WCI #54: Asset Protection

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 podcast number 54, asset protection.

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Coat Investor can help. Welcome back to the podcast. It's been a couple of weeks since we recorded anything, so here we are sitting in the basement studio. Our new tech tax deduction, if you will. Since we got to take the home office deduction this year and record this, it's nice to be able to work in my old ratty sweatshirt. And it's nice to be back with you today. Our quote of the day today comes from Laura Vandercam who said smart women figure out what exactly makes them happiest. They spend generously on those things but cut out the rest. Obviously that applies to smart men as well. It's been a rough day today. It's the 17th of April when we're recording this, and not only is it tax day, but we also had the site go down this morning. It can be really frustrating running a business sometimes when you're not in charge of every aspect of it and you've had to outsource some things and those things go bad. But I guess that's part of the challenge is learning to overcome those things and keep everything running. Keeping all the balls in the air is actually one of the biggest challenges around here. Sometimes taxes were a lot more complicated for me this year. This is the first year that we've filed as an S corporation. I've done partnership returns the last couple of years and before that. You know, it seems like maybe doing a Schedule C as a sole proprietorship was difficult, but looking back, I can't imagine that I ever thought that was difficult compared to what we're doing now. But it's actually introduced a lot of additional complexity being an S corporation. I mailed seven different envelopes yesterday when I went to the post office to get all my Taxes filed between corporate returns and different state returns. Thanks to Physician on Fire, I got to learn all about a Minnesota tax return this year. But it's nice to have that all done and behind me. Well, that's not actually the case. I was just making a list this morning of all the different tax deadlines I have in the next year. And instead of once a year on April 15, it turns out now I get to do taxes or something to do with taxes. Either a payment or a return on January 15, January 31, March 15, March 31, April 15, April 30, June 15, June 30, July 15, July 31, September 15, October 15, October 31 and December 31. It's pretty unbelievable how much time you can spend complying with the tax code. Sometimes I was appalled to actually look on the corporate tax return, see how much time they expected was going to be taking filling out that return. You know, they estimate this for all the tax forms out there. You can turn to the last page on them and it'll tell you how much time it thinks it's going to take you to fill out that return. For the corporate tax return, it told me 240 hours. Unbelievable, right? 10 full 24 hour days, basically an entire month of work weeks in order to take care of that return, which is obviously much more than I actually spent on the return. And maybe that will come back to bite me in an audit. We'll find out. But at any rate, I got to learn lots about the tax code this year that I'm sure will be helpful when I eventually get around to doing a book on taxes. That is, if I can ever stop doing taxes long enough to do a book on taxes. I'm going to go through a bunch of questions we've been getting by email. Please continue to send us your questions by email, by Twitter, by Facebook, however you like to get in touch with us and we'll share them on the podcast. People are always asking me, please let me stay anonymous. And I think I keep just about everybody anonymous on these questions unless it's something that they've, they've asked me not to specifically, or if they put it out there into the public sphere already on Twitter or Facebook. But the first question I wanted to deal with comes from a doc who writes in and says, can you do a podcast on asset protection for physicians, especially their houses, taxable account, real estate, etc. And what physicians can do to better protect their assets? Well, asset protection is kind of a broad field and when I first started blogging back in 2011, I thought I was going to be doing lots of posts about asset protection. I thought it was this really important big part of personal finance for physicians. I mean, I thought it was going to be every sixth or seventh post. Then. Then I got into it and realized that there's not a lot for me to write about it. And that's because of two reasons. The first one is the best asset protection is typically quite simple and inexpensive. And the second is that complex asset protection is something that is almost never used. And I'll get into that a little bit more. But before you get to asset protection, you really have to look at risk management. The ideal, of course, is never to have that risk come up in the first place. And so risk management for a lot of people involves just not doing anything that could get you sued. In the case of a doctor, that means not practicing medicine, which obviously isn't an option for most of us. But there are other ways in which you can manage risk. You can avoid having a pool in your backyard or trampoline or a Rottweiler back there. You can avoid getting a boat or a SnowMobile or a four wheeler. All these things introduce risk to your life. Things like fixing the light bulbs that are burned out at your rental property, for