

And of course, annuities are supposed to be a type of retirement product. And so, withdrawals prior to age 59 and a half are also subject to a 10% penalty. Of course, any growth inside the annuity like growth in a retirement account is tax protected. So you don't have to pay taxes on the interest and dividends and capital gains as the money grows only when it's taken out of the annuity.

And remember of course that it takes many, many years of tax deferred growth, tax protected growth, especially if the underlying asset inside the annuity is relatively tax efficient to make up for this part of the taxation of annuities. When the money comes out, you pay ordinary income tax rates on the gains, not the lower qualified dividend or long-term capital gains rates.

Now, if you inherit a non-qualified annuity, meaning one that's not in a retirement account, you can spread the withdrawals out over the rest of your life if you want. You're still going to pay ordinary income tax rates on the gains when you do take them out. And so, the sooner you want the money, the sooner you're going to pay the taxes.

If you also inherit an IRA though, you can actually roll that annuity into the IRA if you like. Of course, then the money becomes subject to inherited IRA rules. And then if the annuity is inside a qualified plan, if it's a qualified annuity, it basically just follows inherited IRA rules as well.

The main issue I have with annuities is the same problem I have with whole life insurance and it's the way they're sold. They tend to be a financial product that is sold, not bought, and often sold inappropriately. It's sold to people that by making them afraid, make them afraid of higher returning, but more volatile investments like the stock market or real estate, those sorts of things.

It's also sold by pointing out all kinds of cool bells and whistles that get it added onto the annuity for a price. The problem with those bells and whistles is that they're not really worth what you pay for them. That makes it difficult to compare one annuity to another in a fair way. So, you do get some benefits, but they're really expensive benefits.

The commissions on an annuity are typically in the one to 10% range. And that might sound like a lot to you if you're used to paying $5 to trade a share at Vanguard or Fidelity. But it's actually dramatically less than what might be paid for a whole life insurance, which is 50% to 110% of the first year's premium.

The more complex the annuity, the more opaque its features, the higher the commission tends to be. For example, one type I really don't like is called a fixed index annuity. I don't know if they're trying to capitalize on the popularity of index funds or what, but that pays a commission is 6% to 8%.

More vanilla ones I mentioned earlier, these SPIAs tend to have commissions in the 1% to 3% range. Those commissions are built into the price of the annuity, not a separate charge but you're paying them nonetheless.

More complex annuities might have other fees. Surrender charges, mortality charges, administrative fees, expense ratios, etc. You got to really read the fine print. It's really the most important print in the document to be honest.

Okay. Let's talk a little bit about the various kinds of annuities and when you might want to consider them. The first one we mentioned, the SPIA. If you want to guarantee you don't run out of money, buy a SPIA, single premium immediate annuity. Give them a lump sum of money and you get a certain payout every month for the rest of your life.

That payout is determined by how old you are. It's also determined by what current interest rates are. So, you're getting a little more on these than you were a couple of years ago, but the way you make out well on that deal of course is to live a long time. Because this thing's going to stop paying when you die. If you die next year, it stops paying. The insurance company made out like a bandit. You lived 105. You do pretty well though.

In general, people tend to buy these in the 65 to 75 year old range. It allows you to spend more money than 4% and that's the real attraction for some people. They go, “Well shoot, if I buy one of these at age 70, I might be able to spend 6% or more of that initial portfolio value rather than 4%.” So, that can be kind of attractive. You've got the guarantee of not running out of money, you can spend more of the money and of course, you leave nothing for your heirs. That's the big downside.

Another type of annuity that some people might find a benefit for is what's called a deferred income annuity or a DIA as opposed to a SPIA. In some ways a SPIA is longevity insurance. It insures against you live in a long time.

A DIA is kind of like a SPIA on steroids. Instead of paying you out immediately when you give the insurance company the money, it doesn't pay you out for some time, maybe not for five years or 20 years. And because of that, because it doesn't pay you for a while, when it does pay you, it can pay you a lot more.

For example, let's say you buy an annuity at age 50, it's not going to pay out until you're 80. What's the payout rate? It's about 26% a year of that initial amount that you put in.
And that's because the money had 30 years to grow, for the insurance company to hold onto it and use it and grow it. And so, obviously lots of people die before they get there, but for those who do live that long, it provides this big chunk of money, big chunk of income at the end of life.

And some people like that deal, they find that guarantee very valuable. It gives them the mental ability to spend down their portfolio a little more knowing they've got this DIA payment coming late in retirement if they live a long time. And so, they like that. They find that guarantee attractive and buy them.

Now there is a specific type of idea and this was mentioned by the person who wrote in to give us feedback. It's called a QLAC, a qualified longevity annuity contract. And this is a DIA inside a retirement account. That's all it is. And once the Secure Act 2.0 passed, it allows you now to buy a QLAC with up to $200,000 of your retirement money. So, you give the money now to the insurance company and they don't pay you for many years any of that money.

But the beautiful thing about it for those who really hate required minimum distributions is that you don't have to pay required minimum distributions on $200,000 of that retirement money because it's sitting in that QLAC. And so, it's a way to lower your RMDs.

Now my argument about RMDs most of the time is, they're really not that big of a deal. It's like the best possible financial problem to have to have RMDs that are more than you actually want to spend. What a great problem, right? But if you have that problem, this is one option you have to deal with it.

Another option might be a qualified charitable distribution. That counts as an RMD each year. You can give up to $100,000 dollars a year, not just $100,000 total, but $100,000 per year to a charity. And that counts toward your RMD.

Bottom line is the Secure Act 2.0 did make this product, this QLAC product a little more attractive than it was because it increased the amount you can put in it to $200,000. But the same act also made the benefit a little less attractive because now at least people that are my age, won't have to pay RMDs until they're 75 starting in 2033.

Another type of useful annuity is a multi-year guaranteed annuity or a MYGA. And this is basically the insurance industry's answer to certificates of deposits that are sold at a bank. You pick the term, you put the money in, the insurance company pays you a guaranteed income as you go along and you get your principal back at the end. It's like a CD from an insurance company.

