WCI #320: Investment Accounts

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.

This White Coat Investor podcast number 320. I estimate that 80% of doctors need, want and should use a financial advisor and or an investment manager. Some investment gurus, such as Dr. William Bernstein, think my estimate is way too low. At any rate, if you want to use an advisor temporarily or for your entire life, there is no reason to feel guilty about it. Just make sure you are getting good advice at a fair price. If you need help updating your financial plan or just getting one in place, check out our list of recommended financial advisors@whitecoatinvestor.com financial advisors. You can do this and the White Coat Investor can help. All right, welcome back to the White Coat Investor podcast where we try to help you get a fair shake on Wall Street. Mostly, we're here to help you stop doing dumb stuff with your money. Doctors are notorious for being bad business people, for making bad investments. There is a saying in the financial services industry that an investment is so bad you can only sell it to doctors. And I'm trying to stamp that out. Get rid of this financial literacy among doctors we've been working out of here May of 2011. And a podcast and a blog, videocast, online courses, books, however you'd like your information. We're trying to help you be financially literate so you can make smart decisions that allow your money to really demonstrate your values. Whether that's in how you earn and save and invest and spend and give that money. All right, well, I'm still here. As you may have heard, I went skydiving. This was for Whitney's 19th birthday. She wanted her parents to go skydiving with her. And I'll be honest, I do a lot of kind of risky sports, whether that's climbing or canyoneering or paddling or backcountry skiing, whatever. This was scary for me, this idea of jumping out of a perfectly good plane. But I did do it. The nice thing about skydiving is you do it so high that it doesn't even seem real. The ground is so far away that, you know, it doesn't even seem all that real when you jump out of the plane. But I did jump out of the plane and for 50 seconds plummeted toward the ground. I think covered 7,000 vertical feet or something. I mean, you are falling as fast as you go. Terminal velocity, right? It was pretty cool. I'm not going to lie. That wasn't all that scary, though. You know what was scary was once they opened the chute and it took about 1500 vertical feet for that chute to open, I might add. And after that I was under the canopy for about 4,000 vertical feet. That part was a lot more scary for some reason. Maybe it's because the ground was a whole lot closer and we were moving around, but I thought that part was actually more scary than the free fall. I don't know if I'll do that again, although I keep joking with my family that I'm going to take up wingsuit flying those squirrel suits in my 80s so I can die a trauma death instead of drowning in my own secretions in some nursing home somewhere. But I guess you have to do 200 jumps before you can fly the squirrel suit. I don't know if I'm going to get to 200. 200 jumps, but we'll see how that goes. Whitney had a fantastic time. She thought it was the greatest thing ever. Katie sure enjoyed it. I was just happy to see both of their shoots open, to be honest with you. But since I'm still here, I guess we'll record some podcasts. In fact, I think we're recording a whole bunch of podcasts this week. 10 or 10 or 12 podcasts or something. We're going to record this week because I'm still off having fun. It's that time of year when I pretend I'm retired despite the fact I'm not retired. So that means when I'm not on trips, I got to do a lot of work, squishing in shifts, recording podcasts, writing stuff, going to meetings, that sort of stuff. So this week's lots of work. But that's okay because on Friday or Saturday rather, this week we're recording this in June, by the way, we're recording this on the 8th of June, and this Saturday I'm headed to Idaho, gonna go float the middle fork of the salmon, which is a pretty coveted permit to get. I didn't get the permit, but I got an invite. So I'm looking forward to running the sweet rapids in that wilderness up there. But in the meantime, enough about me. Let's talk about you and your questions. This show is driven by you. It's driven by what you want to talk about, finance wise, for the most part. And so we're going to be taking your financial questions if you'd like to leave your financial questions for us. You know, it's Not a live show. Obviously we're not quite popular enough to just have you all calling in. So we have you leave it on the speak pipe, go to whitecoatinvestor.com speakpipe and just record a question. We'll bring it on, we'll try to answer it. And every now and then you guys are really good. You stump the chump. But we'll see how it goes today. Here's the first question. Hi Jim, thanks for all you do. I'm not going to give you my name due to the nature of the question, but can I use monies earned from a lawsuit that'll come to me as 1099 Ms. And put 20% of that in my SEP 401k? Pretty obscure. Thank you. Okay, actually not all that hard of a question. Here's the deal. Yes, you're going to be taxed on this. It's going to be treated as ordinary income and you're going to receive a 1099mis C for it. However, what this is not is earned income. And in order to contribute or to use it to add up toward the income that you do the calculations for contributions on to a retirement account, you have to have earned income. Now, people can get earned income on a 1099, but this income is not earned income. You can also get non earned income on a 1099. For example, if you invested in a private REIT, for instance, they would send you a 1099 at the end of the year. That's not earned income. You can't use that to contribute to retirement accounts. And it's the same way with this sort of a settlement. Sorry, you cannot do that. By the way, a lot of those settlements that are for medical expenses and that sort of a thing are kind of considered reimbursements, I think. I'm not sure all of that is taxable. So it's really truly just paying for stuff that you had to pay for. I don't know that's necessarily taxable. You don't get double taxed as a general rule in our tax code. Okay, next question. This one's about accounts for kids. Hi Jim, this is Steve from Texas.

