WCI #4: The Stealth IRA: A Health Savings Account May Be Your Best Retirement Plan

This is the White Coat Investor Podcast where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high income professionals stop doing dumb things with their money since 2011. Here's your host, Dr. Jim Dahli. Welcome to White Coat Investor Podcast 4.

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Thanks for all the wonderful feedback we've been getting about the podcast and thanks for continuing to send us your questions. We also appreciate it if you've given us a great rating so that we can share this message with others. Remember, I'm not a financial advisor, an attorney or an insurance agent and so any information you get on here should be considered entertainment and informational only. Be sure to double check anything before you implement it in your own portfolio with the source that you consider reliable. Thank you again for what you do in your profession and for spreading our message. I know what you do in your day to day work is not easy and many of you listening to this are on your way into a difficult day or a difficult shift or on your way home from one. And we appreciate you sharing a little bit of time with us. Today. We're going to talk a little bit about Health Savings Accounts. I love Health Savings accounts. I think they're awesome. It's the first account I fund every January just because it is a triple tax free account. We what do I mean by that? Well, when you put the money in you get a tax deduction for the entire contribution. That's money that you are not taxed on either your federal or in most states on your state income taxes. As the money grows in the account it is not taxed, the dividends it pays out or the capital gains distributions the investment may have are not taxed and so it grows in tax protected manner when you pull the money out as long as you spend it on Health care. It also comes out totally tax free. This makes it a better account than all your tax deferred accounts like 401ks and better than your tax free accounts like Roth IRAs. It's your only triple tax free account. And so it is really a great account to use if you have access to one. I like to call it the Stealth ira. And the reason for that is if you get to be age 65 and you still have money in the account, you can actually pull it out without having to pay any penalty on it and spend it on anything you want. Even if it isn't health care. You, you do have to pay taxes on it in that situation, but that's really no different from any of your tax deferred accounts. A 401k, you got to pay taxes on it when you pull the money out. And that's just like an hsa. And so it functions as an extra retirement account for a lot of people. But the best use for it is to use it to spend on health care because then it's triple tax free. So how much can you put into an HSA? Well, if you're single for 2017, you can put in $3,400. And if you're married or basically if you're a family, so even if you're a single parent, you can put in $6,750 a year. If you're over 55, they even let you do a catch up contribution of another thousand dollars on top of those amounts. However, before you use an hsa, you want to make sure that the required high deductible health plan is actually the right health plan for you. It may make sense for you to use a different health plan, especially if your employer is subsidizing it. But if you're a heavy user of healthcare, it's quite possible you'd be better off with a plan that is not a high deductible health plan, which is required for you to be able to use an hsa. Be sure when you're making those calculations that you also weigh in the tax consequences. For example, I spoke with somebody the other day who was looking into some of these Christian health sharing ministries, which seem like a great deal when you look at the equivalent of the premiums. But you got to remember that the, the shares that you send to this Christian health ministry organization are not tax deductible like your health insurance premiums probably are. And so you need to adjust those for your tax bracket and also include the tax benefits of funding an hsa. When you put all that together, you may be better off still with a high deductible health plan just because your marginal tax rate is so high. Another cool benefit of a health savings account is you don't have to pull the money out of the account in the same year that you spend it on healthcare. If you hold onto the receipt, you can pull that money out in a year or two or five or 30 years and still have it come out totally tax and penalty free. Remember, that Penalty is about 20% of what you pull out to spend on something besides health care before age 65. So that's really not a penalty you want to ever pay. But if you have receipts for the amount, you can pull it out. And that allows you to do a few things first, you're allowed to invest it aggressively, right? Because even if you want to spend money on health care in the middle of a big bad bear market, as long as you have money elsewhere, like your emergency fund, you can let that money sit in the investment inside the HSA until the market recovers, and then pull it out and reimburse yourself for what you spent on health care. But this also allows for many different ways to spend your HSA wisely. There's bad ways to spend it and good ways to spend it. Probably the worst way to spend your HSA is to pull it out prior to age 65 and spend it on something besides health care. And the reason for that is not only do you have to pay the taxes on it, but you got to pay that 20% penalty. The next best way to spend it is to pull it out after age 65 and spend it on something besides health care. And that requires you to pay the taxes on it, but not the penalty. Once you get behind that, we're talking about mostly good ways to spend it. One great way to spend your HSA money is for health care in retirement, because that allows you to have your money compound for 20, 30, 40 years before you actually pull it out out. And that tax free compounding is worth a lot. So the later in life you can spend this money from your HSA the better, but you don't really want to leave it to your heirs. It's not a great account to inherit because basically the year you die is the year they get the money and it's all taxable to them in that year. And so while it's always nice to inherit money, that's really an account that you want to spend during your lifetime. So there's two other ways to spend your HSA money. One is to spend it as you go along. And