CDs are backed by the bank and the FDIC. MYGAs are backed by the insurance company and the state guarantee fund. That's probably inferior to FDIC quite honestly, but if it's paying you a lot more in a CD, it might be worth it to you.

One interesting thing about it is CD interest is paid out in taxed as it goes along, but MYGA interest is either paid out in tax or left to compound tax deferred inside the annuity. So you have this option to not pay taxes on it till the end. You can also exchange it into another MYGA further deferring the taxation. So, that's kind of an advantage over a CD.

But given those tax advantages of MYGAs, you kind of might expect them to pay lower yields than a CD. That's not always the case, especially for longer time periods. You might actually get a higher yield on it. So, if you're a CD investor, if you find the proposition that CDs make to be attractive to you, you should also be looking at MYGAs.

The last kind of annuity that is occasionally useful to people was also mentioned by the fellow writing in about giving us feedback. This is a low cost variable annuity. Now there are lots of variable annuities out there that are not low cost, that have bells and whistles that have high commissions, that are products designed to be sold and not bought.

In fact, if you just remember, the variable annuities should be avoided you're probably going to do just fine in this respect. But there are some uses of a very low cost one. The first one is when people realized maybe it was a bad idea to get into a whole life policy, but they got a huge difference between what they're going to get out of that policy and what they've put in it.

You can exchange the cash value of the whole life policy into a low cost variable annuity. Let it grow back to the basis, to the amount you've paid in premiums and then cash out of it. And essentially that growth from the cash value to the basis then is earned tax free.

So, you got to pay some fees to the annuity and deal with some hassle, but you get some tax free growth, it's probably worth it if that is tens of thousands of dollars difference. If it's a few hundred dollars, it's definitely not worth it. That's one use of it.

The second use is for someone that just doesn't have very much tax protected space and they want to hold some tax inefficient asset classes. Maybe they want to put TIPS in there or REITs in there or some debt real estate or something like that. Although I don't know that you can actually get debt real estate into a variable annuity is this gives you a chance to put the investment into an environment where it grows in a tax protected way.

Now obviously it's an annuity, when it comes out it gets taxed like an annuity, ordinary income tax rates, but at least that allows it to grow in a tax protected way for a while. And if it's a tax inefficient enough investment, it's possible you could come out ahead assuming the fees on the annuity are low enough. But this is one other option for it.

Things you should avoid for sure. Most variable annuities I mentioned to you, especially expensive ones. Fixed index annuities. I see no reason to buy these at all. Really complex annuities. If you can't compare it to annuities from a bunch of other companies, you're probably getting ripped off. You want something you can compare like gasoline. If you can buy gas for $3 a gallon, that's a good deal. At $40 a gallon, you're getting ripped off. It's very easy, you buy it by the price and you can do that when you can compare annuities one to another. But if they're all totally different, you're comparing apples to oranges, you just can't tell.

All right, enough on annuities. I hope that was in the weeds enough for those of you who are looking for more information on topics like that. But still an annuity is something that you can just skip over. You don't have to have an annuity in your life and you'll do just fine.

Okay, let's take a question here off the Speak Pipe. You guys are probably sick of listening to my voice by this time. Let's listen to somebody else's.

OWN OCCUPATION DISABILITY POLICY QUESTION

Speaker:
Hi White Coat Investor. I'm considering taking at least a year off working to travel with my family. I'm healthy in my thirties and have an individual own occupation disability policy. If I continue paying the premium and get hurt while traveling, would I still be eligible for coverage? What other things should I be thinking about? Thank you so much.

Dr. Jim Dahle:
Oh, that's a great question. I don't think I've ever had this question before. Well, here's the deal. If you get hurt in the beginning of that year, it's not going to be a problem at all. You just tell them I was on vacation and this is what I make and now I'm disabled. And that's not going to be a problem whatsoever.

If you've been on vacation for 11 months though, that might be a little harder to convince them. Certainly the benefit of continuing to pay your premiums while you take a year off is that you still have the policy when you come back and presumably you're not yet financially independent and you still need the policy. So, I would probably pay the policy for that year even if you were worried or were sure that it wasn't going to pay you if you got disabled while you were on vacation.

I kind of did something similar while I was in the military. I wasn't sure that my policy was really going to pay if I got disabled in the military, but I didn't want to have a chance of not being able to get one when I got back. I think the only thing that really wouldn't have paid while I was out there was getting disabled from an act of war, but it was still worth it to me to have the disability insurance policy. So I kept paying it during the four years I was in the military.

But as far as this goes, what would they do? Well, that's a good question for a disability insurance attorney that spends time fighting for people who've received a disability insurance policy.

And I don't know the answer. I think you probably would run into a fight if you've really not been working for a long time. Because they're going to go, “Well, what'd you make last month? What'd you make the month before?” And now they've gone back six months and you haven't made anything. Well, maybe your occupation for this own occupation policy is vacationer and you should get paid like a vacationer.

So they've got a pretty good argument there. And I think you might have a fight if you have been not working for quite some time and then you try to get paid like a dental subspecialist or whatever you were doing before you went on your 12 month vacation.

I don’t know, it really depends. Maybe if it's an organized sabbatical that everybody does at your university you can argue more. It's kind of part of the job. But if you quit your job to go do this, I think you'd have a tough argument. I think there's a good chance they wouldn't pay you. And you can get an attorney and you can fight it, but I think it's going to be tough.

That said, I'd still go on the sabbatical. Your job is hard. I thank you guys all the time for what you do because it's difficult. If you get a chance to go on a three month or six month or 12 month sabbatical, I'd still take it even if the possibility of getting disabled there and not being able to use your disability insurance was hanging out there.

I just think there are really good things to be able to do at mid-career. You can do stuff at 40 that you're not going to be able to do at 80. So, take advantage of that stuff. There's more to life than just optimizing all the finances and sometimes you got to take a little bit of risk.