My wife's parents recently opened UTMA accounts for each of our teenage sons. I was curious what tax implications there are as these accounts grow, both for my in laws, for the boys and for us both now and when they turn 18.

Thanks so much for all you do. Okay, very interesting question. Obviously it's good to know what the implications are before these accounts get opened. But hopefully the Owners of the account or the custodians of the account are aware of that. UTMA Uniform Transfer to Minors account or UGMA Uniform Gift to Miners account. Depends on what state you're in. They work almost entirely exactly the same. Think of this as a taxable account for your kid. And the nice thing about your kid is they usually don't have all that much earned income, don't have much income at all. And so the money from this investment account is generally taxed at a very low rate, much lower than your rate. For example, if you're in the top bracket, you could be paying 37% federal or even if you got qualified dividend rates or long term capital gains rates on those investments, you might be paying as much as 23.8% once you include the PIPACA taxes. But for the kid, that's usually not the case because usually they don't have any other income. So the nice thing about that is that you can have quite a bit of income and have it be taxed at a very low rate. In fact, I think it's the first 1200 bucks or something. And don't quote, quote me on this, it goes up slightly each year, but about the first $1,200 of income in that account, whether it's interest, capital gains, dividends, the first $1,200 is essentially taxed at 0%. This assumes there's not some other investment this kid owns. And then the next $1,200 is taxed at their tax bracket, which is generally 10%. So it's very good, very nice rate. And in fact, if it's long term capital gains or qualified dividends, it's probably 0% still. So that's great. What you need to be aware of though is the kitty tax. And the kitty tax is essentially this rule that says you can't put all this money into a UGMA or UTMA account just to get out of paying taxes. So once this account has enough money in it that there's more income than that $2,400 ish a year, it gets taxed at the custodian's tax rate. I'm pretty sure it's custodian's tax rate. And so in your case where it's another family member opening this account for them, I believe it's at their tax rate, not the parent's rate. Now in most cases it's the parent opening this thing for those guys. So it's the same thing. This is actually the first time I actually thought about the custodian being somebody other than the parent. And I'm not sure anybody even addresses this online, but I think it's the custodian. I mean, it's a custodial account. And so that's a cool thing. That's a nice something to do. Be sure to thank them for that. But for the most part, these are accounts for a relatively small amount of money. If you're putting more than say $100,000 into a UTMA account total, you're probably doing it wrong. It's fine if you want to get it out of your estate, it now belongs to the kid. And of course, when they reach the age that your state spen classifies, which is usually age 21, they can use that money to do anything they want with no longer have control over it at that point. But for the most part, if you're looking for a tax benefit by doing this, that kind of goes away after $100,000 ish dollars in the account, even if you are investing it very tax efficiently, that's still going to hit the max of income that's going to be taxable in there. Okay, hope that's helpful. And then of course, when they sell it as adults, they're paying at their capital gains rate. So this is where I put my kids 20s fund. So theoretically they don't have much income in their 20s. They'll be able to get it out at a pretty low tax rate, maybe even zero percent. Okay, let's do our quote of the day today. This one comes from Ralph Waldo Emerson who said the desire of gold is not for gold, it is for the means of freedom and benefit. Unless you're Scrooge McDuck, I guess then you really want the gold to swim through. Okay, next question. This one's about the 401 versus a pension plan.