instance, can help reduce your risk. But once you've already been sued, then you have to rely on the asset protection that you put in place. And obviously, you have to put that in place before you ever get sued or it doesn't do any good. But asset protection comes in various layers. The first layer, the first line of defense you have, is generally insurance. Now, for most doctors, when they're thinking about asset protection, they're thinking about the risk of being sued for malpractice. And the insurance that protects against that is malpractice insurance. And it's obviously very expensive. More expensive for neurosurgeons and obgyns than it is for family practitioners and dentists, but expensive for all of us, really. But the truth of the matter is the likelihood of you being sued above and beyond that insurance, incredibly low. That insurance covers not only your defense, but it also covers any payouts, whether they're settlements or whether there's something you have to pay out after you go to court and lose in court. That's what the insurance covers. But the truth of the matter is, most malpractice suits never get anywhere near a courtroom. They're either dismissed, or if the doctor realizes this isn't a great case, they're settled. And you never settle for more than policy limits, which is really the concern doctors have when it comes to asset protection. They're terrified that they're going to be sued for more than policy limits and actually lose their personal assets. That sort of scenario is incredibly rare. Perhaps one out of 10,000 is what I calculated out for a typical emergency physician, 1 in 10,000 per year is your chance of being sued successfully above your policy limits. The reason why is many fold. One, most time you win. Number two, when you don't win, you usually settle. And number three, when you do go to court and you lose, it's usually for less than policy limits. Even in those events where it's above policy limits, it's usually reduced to policy limits on appeal. It's so rare that doctors actually lose personal assets. They've actually examined some of these cases and seen these ones where doctors do lose personal assets. And surprisingly the average amount is a low six figure amount that they lose. It's not that they lose everything they've worked so hard to get. And so I thought that was pretty reassuring when you realize that this risk that we're all worried about really isn't as high as you might think it is. Now, of course, there are other risks besides just malpractice, and that's where your other liability insurance comes in. This is usually thought of as an umbrella policy, but the truth is you have some liability insurance and your homeowners or renters insurance, well as your auto insurance. In fact, the auto insurance is pretty important. About 80% of the suits that occur against personal liability conference policies are related to the use of an automobile. That's really your biggest risk is driving around or especially having your teenage kid driving around. And so you may want to raise those limits as well, even if you don't decide to stack an umbrella policy on top of it. But what I generally recommend is that you have umbrella or personal liability limits that are similar to what you have for your malpractice policy. It needs to be a seven figure amount, at least a million bucks. That's enough that someone can be paid and feel like they got paid well, and that will cover a robust defense for you. And so that's what I recommend you do is raise your home and your auto liability insurance up to perhaps $300,000 and stack an umbrella on top of that. Now people are always asking, well, how much umbrella insurance do I need? Well, the truth of the matter is you need enough. Whatever you're sued for, that's how much you need. And it's hard to predict that in advance, but it's almost surely a seven figure amount. I'd say a million at a minimum and perhaps as high as 5 million is about how much you need. The good news is it's way cheaper than malpractice insurance. For a few hundred dollars, you can get one or two or even $5 million in coverage a year. And so I recommend you do that. Now, once you get beyond the insurance, you're really getting into state specific law as far as what is protected and what is not protected. In most states, your retirement accounts are protected. Now what do I mean by protected? I mean, if you get sued above policy limits, you're that 1 in 10,000 doc that gets sued above policy limits. And they actually come after your personal assets and you have to declare bankruptcy. What do you get to keep? Well, in most states, you get to keep your retirement accounts. In many states you get to keep any life insurance cash value you might have, and you oftentimes get to keep some or all of your home equity. In some states like Texas and Florida, you get to keep, you know, pretty much all of your home equity. In other states, very little is protected. I think In Utah, it's 40 or $50,000 that's protected for a typical married couple. So if I was sued above policy limits and had to declare bankruptcy, I'd basically lose almost all of our home equity. But that's not the case in many states. You know, these laws are actually pretty interesting when you look at them, these homestead laws. A lot of times they include some chickens and some cattle and some rifles or a shotgun. You'd be surprised what gets protected in bankruptcy according to these laws. Oftentimes these laws haven't been rewritten for 100 years or more and