WHOLE LIFE INSURANCE QUESTION

Okay, let's get back into my email box here. This one was titled “Whole Life Insurance.” I get a lot of emails with that in the title. “I'm not a doctor but I'm a high earning tech professional who's a victim.” That's an interesting choice of words. “Of a whole life insurance policy sales pitch sold to me by the brother of a trusted friend.” Aren't they all?

I wonder if the brother of the trusted friend worked for a company that rhymes with “Shmorshwestern Putual”, but I suspect they probably do. That's kind of their general sales practice is to have you try to sell a policy to everybody you know and everybody they know.

It says, “I recently found your website as I was reconsidering my policy.” That is actually how a lot of people find the White Coat Investor. “I purchased what I was sold to believe was an investment product that would help me with future caregiver expenses to care for my aging mother. It was sold to me as number one, a great way to save on taxes because I had already maxed out my 401(k) contributions. And number two, something that would grow in value over time.

The 2 million number for my beneficiaries of course seemed very attractive. I admitted I did not do the due diligence to research and really understand how the policy works. Again, it was sold to me by my friend's brother who is masquerading as a fiduciary financial advisor. So I wholeheartedly trusted him. I've had the policy for 13 months paying a $3,000 per month premium.”

Ouch, $36,000 a year in whole life insurance premiums. “Coincidentally at month 13 my insurance agent friend's brother also left the insurance company.” Which it turns out does rhyme with “Shmorshwestern Putual”.

“I have put in about $39,000 and the value is only $8,000.” Wow, that sounds terrible. “It would take another 11 years for me to break even. I am angry at my friend's brother at the insurance company and mostly at myself.”

Well, I can see why you'd be angry. You have had what Dave Ramsey likes to call a stupid tax of $31,000 in after tax money. So I don't know what he does or she does. I don't have a name here. I think it's a he actually. But it takes most doctors a long time to earn $31,000 in after tax money.

“Do you have any advice on how I could recoup the money I've spent on 13 months of expensive premiums or do I have to chalk this up as a very expensive lesson in life and financial literacy? Thank you in advance for any help you can provide.

Also, I'd very much appreciate if you were able to share my story as I hope my story helps someone else avoid ending up in this situation and could help someone experiencing the same situation. I'm appalled that this kind of practice is legal and happens every day to people who work hard for their money regardless of business sector.”

Okay, here's the tip. If you are talking to an insurance agent and the company they work for or the policy they're promoting has a name on it that rhymes with “Shmorshwestern Putual”, you should not buy the policy or talk to that person anymore. You should throw them out of your house even if they are a friend of your brother-in-law. That's my tip for you today.

And if that's all you take out of this podcast, I have saved a certain percentage of you because 40,000 people are going to listen to this and I don't know, maybe I saved 1% of you. That's 400 of you, tens of thousands of dollars. I just saved White Coat investors a million dollars in this episode. It's wonderful.

All right. I'm sorry man, this sucks. I had a similar experience. I had a very good friend sell me a policy from this same company as a medical student. Luckily I didn't have any money so I couldn't buy a very big policy. It was a pretty small policy and the total amount of money I lost I think was barely into the four figure range.

Because of that, a company that rhymes with “Shmorshwestern Putual” has probably lost millions of dollars in revenue over the years because I was treated so badly. In fact, I'm told by good authority that they actually used the materials on the White Coat Investor website to train their agents now. So, don't be surprised when they've got answers when you have concerns.

All right, what can you do now? Well, you don't have a lot of choices. Are you going to go be able to go back and sue this person for giving you bad advice? Probably not. They operate under the suitability standard, not the fiduciary standard.

Can you call them up and say, “What the heck? You cost me $31,000. Are you going to make any of that whole to me?” And if they're a good friend to you, they might, but they probably don't have that much money. Because if they're leaving after 13 months, it's probably because they're not doing very well. They're not selling very many policies, they don't have much money and they're off to do something else with their life. Maybe they'll sell cars or something. I don't know. So, that's probably not going to work.

You got two options. One, you can just suck it up and say that is the price of me becoming financially literate. Lots and lots of doctors have chosen that option. The other option I mentioned earlier on the podcast is a reasonable use for a low cost variable annuity such as those available at Fidelity. You could exchange your $8,000 in cash value. I think that Fidelity annuity might actually have a $10,000 minimum or something like that though. So you might actually have to add some money to it in order to get this.

But anyway, that's one option is to exchange into the variable annuity, invest it in some reasonable option at Fidelity and there are reasonable options there. Wait for it to grow back until it's worth $39,000 and then cash it out. And at least what there is gained between $8,000 and $39,000 will be tax free to you.

So, that's a little way to make some lemonade out of lemons. But that's it. There's really nothing else. You could exchange it into a long-term care policy but you probably don't need one of those. You could exchange it into a better cash value life insurance policy, but you probably don't want one of those.

Certainly holding onto this thing probably doesn't make sense unless there's some reason you can no longer get term life insurance. Obviously before you surrender it or before you exchange it into a variable annuity, you need to have adequate term life insurance in place. Don't make that mistake. You don't want to run around uninsured if you have a need for life insurance. Better to have whole life insurance than nothing.

But I'm sorry this is common. This happens to doctors all the time. I have written two blog posts because I got so sick of typing this stuff into my email box over and over again. The first one is called “How to Evaluate Your Own Whole Life Policy.” It’s on the White Coat Investor Blog. The second one is called “How to Dump Your Whole Life Policy.” You can search those terms, “evaluate” and “dump” is probably all you got to put in there and they will pull up.

There are lots and lots of other members of this club that you were in now. Hundreds, maybe thousands, maybe tens of thousands. Most doctors have been pitched a policy mostly from this company because somehow they managed to get into residencies like crazy. But it happens. Some of us make mistake, we buy it. Few years later, we realize what we bought. We realize it's a mistake and we get rid of it.

Now occasionally, if you've had it for a long time, if you've had these things for 10 or 20 years, even if it didn't make sense to buy it initially, it might make sense to hold onto it. And that's what that post “How to Evaluate Your Own Whole Life Policy” is all about. It’s helping you decide whether you want to hold onto the policy. Because all the crummy return years are pretty heavily front loaded and once you've kind of been through those, the return is not the worst thing in the world. So, you got to run the numbers if you've had it for a long time.