that means you take the money out every time you have a health care expense and use it to pay the health care provider for that expense. And this is the way the original drafters of the law envisioned it being used, that you would use it that way and then just carry over anything you didn't spend to the next year. But in reality, what a lot of people are doing just because the way the law is written, is they're saving receipts and plan to pull the money out later totally tax free and after allowing it to compound for a decade or two. And it can be difficult choosing between these last two options, whether to spend it as you go or to save the receipts. You have to weigh a number of things. First, do you have cash elsewhere to pay for your health care as you go along? If you don't, you really don't have an option. You need to spend the HSA as you go. Second, those receipts are not adjusted for inflation. So maybe you spend five grand on an appendectomy this year and want to pull that same five grand out in 30 years. Well, if you had pulled the money out this year and invested it in a taxable account, you know, it would continue to compound. Whereas if you leave it inside the HSA, you still only get to pull out 5,000 bucks. You don't get to pull out what that would have grown to in another account. And so you have to weigh those things together. For some people it makes sense to save the receipts and pull it out later. Even though that can be a big hassle for other people, including me, it probably makes sense to spend as you go. And the reason why is I'm afraid I'll end up at the end of my life with a big huge hsa because we don't spend a lot on health care. And I'm putting a lot in that account every year and investing it aggressively. If I left it all to compound over the next 30 years, it wouldn't be unreasonable for me to have a half million bucks in that hsa. And the likelihood of me being able to figure out how to spend all that on health care and retirement doesn't seem that high. So several good ways to spend it. The best way is to spend it on health care and retirement. It's also a good idea to spend it on health care as you go along or to do the saving receipts strategy. Of course, bear in mind that strategy could be changed by future laws that Congress might get. Alright, let's go into a few questions I've been getting. This one comes from an anesthesiologist married to an orthopedist. She says. I'm 34, been practicing anesthesia for three years. I read your book when I first got done and I followed your advice. Thank goodness it was out there. My issue is I am a busy mom and doctor and I'm married to an orthopedic surgeon who is not interested in anything financial. Luckily, I'm in charge of the money and I actively save, pay off debts, look for ways to reduce our taxable income and I actually find it fun. However, I'm having a hard time deciding who to go with in regards to a financial planner and I desperately need help now that we have some extra dollars coming in. I've discussed using an advisor with a flat fee structure, but my husband feels that using a percentage based advisor provides more motivation for him or her to make money for us and them in return. Can you dispute that logic? I also wonder if the services provided with a fee only advisor would be enough. That is I need more help than what their fee would get me. The idea of having someone local is also not very appealing to me, although I know it can be done. I have a tie with an advisor through Edward Jones, rolled over a 401k through him and he did a family member's investing, but I am leery of using him. After reading the book and when I asked about doing a backdoor Roth he told me that was not possible so that was confusing. I tried to read about their fee structure but it's confusing. We also have ties to a small firm Advisor who is married to a physician friend, but my husband was told only to use someone with ties to a large company like Goldman Sachs. After receiving so many different opinions I just feel stuck and unsure where to go with our hard earned dollars. I manage our entire household, work three days a week and have a 2.5 and an eight month old 2.5 year old and an eight month old. I don't have a lot of time to be researching investments even though I find financial planning enjoyable, but I don't want to give our money away. I know you're very busy, but any advice you could provide would be greatly appreciated. This isn't unusual. This is similar to many, many emails I get all the time and in fact this is part of the reason. I put together a list of recommended financial advisors on the website that you can find under the recommendations tab. There's a lot of questions built into this email. For example there's this discussion of whether a flat fee structure doesn't give an advisor the proper incentive to try to outperform with your portfolio. Well, I think that's a bunch of bunk because what you're really looking for with investment management is not to outperform the market. The goal is to get market returns to the lowest possible cost. And the lowest possible cost advisor is usually a flat fee advisor. Maybe not in the beginning, but as your assets grow, that asset under management fee grows right along with it. For example, when you got a $500,000 portfolio, a 1% fee might only be five grand a year. But as that grows to a million, that fee doubles. At 2 million, it's $20,000 a year. At 3 million is $30,000 a year. And after a while, that can really have a dramatic effect on how quickly your portfolio grows. Especially the size of a portfolio I would expect an anesthesiologist and an orthopedist to acquire. So I certain flat fee structure is bad. Problem is, there aren't very many people out there that offer a flat fee structure. And so you're really limited to just a handful of firms that will do either a financial plan for you on a flat fee or that will do investment management on a flat fee for you. But I certainly think it's worth taking a look at each of those firms and seeing if they seem to mesh well with you and your style. I do think that the services provided with a fee only advisor would be enough. I the opposite of a fee only advisor, of course, is a commission salesman. And I don't think you're getting any additional service out of a commission salesman. But a flat fee advisor, I think is enough. You may have to pay a larger another fee if you need a different service that they're not offering you. For example, if they're not doing, you know, tax preparation, you're gonna