they're often not indexed. The amounts are often not indexed to inflation. So. So that can be pretty interesting when you dive into those laws. Some other things that people do to protect their assets is that in some states you can title your house and even other property as tenants by the entirety. And what that means is that both you and your spouse own the entire property or the entire account. So if only one of you gets sued, they can't lose any of the assets in that account because they're entirely owned by the other person. And so if that's available in your state, you should use it to title as much as you can, certainly your house and probably your taxable investing account as well. Now, if you're into real estate investing, you've got a bunch of income properties you probably want to put those into limited liability companies. Now, LLC law is also state specific, so you got to see what remedies are available to people who want to sue your llc. But in a lot of states, they're limited just to a charging order, which means that when the LLC distributes income that they get their piece of it. You know, really your piece of it that now goes to them because they successfully sued you. But the fun thing about an LLC is you don't actually have to distribute the income, but despite not distributing the income, those who would have gotten the income are responsible for the taxes due on it. And so you can basically send this person that sued you a tax bill without actually sending them any income, as long as you don't take any income out of the llc. And so having that remedy available to you oftentimes will lead them to want to settle with you rather than take you to court in the event that something bad happens. And so you want to use LLCs and corporations in that sort of a manner to try to give yourself a little bit of additional protection if you own businesses such as rental properties above and beyond that, there's not a lot that you can do as far as protecting your taxable account. For instance, like this questioner asked, you know, you can start using some creative things like family limited partnerships and overseas trusts, but the more complex you get, the less likely it is to work. And the reason why is you have to be able to stand in front of a judge and give a good reason why you put this structure in place. And the good reason can't be asset protection. It has to either be business purposes or it has to be for estate planning purposes. And so if you don't have some other good reason to be using this structure and probably not going to last in court, and they're probably going to pull the money through on it, don't assume that there is some way that you can, you know, absolutely protect these assets. A lot of docs think in terms of am I protected or am I not protected? And it's really far more shades of gray than it is black and white like that. So asset protection is worth learning a little bit about. It's certainly worth knowing your state specific laws. It's definitely worth getting high insurance amounts put in place as well as doing the other things that are cheap and easy, like titling your properties and putting them inside LLCs. But for the most part, you know, this is something that docs worry about far more than they really should be. Okay, let's go on to another question here. This one is about the step transaction doctrine. This is a doc who is looking to do a backdoor Roth IRA for the first time. And he stumbled on my backdoor Roth IRA tutorial, which apparently I wrote in January of 2014. And he wanted to know, is that still accurate? Especially with regard to the step transaction doctrine? Is your perspective on not waiting to make the conversion still the same? Have there been any IRS specific rule changes or is the method the exact same? Are there any income limits that prevent anyone from doing the backdoor Roth conversion? This seems too easy. I've opened my traditional IRA account with Vanguard and deposited the 5500 into it via the Money Market Fund as you described. I'm prepared to then convert it into my existing Roth ira, but wanted to double check that nothing has changed in four years. Yeah, nothing's changed in four years. That's the bottom line. In fact, in early 2018, Congress has basically come out and blessed the backdoor Roth ira. And so I think it's very clear now that this is legal, that you don't have to wait a day in order to do, you know, you don't have to wait a year or a month or weeks between your contribution and your conversion step. I think it's very clear nobody is being prosecuted for doing this. And it is, you know, basically the law of the land right now until Congress changes the rules. For those not familiar with the step transaction doctrine, it's basically an IRS doctrine that says if the sum of two steps is not legal, you can't do it even if each of the individual steps is legal. And people have been worried for years that someone would apply this step transaction doctrine to the backdoor Roth ira, even though nobody has ever done it. And so, bottom line, you can still do a backdoor Roth ira. We do it every year. I broadcast it to the world. The IRS is very much aware that this is what I'm doing is I send them documentation every year now for what, nine years? They don't have a problem with it. And if you'd like to have some tax free income in retirement, I highly recommend you do a backdoor Roth IRA each year. There is a question. Are there any income limits that prevent anyone from doing the backdoor Roth