TERM LIFE INSURANCE QUESTION

Okay, enough ranting about that. Let's talk about term life insurance. Here's another email I got. “On your blog you recommend term life over whole life insurance.” That is the truth, although I do also list a number of reasonable uses for whole life insurance. They're pretty niche. You probably don't have one, but if you're curious what they are, you can look up that blog post.

It goes on. “I follow the Term4Sale link.” That's one of our sponsors by the way. “And found out that a lot of the companies selling term life insurance are not the popular insurance companies like State Farm and AAA, Nationwide and Liberty. Is it advisable to buy life insurance from these popular companies or buy life insurance from a company that already sells disability insurance like Principle or Ameritas? Thanks for your time and response.”

Well, here's the truth. It doesn't need to be a popular company. It doesn't need to be a company that sells disability insurance. It needs to be reasonably financially stable. But that's about it.

In general, when you use an aggregation site like Term4Sale, you want to pick the top two or three or four ratings. So, in my book, and this is the default setting on Term4Sale. If it's rated A- or better, it's fine to use. If you want the higher or lower standard of financial stability, you're free to adjust that as needed.

But after that, think of it like gasoline. Do you only buy Chevron gas or are you okay with non-name brand gas? Well, for most of us to put into our car that we drive around every day, it's fine to use whatever kind of gas.

If you're putting it in your trimmer you might go take the trouble to go to a special gas station that sells Ethanol free 91 octane gas and you'll put some fuel stabilizer in it and you'll put premium oil in it so that two stroke engine lasts forever. But for most of us, you don't need the equivalent of that when it comes to term life insurance. You need the random Costco gas that you can just buy and it'll be fine.

If you want the very highest quality, just in case, that's going to cost you a little more. But in general, term life insurance is like a commodity. You buy it based on price and if you're healthy, you can get that right off an aggregation site. It'll tell you the lowest price one. When you go to see an agent, you can say “I want this policy.” If you are not healthy, you ought to have the agent shop you around a little bit informally before you apply because you don't want a denial on your record. That's usually a bad thing.

Obviously if you're not healthy, you're either not going to be able to get a policy or you're going to get a policy that costs you a little bit more. Unlike disability insurance where they give you a policy that exempts something like my policy, I used to have exempted injuries from rock climbing. And so, you don't tend to get that with life insurance. They just charge you more for the life insurance or they don't give it at all. They don't exclude if you die from cancer, it's not going to pay. They don't really do that.

I'm kind of burned out on insurance. We've talked about annuities, we've talked about whole life insurance, we've talked about term life insurance. Let's talk about something else. Here's a question on a different subject on the Speak Pipe.

DONOR-ADVISED FUND QUESTION

Speaker 2:
Hi Jim. Thanks for all you do. I have some questions regarding using a donor-advised fund. At Vanguard the minimum initial investment is $25,000. I plan to open a DAF this year and use it to donate to my church in the form of tithes. I anticipate to have approximately $40,000 in “donations” accumulated by the end of the calendar year.

My understanding is that the money that would typically be allocated to the church should be invested into my brokerage account according to my asset allocation, and then immediately donate the most appreciated shares from my brokerage account to the DAF.

My questions are as follows. One, do you donate all of your appreciated shares all at once at the end of the year when you know how much money you want to donate, assuming that the calculation is based on a percentage of your income?

And two, if this is your approach, how do you reconcile your end of your donation amount when you have invested, say $40,000 of the course of the year that you would've previously given to church periodically after each paycheck, when now by the end of the year those investments have lost 10% in value?

Dr. Jim Dahle:
Good question. A little confusing. We got really into a lot of weeds there. I'm just going to tell you what I do. I do make regular donations to charities as well as the church we attend. And I do that using a donor-advised fund and I fund the donor-advised fund by donating shares of appreciated mutual funds and ETFs that I've owned for at least one year into the DAF.

Once it's in the DAF I leave it in cash because I don't really store a bunch of money in there long term. Now once it's in there a few days later, it generally goes to charities. And so, that's kind of how we use our DAF.

Now each month we know what we're not spending and pretty much what we do at that point and what we're putting aside for taxes as well. But pretty much everything else, including what we expect to give away eventually as well as everything we're saving and investing, I invest. Because I know there's this huge taxable account sitting out there that I can use to make donations for charities.

So, once you get that taxable account to a certain size, you can do this as well. In the beginning maybe you can't because the donation size is so big compared to the taxable account. But eventually once that taxable account is big, you can do this.

And then when it comes time to donate, I just transfer whatever's appreciated the most in there and I've owned for at least one year. You don't wait until you've owned it at least a year. You lose one of the significant tax benefits of that donation. So, it needs to be something you've owned for at least a year.

You don't have to use the DAF for that by the way. You can donate directly to the charity, but the DAF not only makes it confidential, it just makes it really convenient. And so, I think it's pretty nice to use.

In your case, you got a couple options. One, you can just put the money directly into the DAF. That's one option. And you can invest it in the DAF if you want, but if you want to make sure it doesn't go down in value, you just leave it in cash. You basically put it into a money market fund there in the donor-advised fund and then it won't go down in principle. So, that's great.

Another option you could do is you could just invest it like all your other investments and knowing that some of those investments are going to go into the DAF, but it's got to be money you invested the prior year because it's got to sit there for a year if you want their true tax benefit of using appreciated shares instead of cash. Those activities I think have to be a little more disconnected I think than they are in your mind right now.

As far as Vanguard, Vanguard is great. It's $25,000 minimum to start. I can't remember what the ongoing contributions are. I think that to be $5,000. They don't let you donate less than $500. So it's kind of the high dollar, high roller DAF if you will.

If you want to give smaller donations or you want to start with less money, use the Fidelity one. Fidelity one is pretty good too. It's slightly higher expenses than the Vanguard one. I'm kind of loyal to Vanguard. I got my taxable account at Vanguard's. So it’s convenient to us to use Vanguard and the minimums aren't an issue for us and so we use the Vanguard Charitable DAF.