Hi Jim, this is Peter from upstate New York. My wife is a neonatologist and I'm a medical physicist in radiation oncology. We are both mid-30s and each make about $200,000 to $225,000 a year. I'll be starting a new job with New York State Hospital system and I'm torn about which benefits option to select since they cannot be changed during any period of employment. My options are a defined benefit pension plan or a 401A program. For the pension plan I'll be vested after five years and if I stay with the hospital system for 5 to 20 years, I receive 1.75% of my final average salary times the number of years that I worked. Employee contributions are 6% of my gross salary. It's great because this is guaranteed income for life, assuming New York State doesn't collapse. But I can't touch it without losing value until age 63. I also can't pass it on, and it's not portable for the 401A. I'll be a vested after one year, and the hospital system will contribute 8% of my gross salary for the first seven years of service and 10% of gross salary thereafter. I'll also be maxing out the 403 offered by the employer. I ran the numbers in Excel, and if I can get a 6% CAGR in the 401A with a 4% withdrawal rate, it would mathematically make more sense to take the 401A option. I suppose this is why they say financial planning isn't just an exercise in mathematics. What are your thoughts on choosing one versus the other? Thank you so much.

All right. Well, first of all, thanks for what you do. Thank you, everybody, for what you do. But those of you who are willing to live in states like New York and California, you deserve a particular thank you for being there and being willing to take care of people there. Despite how you're taxed for being there. Taxes can be pretty bad in some of those states. Cost of living can also be quite high. So thanks for serving people there. Whatever reason you're there, whether it's family or you grew up there, just a good job or whatever. Thanks. What should you do? Well, you have correctly identified the fact that the state has had very smart actuaries look at this and essentially make these two options equivalent. These are about the same thing. Once the state adjusts for the risk it's taking and the money it's paying out, these are not all that different. This is about what it would cost to buy a pension. So if you really want a pension, here's a chance to buy a pension. There's lots of great things about a pension. A pension is a way to make sure you're going to spend your money if it's hard. If you're the type of person that has a hard time spending your money, a pension's good that way. It's like buying a single premium immediate annuity from an insurance company, right? It gives you permission to spend because you know you're going to get another payment next month. And so that's cool. Even if markets do terribly, you put that risk essentially on New York State. And so lots of people like pensions. Lots of people bemoan the Fact that there are no longer very many pensions out there. Here's your chance to actually have one. You know, I'm not going to have a pension, and you got a chance to have one. So if you want a pension, go get a pension. That said, I would be very comfortable taking the other option. You know, a 401. A what most people end up doing with that money when they leave the employers, it ends up in their tax deferred account. You know, usually in traditional IRA is where that money ends up eventually. You could do Roth conversions on it down the road. It sounds like you're getting a big fat match in it, which is awesome. But that's just the money they were going to put toward the pension anyway. It's actuarially probably the same for them. And most of the time, when you actually get into crunching the numbers, you'll see that 6% figure that you calculated pop up a lot. And that's where the actuaries think they're about equal options. And so if you're the kind of person that likes to be in control of their money, I think this is a good option. Especially if you're thinking maybe an early retirement, then it can be a good option to have a little more control of your money rather than having to wait until age 63 or whenever they'll start paying this to you. The fact that you listen to the White Coat Investor podcast tells me that I probably don't have to worry about you not knowing how to manage money. That's the big risk of somebody taking a 401 or a 401 instead of a pension. There's all these people out there who are financially illiterate. You give them a big sum of money, lump