have to go pay a fee to somebody else to do that. But I don't think most investment advisors working under an asset under management fee are gonna do that for you anyway. They're gonna refer you elsewhere. You mention an advisor you have with Edward Jones. Edward Jones is a firm of commissioned salesmen. They basically sell mutual funds. And so these are loaded funds that have, you know, an extra fee built in to pay the advisor. And the problem is the worst funds tend to have the highest fees. And so the commission salesman advisor have this built in conflict of interest where they're constantly incentivized to do the wrong thing for you. So I don't think going to Edward Jones to get financial advice is a good idea at all. I mean, a lot of these guys are cold calling and going around knocking on doors trying to get more business. And that's really not the kind of person you want for a financial advisor. If they're so young in their career that they have time to spend doing that to try to get new clients, that's probably not the person you want. However, you mentioned a small firm advisor versus a large company like Goldman Sachs. And at the same time, even at large companies, many of their advisors are also structured as commission salesmen. And so I'm not terribly sold on some benefit from going to a large company. I think a small boutique shop a lot of times provides the best advice. Certainly there are more important things in whether their company is large or small. And I would look at how they're paid, how much they're paid and what kind of advice they're providing rather than just the name on the front door. I certainly don't think you're getting some huge benefit by going with a well known Wall street bank financial advisor. However, I want to give you a lot of encouragement. You're doing a lot of things right, you're reading books, you're trying to learn as much as you can and you're just very busy as you interact with a financial advisor, it would be best if you use them to teach you rather than to just do it for you. You seem like the person that after a while might want to move on to just doing it yourself. Alright, one more question. This one comes from an emergency doc in Texas. For tax year 2015, I was an employee at corporate emergency medicine firm that will remain unnamed but with whom I'm not very happy. With only W2 earnings, they had limited benefits for their full time employees. So I went through the ACA Healthcare Marketplace for my own health insurance and already had my own disability insurance policies all paid with after tax dollars. Can I use these premium payments I made as deductions? Can I use my $3350 HSA and $5000 backdoor IRA contributions in some way to my advantage? I maxed out everything on my pension plan. 34,500 and 401k 17,500. But seems like I still owe more money to uncle sam on my 1040. I'm looking to see if there's anything else I can do to mitigate having to pay out any more taxes than I already do. I am single, have no dependents, rent an apartment in the 33% tax bracket. No independent contractor work in 2015. All loans paid off from school. I appreciate your time and advice. Well, this guy's in a terrible tax situation. Aside from the fact that he's in Texas and doesn't have any state income tax from Texas, he's got a lot of things working against him that make his tax bill higher. When you're single, you pay more in taxes. When you're married, you get a more advantageous tax bracket system. Of course, there's also a marriage penalty if you're both high earners. But if you're single, if you're married to somebody that earns much less than you do or nothing at all, that's a huge tax advantage in many brackets that physicians are in. Having dependents also lowers your taxes. But as you move into some of the higher paid specialties, that actually phases out. My kids aren't worth a thing to me, to be honest, when it comes to my taxes. Renting an apartment obviously means you're not getting a mortgage interest tax deduction. Now, paying a dollar in interest to get 33 cents in deductions isn't terribly useful. Or rather to get 33 cents off your taxes is not a terribly smart way to get rich. But there's no doubt if you want a home anyway, that you might as well take that tax break. The goal is, of course, to have more money after tax, not just to pay the lowest possible taxes. Again, he mentions he's not an independent contractor. It's always nice to have a little bit of 1099 income, and that's because you can use that to open an individual 401K. And the individual 401K allows you to shelter even more money than your employer's plan allows you to do. And so it might be wise to do a little bit of moonlighting or somehow figure out a way to get some 1099 income. So you can also open a individual 401k, but if you're not making much on the side, you're not gonna be able to put a lot in there anyway. This doc is doing a pretty great job. He's maxing out his HSA, he's maxing out his 401k profit sharing plan. That's. Those are really his best tax deductions out there. The backdoor Roth IRA contributions are also a smart thing to do, but there's no upfront tax break for that. So that doesn't lower your taxes this year. It will lower your taxes later though. So it sounds like this doc that's an employee in Texas is doing pretty darn well on his taxes about as well as he can. But for him to do any better, he's going to have to make some significant lifestyle changes which may or may not be worth it to him. Alright, our quote of the day comes from Charlie Ellis, who says the hardest work is not figuring out the optimal investment policy. It's sustaining a long term focus, particularly at market highs or market lows, and staying committed to your optimal investment policy.

Still not sure what to do with your student loans? Overwhelmed with how to tackle that giant debt in an ever changing political climate, the experts@studentloanadvice.com are here to help guide you through the best options to manage your loans. Our experienced staff have consulted on over $250 million in student loan debt and the averagestudentloanadvice.com client has saved over $190,000. You will receive a customized student loan plan using the principles of the White Coat Investor. Get answers to all of your student loan questions, gain clarity about your financial future future and start down the right path toward financial freedom. Book a consult today@studentloanadvice.com you can do this and the White Coat Investor can help.

Thanks for listening and we'll see you next time.