But if that $25,000 amount or that $5,000 amount or that $500 amount all feel a little too high to you, then just go to Fidelity and use theirs, it's fine. In fact, you can make a donation from the Vanguard DAF to the Fidelity DAF and vice versa. So, that's kind of a cool feature.

All right, enough on DAFs. Let's talk about something else. Here's a Speak Pipe from Adam who wants to talk about trusts and charitable contributions.

TRUSTS AND CHARITABLE CONTRIBUTIONS QUESTIONS

Adam:
Hi Jim. I was wondering if you could answer a question about calculating the amount to put on tax returns for charitable contributions when a trust is involved. I understand it's pretty simple when donating directly to a charity or donating to a donor advised fund and then to a charity. You just take the deduction in the year that you donate.

But for example, let's say I established a charitable lead trust with an initial $1 million contribution. Let's say I wanted the trust to distribute 5% every year for 15 years to my favorite charities, and then the remaining amount can be passed on to an heir.

In a scenario like this, when am I allowed to take the deduction for the charitable contribution and how much? 5% of a million would be $50,000, which after 15 years would be about $750,000. Do I take the deduction of $50,000 every year or whatever 5% of the portfolio and the charitable contribution happens to be at that time in that year or is the initial estimated $750,000 total used in the year of establishing the trust as a deduction? I’m hoping you can shed some light on this question. Thank you.

Dr. Jim Dahle:
Okay. The first thing I want to emphasize is if you are establishing a charitable remainder trust or a charitable lead trust, whether that is an annuity trust or a uni trust, these are CRATs and CRUTs and CLUTs and CLATs is how they're abbreviated.

This is not a do-it-yourself project. You don't go out and just start one of these things. You go get an estate planning attorney and they help you with it and you may have an accountant that assists you with it as well. This is not something that you need to calculate. They will calculate it, they will help you with it.

You're making it sound like this is something that's routine for somebody to just take care of on their own like an IRA rollover or something. It is not. Go get some advice on this sort of a thing.

The deduction for both of those trusts happens when you establish the trust. In the year you establish and fund the trust that's when you get the deduction. But these are both split interest trusts or split interest gifts.

And so, you don't get a deduction for the entire contribution into the trust because some of that money is not going to charity. Only part of the money is going to charity and they have ways of calculating exactly how much that is and that's what you get a deduction for.

That's the point of these split interest gifts is to be able to get a deduction while still being able to use the money or making sure your heir gets some asset while still getting some sort of a charitable deduction for it.

So, get some professional help with that one and they can help you do the calculation, but no, it's not based on the value at some point in the future. It's based on the value when you establish the trust, you get the deduction for the donation upfront.

Okay. Another estate planning question we've got here on the Speak Pipe.

ESTATE PLANNING QUESTION

Speaker 3:
Dear Dr. Dahle, thank you for everything that you do. Our question pertains to the efficient transfer of wealth from one generation to another prior to death. My husband and I are extremely fortunate to be in a situation where we expect to receive a sizable inheritance from my parents, who through their hard work currently have an estate of several million dollars and continue to make a good income even in retirement.

They have repeatedly expressed their desire to pass this money onto us and to our child. However, most likely this money would not come to us for at least 10 to 15 years. My husband and I are currently making a high income and thanks to you save and invest wisely.

As a result, we most likely will be in a very comfortable position 15 years from now. And thus, while an inheritance is always nice, the money would be way more useful and impactful to our lives now than it would be in 15 years as it could help fund large expenses like a home purchase and child education.

Is there a smart way to transfer assets from one generation to another that would be as tax efficient as receiving a step up in basis on death? Or is there no way to get earlier access to those funds without paying some sort of tax or premium?

Dr. Jim Dahle:
Okay, good question. You remember when we talk about these sort of subjects, we are talking about two different types of taxes. The first is income taxes. Whether you inherit the asset or your child inherits the asset, there is a step up in basis at death such that no income tax is due.

However, if you are going to be having an estate tax problem, which right now means that since you're married, it sounds like you're going to die with an estate of larger than $26 million in today's dollars. Although bear in mind, that's set to be cut in half after 2025 if Congress doesn't act. If you're not going to have more than that, you don't have an estate tax problem.

And so, that means that you can just inherit the money and you can give to your kids when you want. No big deal. You can gift a couple million dollars at a time if you want. You're just using up your estate tax exemption. You got to file a gift tax but that's fine. That's no big deal. There's no tax due until your estate gets to be larger than whatever that amount is at the time of your death.

Now, because Congress is not filled with complete idiots and the IRS is not filled with people who merely want to hurt you, they have spent a great deal of time thinking about this and they have decided that, “Well, we don't want people to be able to just skip a generation and somehow get out of paying a bunch of estate tax.” They have put in place what is called the generation-skipping transfer tax. That's a federal tax that results when there's a transfer of property by gift or inheritance to a beneficiary other than a spouse who is at least 37 and a half years younger than the donor.

And essentially what this is, it's using up your estate tax exemption for the middle generation, the generation that's being skipped. It closed a loophole that allowed the wealthy to legally gift money and bequeath property to their grandchildren, great-grandchildren without paying estate taxes. It's the same rate essentially as the estate tax. It's a flat 40%. But obviously it's not going to apply to most people because most people are not dying with the estates larger than the estate tax exemption.

I suspect there are some states that may have some sort of generation skipping transfer tax as well. I haven't looked into all of those for the states, but there's still, I don't know, a dozen, maybe eight or 10 maybe states that have their own estate tax. Or sometimes it's an inheritance tax, which is taxed on the person that receives it rather than the estate.

But yeah, that's how they nail you with that. But you can always decline an inheritance. You don't have to take it. Then it goes to whoever's next in line essentially. But good estate planning is a good idea here. If there's going to be millions of dollars transferred between the generations, you guys should go see an estate planning attorney in your parents' state and really work this plan out in advance, especially if you think there's any chance they could get up around those estate tax exemption limits which could be as low as $13-ish million if Congress doesn't do anything after 2025.