conversion? No. And in fact, if you're worried that you're getting close to that direct Roth IRA contribution limit, just do it by the back door. Even people below that limit can do it by the back door. And so you might as well, if you're worried about that all right, next question. This is another question similar to the other one which asks if I kept money in the traditional IRA for a few months and now have a balance of 5503.23, do I move the entire amount to the Roth IRA and pay taxes on the 323 or do I move over 5500 and keep 323 in the traditional IRA? I actually wrote a whole post about this because I get this question all the time. I called the post pennies in the backdoor Roth ira. And this happens because the money earns interest while it's sitting in the traditional IRA before you convert it. So the longer you leave it there, the larger this amount can be. But. But the bottom line is when you go to convert it, just convert the whole thing. You might end up having to pay taxes on a dollar or two, but that's not going to be a big deal. More likely it'll be a few cents. And since you round those down on your tax forms, you'll actually get that growth for free. You got, you know, like mine's got 42 cents in it, I think, and that 42 cents isn't going to be taxed. Isn't that wonderful? But yeah, bottom line, people worry about these pennies too much. If you leave it in the traditional IRA and convert it next year, that's fine. If you convert it to a Roth IRA this year, that's fine too. It' deal. Just make sure you fill out Form 8606 properly according to whatever you did. Next question comes from someone who calls himself or herself a young and restless resident. I'm a pediatric resident about to wrap up my last year and will start a neonatology fellowship in July. I've been able to moonlight a lot lately and successfully paid off my student loans. That's really great. As a resident, I also fully invested into my 2017, 2018 Roth IRAs. I'm lucky in the sense that I have a no deductible health insurance near my current university also for my fellowship. But that means I can't open an HSA account. My current and next job offer a 403B with no match by the employer. Since I cannot open an HSA nor do a matched 401k. What should I do with any money I save during fellowship? Should I save it aside for a future house down payment? Should I contribute to the 403 even though it's not matched? Any other good options? I am single and without kids, thus no opportunity for spouse Roth IRAs or 529s, etc. There's nothing really I need right now and love to put the money to the best use possible. I actually get questions like these a lot. People are wondering, what should I do with my money? Well, what do you want to do with your money? You know, it really comes down to what your goals are. If your goal is to save for your kids, retire your kids college, then you ought to put it in a 529. If your goal is to save up a house down payment to pay for a house, well, you ought to, you know, start saving for your house down payment. If you can't think of anything else, you know, the usual default option is to save for retirement. And this sort of a scenario, that's probably the right thing to do as a resident or even as a fellow. If you have a Roth 403 option, that's probably the way to go. And that way you can contribute and get even more into a Roth account while you're still in a low tax bracket than just putting it into a Roth ira. If somehow you've already maxed out all your available retirement accounts, you can always invest more money into taxable. But the truth is, for most residents and most young attendings, you have so many competing needs for money that you can't fund them all. So you're going to have to make some decisions about whether you save for a down payment or whether you max out retirement accounts or whether you pay down student loans. And there's not always a right answer to these questions. So just do the best you can. Make sure you're putting a significant percentage of your money toward building wealth. And don't sweat the small stuff so much. Whether it's going toward paying down your student loans, whether it's going toward maxing out retirement accounts, those are both good things to do. So I wouldn't feel bad that you might make a mistake there. The mistake that most people make is they don't put enough money toward building wealth. Period. Not so much where that money actually goes. So don't sweat it too much. Another question, this one about public service loan forgiveness. If public service loan forgiveness goes away via policy changes or I opt out after residency, will I be left with a bigger problem than if I would have just started on a regular repayment plan July of my intern year? Because if I start a regular repayment plan, assuming I can make the monthly payments after residency, I'm seven years away from completion, at which point I can refinance and be done in under 5 like you recommend. Well, I mean this is just a classic student loan management question, right? First, decide whether you're going for public service loan forgiveness. If you're going for public service loan forgiveness, stay in the government programs. Usually that means the revised pay as you earn program because the government will subsidize your interest rate if you're in that program. There are a few exceptions, particularly if your spouse is a high earner in which you might be under the regular pay as you earn program and be filing your taxes married filing separately. If you're in