sum of money, and worst case scenario, they take it out at age 52 and just buy a big truck with it, or they burn through it in the first three or four years of retirement. But I think you're probably financially literate enough, given you've already run these numbers, that you're not going to do that. So I don't think that risk exists for you. I don't think there's a behavioral reason that you should feel like you need to take a pension unless you really want one. Otherwise, I think you probably going to be better off taking that 401. A hope that helps. All right, let's talk about the Secure Act 2.0 we've talked about a number of times on this podcast. Let's do a question about it. Hey, Jim, thank you for all you do. I'm Bradley from South Georgia. I traditionally have contributed to my traditional 401k through my employer and maxed that out. But with the new Secure 2.0 changes contributing to a Roth 401K now, the employer match is also Roth money. Does that change our perspective during our peak earning years? And will that Roth match be untaxed money now and untaxed money in the future? Thank you, Jim. Okay, here's the deal with Secure Act 2.0. It made lots of huge changes. And if you've never heard about this, like I just got an email or saw it on the forum or something from someone who's been around a long time who like totally missed this news about Secure Act 2.0. This thing was passed right at the end of December last year. So if you were out of the country or something and you missed a bunch of white coat investor posts or whatever and you've never heard of Secure Act 2.0, you need to go back and do some review. And the best place to do that is just on the blog. Whitecoatinvestor.com Secure Act 2. O is the actual URL. If you search Secure Act 2.0 in our search bar, it'll come right up. I go through everything that changed with the Secure Act 2.0. One of those things, of course, is this 401 match. It basically gives employees, employers the opportunity to do the match in Roth dollars. Okay. So the employer can put the match now into the Roth sub account of the 401, and that's immediately. So even this year your employer could be doing this in a 401, 403, 457, it's all allowed. Whether your employer will actually do it is completely different question. Right. This is an option for the employer. So don't be surprised if you go talk to hr. They don't even know about this or that they haven't decided that the plan is going to allow it. So that's the first thing to check on. Is this even an option? If it is an option and they're willing to do either one, well, then you got to decide what you want. It may be that they aren't going to give you the option. And it's like anything else. When you don't have the option, you take what you have. Like most high earners have 401 at work and they can't do a traditional IRA. They can't get a deduction for that. So they do the backdoor Roth IRA. It's not an option. They just do backdoor Roth IRA. Other people have a 401 that doesn't allow for Roth contributions. Well, that's an easy decision. You just do the tax deferred contributions because it's your only option. Only when you have the option of doing both do you actually have to worry about that. Is this actually a big decision for you to make? So if it is, then you got to start thinking, because this is complicated. For most people in their peak earnings years, the rule of thumb is tax deferred. Any other year that's not your peak earnings year. The rule of thumb is Roth contributions matches everything, conversions, everything. But there's lots of exceptions to those general rules of thumb. One of those exceptions is if you're a super saver. If you're just going to be in a way higher tax bracket for whatever reason in retirement because you're going to have a huge military pension, or because you own 25 doors worth of rental properties, or just because you save gazillions of dollars every year, you may be better off doing Roth. Now, that's entirely possible even though you're in your peak earnings years. So keep that in mind. Hope that's helpful and answers your question. All right, next question is about a Solo 401. When you go take a real job with a real employer. Let's listen to that.

Hey, Dr. Dali, this is John from the Midwest. I recently left my independent contractor job where I had a Solo 401 and switched to a W2 job. My question is, what and when do I need to do something with my solo 401k? Can I just leave it there? Or do I have to shut it down and roll it over into my New Employee Sponsored 403?