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All right, we've come to the end. We're almost at the end of the summer here. Kids are probably back in school by now. Soon it'll be cooling off. I hope you've had a great summer. I know that I have lots of fun trips, but it's time to get ready for Labor Day. Have a great time out there. I hope you get some time off for it. And if not, well, thanks for what you're doing in the hospitals and the clinics and elsewhere if you're working on that day.

Keep your head up, shoulders back. You've got this. We'll see you next time on the podcast.

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

Dr. Jim Dahle:
This is Milestones to Millionaire podcast number 132 – Emergency medicine resident hits $100,000 in retirement accounts.

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All right, we got a great guest today that's really accomplished something remarkable. Stay tuned after this interview with Paul, we're going to talk about cash. What you should do with your cash. So, let's get him on the line.

INTERVIEW
Our guest today on the Milestone to Millionaire podcast is Paul. Paul, welcome to the podcast.

Paul:
Thank you. Thank you for having me.

Dr. Jim Dahle:
Tell us what you do for a living and how far you're out of training.

Paul:
I actually just graduated in the end of June. And I'm in ER so I've actually yet to start my actual first attending job, but that starts in about a week.

Dr. Jim Dahle:
Oh, that's exciting.

Paul:
Yeah.

Dr. Jim Dahle:
You got a few weeks off. What'd you do with those?

Paul:
I just came back from Europe. We went to London, Liverpool, Naples, Amalfi and Rome. I just got back.

Dr. Jim Dahle:
Awesome. First time over there?

Paul:
No, I've been over there multiple times.

Dr. Jim Dahle:
And what part of the country are you going to be practicing in?

Paul:
In the Midwest.

Dr. Jim Dahle:
In the Midwest. Okay. So your income during residency was?

Paul:
It started off at around like $52,000 I believe. And then of third year I was moonlighting quite a bit. So I doubled my income too. About $110,000.

Dr. Jim Dahle:
$110,000 was the highest you got. All right.

Paul:
Yeah.

Dr. Jim Dahle:
This is all very relevant because next I want you to tell the audience what milestone you recently hit.

Paul:
The milestone I reached, I actually ended up saving up $100,000 in retirement account. So, it was a pretty frugal living throughout residency for sure.

Dr. Jim Dahle:
You started out making like $50,000, you finished making like $100,000. So let's say in total you made, I don't know, $225,000 before tax, something like that over the course of three years and somehow $100,000 of it went into retirement accounts. How did you do that?

Paul:
It helps living in the Midwest for sure, like low cost of living. I was able to control a lot of people's big expenses, transportation. I live very close to the hospital and actually biked quite a bit to the hospital. It was only three miles and it took me about 15 minutes to bike there. That helped a lot. And my rent was pretty low. It started out at $890 for two bedroom, one bath.

And then the other thing was food costs. I had a pretty low food budget. Eating out was only $40 a month and actual groceries was $150. It helps because I know how to cook pretty well, so I didn't feel like I was lacking anything from that side either.

Dr. Jim Dahle:
Is it just you? Are you married with kids or just you?

Paul:
I just got married too. Just towards the end of second year is when I got married.

Dr. Jim Dahle:
Okay. So part of that was with the spouse. Was your spouse working?

Paul:
She was, but after we got married she stopped working.

Dr. Jim Dahle:
Okay. I biked to residency as well every day to the hospital. It was about a half mile for me to bike down the road to the university hospital there in Tucson. This was in Tucson. I did not have to bike once in snow. What did you do in the winter on your bike?

Paul:
Oh, I bundled up. You could always put on more clothes. Plus when you're biking it gets pretty kind of sweaty. So, once you get to the hospital you just take everything off and then I just packed my scrubs and I changed.

Dr. Jim Dahle:
Yeah, I grew up in Alaska and they don't believe up there that there's such a thing as cold weather. There's just being underdressed.

Paul:
Yeah, basically.

Dr. Jim Dahle:
Okay. So, you biked to work for three years, three year residency I assume, right?

Paul:
Yes.

Dr. Jim Dahle:
Three years you biked to work and you lived in this apartment that was less than $1,000 a month. You spent $140 or something, $160 on food. How much did you eat at the hospital?

Paul:
Our hospital actually didn't give food so I packed my own lunch.

Dr. Jim Dahle:
Never ate at the hospital. You had to pack a lunch?

Paul:
Yeah.

Dr. Jim Dahle:
So you got some 24 hour shift on a medicine rotation and you had to take the food, huh?

Paul:
Yeah, I brought a lot of food during those days.

Dr. Jim Dahle:
All right. So, were you like this in med school too?

Paul:
No, I wasn't. And in med school it worked out because I went to Midwestern in Chicago, which is pretty expensive, but I'm from around there so I just drove to school and I lived at home and it was pretty easy because my parents took care of all those other expenses. I just worked mainly about tuition. That was the biggest thing. But it was still kind of pretty frugal living.

Dr. Jim Dahle:
Yeah. How'd you pay for tuition? Did you borrow it?

Paul:
That is all borrowed money.

Dr. Jim Dahle:
So how much do you owe in student loans?

Paul:
Total is $380,000 right now.

Dr. Jim Dahle:
$380,000. So, you got some work ahead of you.

Paul:
Yeah.

Dr. Jim Dahle:
I have a feeling I know what the next milestone you're going to be on this podcast with is.

Paul:
Actually my target is actually PSLF because I'm working at university. I had three years of residency for towards PSLF and now just seven more years.

Dr. Jim Dahle:
Seven years before you get that though.

Paul:
Yeah.

Dr. Jim Dahle:
Very cool. All right. Well, what'd you do with this money? Tell us about your retirement accounts you contributed to.

Paul:
The majority is actually like Roth contributions. We had option of Roth 401(k)s. So, I did that. Then I maxed out my HSA and maxed out Roth IRAs. The majority is… Actually almost all of it is like passive index mutual funds.

Dr. Jim Dahle:
Your spouse now too, she's got a backdoor Roth IRA?