that category, you probably need to get some professional advice as far as doing the right thing. But this question is more about if public service loan forgiveness goes away, am I hosed? Well, not really because typically you're going to be in the revised pay as you earn program anyway and that's usually going to offer you a better effective interest rate than what you can refinance to as a resident. And so you're really not hosed in that manner. Now, once you're an attending, you actually have enough money to be paying off these loans. What you want to be doing if you're going for public service loan forgiveness is saving money in a side account that would pay off those loans. That way, if something happens to public service loan forgiveness like the Obama proposal in 2013, that would limit it to just $57,000 of forgiveness, then you'll have that side fund and you can just take that side fund and use it to pay off the loans. Just like somebody who had refinanced their loans and was just pounding them out to be rid of them in two or three years after residency would have been doing. And you can do the same thing. So that's the way to usually deal with public service loan forgiveness is to keep that side effect, that side fund going that you can use in case legislative risk shows up. Alright, here's one about disability insurance. I wanted to pick your brain about disability insurance and saving for retirement. I've dutifully signed up for the most important insurances available to me while avoiding the trap of whole life. My insurance guy keeps telling me that disability insurance is not enough because if I become disabled then I will not be able to save enough for retirement while also paying the medical and day to day bills. How do you recommend saving for retirement and disability or insuring against that without waiver of premium whole life? Well, here's the deal. When you decide how much disability insurance you need, you need to include enough to pay for not only your lifestyle but also perhaps a little more expensive lifestyle if you're going to have a bunch of new medical bills and also enough to save for retirement, because most disability insurance only pays until you're 65 or 67. After that, if you haven't saved for retirement, you're going to be reliant wholly on Social Security, which isn't what most doctors envision as a comfortable retirement. And so you need to take out a little bit more than just enough to pay for your lifestyle. That disability insurance benefit needs to be large enough to pay for all your expenses plus retirement savings. And that's really the way I would do it, rather than buying some additional insurance product. Now, some disability insurance policies come with an additional benefit to save for retirement. It's usually a rider that you pay extra for. But I think in general this is a bad idea. I'd rather see you use your money to just buy a bigger benefit in the first place. And certainly I don't see a need to be messing around with things like waiver of premium whole life insurance in order to cover this need. The insurance you need is disability insurance. Just buy enough of it to meet your needs. Here's another whole life question. My parents got me life insurance as a child and they still pay on it to this day. How do I sell it? I'm 35 years old, no kids, and I smoke. Well, none of that has anything to do with whether you can sell it or not. There are a few things you can do with a life insurance policy that you don't want. The easiest is just to surrender it and walk away. Now, if it's a term policy, you just walk away. You don't get anything. It doesn't cost you anything. If it's a cash value policy, there's usually some cash value in there that you can walk away with, and the insurance company can tell you what the surrender value is. So if you call them up and say, hey, I'd like to surrender this policy, how much money do I get? They'll tell you how much money it is. And that's one option. You can just surrender the policy and walk away. If you're elderly, particularly in bad health, a lot of times you can sell the policy for more than that cash value. There are investors who go around buying these things. They're called biadical settlements, and they'll give you more money than the insurance company will because they think it's a good bet to keep that policy in force. So basically then they pay the premiums and when you die, they get the payout. So that's another option. But it's probably not an option for this doc. In this case, that's 35 years old. Chances are if your parents bought you a whole life insurance policy on you when you were a kid, it's not a very good policy. You know, if you're buying your insurance from the same people that are selling you baby food, you're probably making a mistake. But most of these policies are pretty common policies. But this is something you want to be a little bit careful with, right? Your parents were trying to help you out, they were trying to do the good thing. And they've been paying on this thing now, in this case for 35 years. And so I think the most important thing is to say, hey, mom and dad, thanks. You know, you've given me a nice gift. You know, I think I probably have a better use for it now than leaving it in place as a whole life insurance policy. But it's totally reasonable to cash that out and put it toward paying off your student loans or maxing out retirement accounts, etc. Now, if you thought this might be a good policy worth holding onto, that the returns going forward