Thanks for the advice. Okay, so here's the deal. You think of this as having left a 1099 job and gone to a W2 job. That's not the right way to conceptualize what you have done. What you have done is you happen to own a business. When you are getting paid on a 1099, you own a business. And maybe it's an LLC or a partnership or a corporation, but most of the time it's a sole proprietorship. But it's a business, okay? Last year you had a whole bunch of income in that business. This year you didn't have very much income because you spent all your time working this W2 job. But you're still in business. The business didn't go away. And because the business didn't go away, the Solo 401k doesn't have to go away. That retirement plan is tied to the business. So I presume you're like most people that have a solo or individual 401 and you like, probably has very low costs and has great investments that you've selected and probably has some cool options that you like about the 401 and you really don't want to get rid of it. You don't want to roll it into some crappy 403 at your new employer and pay some aum fee to some crappy advisor associated with it and have to invest in some high er, crappy fund inside the 403. And so you'd rather leave your money with the Solo 401. So why don't you just keep that business open and who knows, maybe later this year you'll do a few days that you get paid on a 1099 for, or next year you will, or the year after that. The IR does not specify that your business goes away after a certain number of years. It's a bit of a gray area. Now if you never have any more 1099 income ever again the whole rest of your life, maybe you ought to get rid of that solo 401 at some point. But the IRS is not going to come knocking going, hey, you didn't make any 1099 money this year. What are you going to do with that 401? They don't care, so just leave the Money in the 401. What you probably don't want to do if you're like most docs, is roll it out to an ira because that's going to screw up your pro rata calculation if you're doing a backdoor Roth IRA every year. The other nice thing about keeping a solo 401 is when you leave this W2 job, you can roll that 403 money in there and that's usually a pretty good option. Again, still preserves the opportunity to do a backdoor Roth ira. So yeah, hopefully that's helpful. There's no rush to do this. If you do decide to close the business and you do it in a year or two, that's fine, right? It's not like you just stop getting 1099s and you have to have the business closed in 30 days or something. There's no rule like that. Alright, for those of you who are still in medical school, we want to give you some cash. Cash money. This is what we call the WCI scholarship and it is one way in which we give back to the community by directly reducing their indebtedness from medical school. We call it the White Coat Investor Scholarship. It's competitive. Hundreds of people apply for it every year. You can apply as well. @whitecoatinvestor.com scholarship, applications will be accepted through the end of August. There's basically two categories you can apply in. The second one, the financial one, usually has fewer applications in it. So you may want to take a closer look at that as you apply. It may be a little bit less competitive than the inspiring story category, which is always very inspiring, but can be somewhat competitive. I haven't looked at the latest numbers, but typically the checks we're sending out to the 10 winners for this are in the six or $7,000 range. And it's just a check you get and you can use it for whatever you want. We did implement a new rule this year. If you're already on a full ride scholarship, you can't win anymore. All right, we want this to be spread around a little bit and not necessarily just go to those who are already coming through for free. But otherwise, it's the same scholarship we've been running for years and years and years. And the White Coat Investor staff, we are not the judges. The judges are you guys, the White Coat investors. And so if you'd like to be a judge, please apply. You can do that by emailing scholarshiphitecoatinvestor.com and just put volunteer judge in the title. You can't be a student, you can't be a resident, but otherwise, whatever profession you're in, or if you're a retiree, you can be a judge. So please apply. We need dozens of judges to read through these hundreds of applications and decide who's going to get the cash. All right, let's take a question about a backdoor Roth ira. We never hear very many of these. Actually, we do, but most of the time we're hearing them between January and April. So here we are in June with a backdoor Roth IRA question. So that's actually a little unusual.