Paul:
Yeah. I’m doing that for her too.

Dr. Jim Dahle:
Very cool. Well, that's exciting. And so, how do you feel about that? I don't know how you grew up. Is $100,000 a lot of money to you?

Paul:
It is. I feel like it's a big deal. Especially at my age, I'm only like 33 right now. If I wanted to coast FIRE, I could sort of can because if you look at 30 year retirements and maybe 9%, 10% returns, talking about no more contributions and that grows with compound interest up to like $1.6, $2.1 million, which I could easily live off of.

Dr. Jim Dahle:
Well, I can tell you this. I came out of residency at 31 and I definitely did not have $100,000 in retirement accounts at 33. So congratulations to you on that. That is an accomplishment you should be proud of. I don't know most people coming out of residency have already saved that much for retirement.

I was recording a podcast earlier today. I think it runs after yours actually. But where I was talking about if residents save anything, I'm happy. Just getting in the habit of saving something. And you've done so well. You've basically been maxing out retirement accounts as a resident, which is pretty impressive and reflects a lot of disciplines. So, kudos to you on that.

Let's say there's somebody out there who's doing the same thing as you. Maybe they got a bunch of student loans, maybe they don't, but they want to get started in residency, they want to save for retirement. What advice do you have for them?

Paul:
My advice would be if you can control your expenses as much as possible that would help save early and save often as you can. It'll pay dividends long in the future. When you want to spend more time with your family, you could have that flexibility, go part-time, switch careers. It gives you a lot of advantage, a lot of power in your court compared to the employer. So, that helps a lot.

Other thing is if you have hobbies that are low expenses or free because I like to run and work out and I could do all that stuff outside. So, that helps too. And the other thing is cook if you can, because you could eat very healthy if you cook at home and it does wonders on your budget.

Dr. Jim Dahle:
And you're not afraid to get outside and exercise as we've already determined even in the winter.

Paul:
No. I was the only one in my program to bike to work.

Dr. Jim Dahle:
Well, one of my residency classmates, he was a really high level triathlete and his commute was not three miles, it was more like 12 and some days he would run. He'd lose like eight pounds of water on the way into work. It was impressive in Tucson. That's pretty awesome.

A question for you. You've recently gotten married. What kind of financial discussions did you have with your spouse before and after getting married?

Paul:
Because I've read a lot of financial stuff and I'm really in tune to it basically, but my wife isn't, so it's kind of just like educating her along the way. I'm very open about all my numbers. I'm open with my wife, she knows everything and I show her and then we do have net worth tracking kind of stuff. And then we have goals and budgets and we're pretty good on that.

Everything is pretty open to everybody. Even throughout residency I was giving a lot of financial lectures to my fellow residents and actually even help some of my attendings on their investments because they didn't know some of this stuff, which is shocking given they've been out for so long.

Dr. Jim Dahle:
It might be shocking to you. It's not shocking to me at all. I run into that all the time and that's a good message out there for you students, for you residents and fellows, new attendings. Don't assume just because that person knows a lot more about medicine than you, that they also know a lot more about finance. That is not the case in many situations.

If you've been listening to this podcast regularly for a while, there's a very good chance that you are the smartest person about finances in your residency. So, be sure to spread the love around a little bit.

All right, what's next for you in your financial goals? PSLF is seven years away. Do you think you'll hit anything else big before then?

Paul:
I'm hoping to reach a million net worth probably in three years. It's my target. But three or five years hopefully by then.

Dr. Jim Dahle:
It wouldn’t surprise me knowing how disciplined you are.

Paul:
Yeah. Well, I also do real estate on the side too, so using leverage will help.

Dr. Jim Dahle:
Awesome. Well, just be careful with it. Don't get in too much leverage. It works both ways for sure.

Paul:
Yeah.

Dr. Jim Dahle:
Awesome. Paul, congratulations to you on your success. It's wonderful. Thank you for coming on the podcast and sharing it with our audience. Hopefully you can inspire somebody else to do the same.

Paul:
Yeah, thank you to you too. I definitely couldn't have done this without the material you put out. It's been extremely helpful. I think you were the first one that actually exposed me to finance from your blogs and then I read your book.

Dr. Jim Dahle:
Well, it's our pleasure. We work hard to try to have that effect on people and it's wonderful to hear that we have on you.

Paul:
Yeah, thank you.

Dr. Jim Dahle:
All right. I hope you had enjoyed that interview with Paul. I wouldn't be surprised if Paul becomes one of our financial educator award winners down the line as much as he's doing in his own life and as much as he is helping his peers and even attendings in residency. If you're lucky enough to be near Paul and be around him, you may benefit from his expertise in coming years.

But it really is interesting to see just how well you can do even as a resident when you optimize everything. He is in a low cost living area. He lives on a tight budget. He knows how investing works. He’s already got real estate investing and retirement account and index fund investing all going in his life. He’s got a spouse on the same page. You can really do some pretty awesome stuff. He's talking about being a millionaire three years out of residency. That's about four years faster than I was. So, it just goes to show what can be done when you start early and really optimize.

Finance 101: Cash

All right. As I promised you at the beginning of the podcast, we're going to talk about cash today. Everybody likes cash, right? Of course. More money, more problems. But more cash is generally better than having less cash.

What do I mean when I'm talking about cash? I'm talking about a safe investment. Cash is an investment in which you don't lose principle, at least on a nominal basis. Remember, nominal means just regular, not inflation adjusted. Real means you've adjusted it for inflation. And of course, you can lose the value of your cash to inflation, but if it's a cash investment, you don't actually lose on a nominal basis.

What are we talking about here? We're talking about checking accounts, we're talking about savings accounts. We're talking about money market funds. There are some other investments out there. If you have access to the TSP, the G fund is a cash investment. You can't lose principle on that. Certificates of deposit. Same thing. You can lose interest if you cancel out of the thing early, but you're not going to lose principle.

Savings bonds, type EE and type I. Treasury bills are essentially cash as well. Very short term investment grade treasury, corporate and municipal bonds could also be considered cash investments.