would be acceptable to you, then you'd have to do the typical thing of running your numbers and seeing what the return going forward on the policy is going to be. With most whole life policies, the first few years are the terrible return years and then they start getting better. But those years are water under the bridge. If you've already had this thing for 10 or 20 or 30 years, it might be perfectly reasonable to keep a policy after a decade that you never should have bought in the first place. And so if you're in one of those situations, run the numbers. But chances are, if this is something your parents bought for you 35 years ago, it's a tiny little policy, it's got terrible returns, and you really should be using the money for something else. Just thank your parents and move on and use whatever you can cash it out for, usually a few thousand dollars to pay off your student loans or something. Okay, here's another question. This one was a little bit off the wall. I'm wondering what you think of the emerging marijuana market. Medicinal and recreational. That's it. That was the whole email. I wasn't really sure what this person was asking. I guess I could start with my opinion about medicinal marijuana. I think it's all a bunch of bunk, right? I'm all for more study there. I think it's great to study things that might help people I'm not even really totally against recreational marijuana, but calling it medical is really misleading. I mean, this isn't medical. I think if it's medical, you got to go, well, what are the medication interactions? What is the dosage, what are the side effects? And Exactly. Nobody really knows that stuff. And so calling it medicinal marijuana is really just kind of the backdoor route into making it legal in a state. State. You know, I think taking some of the compounds out and using them for, you know, seizures and that sort of thing is great. But let's study it and let's figure out what the dosages are and let's figure out what the safety concerns are like any other medication, rather than just saying, you know, marijuana is awesome. But I'm not sure that that's what this doc was asking. I think he was probably asking more about investing in marijuana stocks. When it comes to buying individual stocks or sectors, I pretty much just buy all the publicly traded stocks by using index funds. I don't buy individual stocks. I don't buy narrowly focused funds. Maybe the doc was asking about opening a small business selling marijuana. I live in Utah, so that's not really an option. It's pretty much illegal here. It's not going to be legal anytime soon. I think I'd probably have an ethical issue selling it myself. But if that's something you want to open and have an individual business, you can go ahead and do that. You know, it's like any small business, though. There's a lot of risk to it, and you need to evaluate every deal individually because they're each an individual deal. Some are less risky than others, and you've got to know enough to analyze that and know enough about business to run it well. Okay, another question here comes from a couple of residents. My wife and I were both residents. She in her final year. I'm an intern. We were recently told by a financial advisor about this new way of life insurance called cash flow flow banking. I've not read anything about it on your blog or have not heard you mention it in the podcast. They sell it as a way of savings account that will be tax free in the future when you take the money out. My question is, do you know anything about this financial tool? Any experiences or recommendations? Yeah, I've got a lot of experiences with it. This is whole life insurance. It's whole life insurance by another name. Why do they call it cash flow banking? Because you probably already know to avoid whole life insurance, but you don't know to avoid cash flow banking. But it's the same stuff sometimes this goes under the name of Infinite Banking or Bank on Yourself. I've got a whole post on the blog called A Twist on Whole Life Insurance. But basically the idea here is you buy a cash value, usually a whole life insurance policy. You overfund it in the beginning and then after four or five years hopefully it breaks even by then. If you've designed it well, you can start borrowing against it now, like borrowing against your house or borrowing against your portfolio. You can borrow tax free. And so technically, yes, that is tax free. You can get the use of the money, but if you actually want to close it out, you know, like anything, any gains you have, you're going to have to pay taxes on the gains. And they're not even long term rates. They are the ordinary income tax rates that you have to pay on that. So I don't think it's the craziest thing to do if you really understand it and you buy a policy that's designed specifically to do that. But I don't do it in my life and I generally recommend against whole life insurance. I think most of the people that are being that this is being pushed on are just meeting with somebody that they've mistaken for a financial advisor that is really a commission salesman and just trying to get a commission on whole life insurance from them.

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Coat investor can help. Head up, shoulders back. You've got this and we can help. Come by and make sure you connect with us on Twitter and Facebook. Come by the forum and sign up if you have complicated questions and you'd be surprised how much help you can get there. See you next time. Sam.