Hey, white coat investor. My name is Stephanie and my question, like most, is regarding the backdoor Roth ira. I recently got married in November. Prior to getting married, my husband was eligible to make direct Roth IRA contributions because he was within the income limit. I, however, was not. So I was doing backdoor Roths. Now that we are married and filing joint, we combined or over the income limit to make direct contributions. So we will both be doing backdoor. My question is, do I make the 6,500 backdoor contribution for me in my account and he makes the 6,500 contribution for him in his account, or can I make a total of 13,000 in my account? 6,500 for me, 6,500 for him. What is the easiest way to do a backdoor Roth contribution? If you're doing one for yourself as well as your spouse. Thank you, and look forward to hearing from you soon. Bye.

Okay, the first thing I think you said it was last year that he did that and you got married last year. So this is 2022, and I might be reading too much into this, but I'm assuming you're filing jointly or you filed jointly for 2022. It usually saves some money if you file married. Filing jointly, maybe. Not in your case, if you're both working, but if you did, then he needs to recharacterize that contribution to a traditional IRA contribution. There's a time limit on that. So make sure you look into that and recharacterize his contribution, then reconvert it to a Roth. If you didn't do that, then don't worry about that going forward. What you need to understand is what IRA stands for. And what IRA stands for is Individual Retirement Arrangement. It's not account, despite what most people think. Individual Retirement Arrangement, and the key word there is individual. These are not joint accounts. It's not like a joint taxable investing account. It's not like a joint bank account. Retirement accounts are always individual. They only have one person's name on them. Even if you have a solo 401 with you and your spouse, you each have your own individual sub accounts within that 401. Just like multiple employees at a company have their own individual sub accounts. So what does that mean? That means you can't make the contribution for him into your account. Now, spousal IRAs mean that you can make contributions from your income to your spouse's ira, but you can't do it into your ira. You have to do it into their ira. And so I hope that clarifies that. Right now, the contribution limit for those under 50,000 is $6,500. So you would put $6,500 into your traditional IRA. You or he could put $6,500 into his traditional IRA, and then you would convert yours to your Roth IRA, and he would convert his to his Roth IRA. Hope that makes sense. All right, enough of your questions for today. You guys gotta send us some more if you want longer podcasts, and that's okay. I got a dentist appointment later today, so I gotta wrap up recordings sooner rather than later. I don't mind that we don't have a whole bunch more questions today, so this episode might be a little shorter than some. That's okay. I estimate that 80% of doctors need, want and should use a financial advisor and or an investment manager. Some investment gurus, such as Dr. William Bernstein, think my estimate is way too low. At any rate, if you want to use an advisor temporarily or for your entire life, there's no reason to feel guilty about it. Just make sure you're getting good advice at a fair price. If you need help updating your financial plan or just getting one in place, check out our list of recommended financial advisors@whitecoatinvestor.com financial advisors. You can do this and the White Coat Investor can Help Sounds like federal student loans are coming out of the 0% term coming up probably last day of August. So if you've got loans that are above what you can refinance them to and you're not going for pslf, you don't need the IDR program protections. It's time to refinance. So look into that. See if you can knock off a half point or 1% or 1.5% off your federal student loans and get a little better rate so a little more money goes toward principal and interest. Unfortunately, rates have gone up a lot in the last year. Those who refinanced a year ago that are planning to hold onto their loans for a while might be feeling pretty good about that. The rest of you can feel good about the fact that you got the whole 0% time period and the benefits of that. All right, thanks. For those of you leaving us a five star review telling your friends about the podcast, this one comes in from Hari Said. Five stars a must for any medical professional. I discovered the White Coat Investor for the fifth year of my training. Although it's been only four years since then, it's been life changing. Thanks for that kind review. Appreciate that. Don't Forget the scholarship WhiteCodeInvestor.com scholarship. You have to the end of August to apply. Otherwise keep your head up, shoulders back. You've got this. We can help. See you next time on the White Coat Investor Podcast.

The hosts of the White Coat Investor 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.