The main thing with cash is it's guaranteed. And when there's a guarantee, you need to understand who is providing it because a guarantee is only as useful as the entity that's providing the guarantee. When we're talking about something at a bank, CDs, savings accounts, checking accounts. The banks are providing the guarantee.

When you have a money market fund, the entity that's borrowing that money, which is a corporation or a government, typically is the entity providing the guarantee with savings bonds and treasury bonds. TIPS. The TSP G funds. It’s the US government providing the guarantee. With very short-term corporate bonds like you might find in a prime money market fund that would be an individual corporation. Same thing with very short-term muni bonds. Those are state and local governments.

So, it's all about the guarantee and who's providing it. But there's also often insurance on cash investments. You've been to a bank, you walk in, they got the letters FDIC on the side of the door. What does that mean? That's the Federal Deposit Insurance Corporation.

And this is a federal agency essentially that was started during the Great Depression to prevent runs on banks. If you've seen old movies about the 1930s, everybody hears the bank's failing, runs down there and tries to get their money out before it fails.

What the FDIC does is it provides an orderly transition when banks fail. And typically it does this on Friday afternoons. Friday afternoon, 05:00 o'clock rolls around and about five minutes to 05:00, the FDIC walks in the door, shuts down the bank.

And then over the weekend they restructure it. They ensure that all of those who had insured money in the bank can get their money. And Monday morning when they open, nobody panics because everything's all taken care of. And so, that's the role of the FDIC.

Now the way FDIC insurance works is that they cover up to $250,000 in deposits. That's your checking, that's your savings, that's your CDs per depositor. So, they're per depositor, per bank, per ownership category.

If you're married and you have a joint checking account at the bank, up to $500,000 in that account is going to be insured. If you have more money than that, you better take it to another FDIC insured bank or it's not going to be insured.

They also have these ownership categories. That doesn't mean type of deposit products. You don't get $250,000 in your checking account and $250,000 in your savings account and $250,000 in your money market account and $250,000 in CDs. And those are deposit products.

Ownership categories are single accounts, joint accounts, trust accounts, business accounts, et cetera. So, you could have $250,000 in your business account, $250,000 in a trust account. You and your spouse could have $500,000 in your joint account and you could each have another $250,000 in single accounts. And that would all be covered by the FDIC.

If you have retirement accounts at the bank, which you shouldn't by the way. Don't have those at a bank, it’s generally a bad idea. You want them in places like Vanguard and Schwab and Fidelity. Those sorts of places, not a bank. But if you had them at a bank, those would be another $250,000.

You can have a whole lot more than $250,000 protected at a single bank. When you run out of those limits, you could go to another bank. But the point is that there are limits to the insurance and you should be aware of what those are if you have a lot of money sitting around cash. Of course, if you've got millions of dollars sitting around in cash, you might want to wonder if maybe you should be investing some of that for the long run.

There's also an entity called the NCUA, National Credit Union Administration. Think of this as FDIC for credit unions. It's almost exactly the same thing. And so, your money at a credit union is protected in the same way that it is at a bank.

At brokerages accounts there is another entity out there called the Securities Investor Protection Corporation or the SIPC. And that was formed in 1970 in response to a bunch of broker dealers that were merging and being acquired and going out of business in some really turbulent markets at the end of the 1960s.

Basically, they couldn't meet their obligations to customers when they were going bankrupt. They lost public confidence in the securities markets. And so, the Congress helped form the SIPC.

The way the SIPC works, it doesn't protect your investments from investment loss. The market goes down, it doesn't ensure the value of your investments. But it includes up to $500,000, including up to $250,000 in cash.

What's it protecting you from though? Basically it's protecting you from failure of your brokerage. It oversees the liquidation of their member firms that close when the firm is bankrupt or in financial trouble and customer assets are missing. So, if there's a liquidation under the SIPC, they work to get you your securities and your cash as quickly as possible and it's an important part of our investor protection and the United States.

But their role is basically to get you your money. They're not doing fractional banking at your brokerage. It's not like they don't have the money or the securities. They have the money or the securities. It's in there. You need to get it out of a firm that's not really working well. And so, that's the role of the SIPC. It's not exactly like the FDIC, but it's nice to have anyway.

Okay. That's how cash works. What is the best cash investment today as we're recording this? For most of you it’s probably a money market fund. One of the excellent ones is at Vanguard. It's the Federal Money Market Fund. And that's generally your sweep account at Vanguard if you have a brokerage account there. But it's paying, I think as I record this, something like 5.2%.

So, if your money is sitting at some Podunk bank down the street from you and you're making 0.25% on your savings, you need to move that money. It needs to go somewhere where you're making 3%, 4%, 5% something.

There's a lot of high yield savings accounts out there. Usually these are online banks. Ours is at Ally. I don't have any money in it right now. My money's all in that federal money market fund at Vanguard.

But Ally has one, Discover has one. A bunch of these online banks have these, and they'll pay something similar to what you can get with a money market fund. Sometimes a little bit less, sometimes a little bit more though. A couple of years ago you'd get more in a high yield savings account than you could in a money market fund.

But basically if your money's all sitting in checking, your money's all sitting in some terrible savings account, you need to move it. If you got hundreds of thousands of dollars in cash, you need to be earning something on that money. If you can make 5% on $100,000, that's $5,000 a year. How long you got to go to work for $5,000 a year? Probably a little while, most of us do. So, even if you only have $10,000 in cash, would you rather get $500 this year from it or $10 this year from it? It matters. So, pay attention to where your cash is.

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All right, this is the Milestones to Millionaire podcast. It features you and your inspirational stories to inspire others to do the same and to accomplish those financial milestones that we all have set before us. If you'd like to come on the podcast, you can apply at whitecoatinvestor.com/milestones, and we would love to celebrate your milestone with you. No matter how trivial it might be or how incredible it might be, we'd like you to use it to help others to do the same.

All right, that's it for today's episode. Keep your head up, shoulders back. You've got this. We'll see you next time on the Milestones to Millionaire podcast.

DISCLAIMER

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