Get Rich Fast as a Millionaire with Roth Conversions

INTRODUCTION

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 417 – Get Rich Fast As a Millionaire With Roth Conversions brought to you by Laurel Road for Doctors.

Laurel Road is committed to serving the unique financial needs of residents and doctors. We want to help make your money work harder and smarter. If credit card debt is weighing you down and you're struggling with monthly payments, a personal loan designed for residents with special repayment terms during training could help you consolidate your debt. Check if you qualify for a lower rate. Plus, White Coat Investors also get an additional rate discount when they apply through laurelroad.com/wci.

For terms and conditions, please visit www.laurelroad.com/wci. Laurel Road is a brand of KeyBank N.A. Member FDIC.

All right, how do you like that clickbaity title? I'm being told that if we title these podcasts differently, a different number of people listen to them. The key is apparently to put “Get Rich”, “Millionaire” and something about Roth in the title, and then you all listen to the podcast. I can't explain this, but this is the way it works. And so, we're going to talk about some of that stuff today. I figured it was fair enough to put it all into the title. And now you know how the online financial, whatever business we're in, functions.

Thanks everybody out there for what you're doing. I know you're not all online infopreneurs like we are. You're actually doing important work where it makes a difference in people's lives. And I thank you for that. Sometimes we don't acknowledge as much as we should just how difficult your jobs are. And I appreciate you doing that.

By the way, we have got a promotion going right now on our online courses. This podcast drops May 1st, I'm told. This promotion goes through May 9th. So you got about nine days if you listen to this the day it drops.

If you go to whitecoatinvestor.com/courses, you'll see that we have 20% off everything. That's all of our online courses. That makes our new Fire Your Financial Advisor student course just $79. People have asked for years, “We need cheaper courses.”

Well, here's as cheap as we can make a course and have this thing. I don't even know if it pencils out. We're probably losing money on this course. But it's designed for students. It's Fire Your Financial Advisor designed for students. You can upgrade to the resident version. You get credit for what you paid for the student version. You can upgrade to the attending version later.

You can even upgrade to the CME version. That CME version is called Financial Wellness and Burnout Prevention for Medical Professionals. It's our full attending version, Fire Your Financial Advisor, plus eight hours of wellness content. It's great content, even by itself, but it makes the entire thing qualify for CME. So, you can use your CME funds to buy that. Well, it's 20% off through May 9.

The return on investment of these courses, if you don't know the stuff we're teaching in this, and you could spend a lot of hours trying to learn it yourself, reading blog posts and listening to podcasts and reading books, or we will spoon feed it to you in these courses, having taken all the high yield stuff, put it all together in one place and given it to you all at once.

There's serious return on investment for these courses, whether it's our No Hype Real Estate Investing course, whether it is our Fire Your Financial Advisor course, whether it's our Continuing Financial Education 2025 course, the one we make from the conference each year.

You don't have to learn much from these more than pay for the price of the course, especially when we're giving it to you 20% off. So check that out, whitecoatinvestor.com/courses. It’s 20% off through May 9.

GET YOUR DISABILITY INSURANCE IN PLACE

I got an email from one of the people we work with for insurance. We have these agents that we have worked with for a long time that help a lot of White Coat Investors to get their term life and disability insurance in place. These are the experts in the industry. They sell together more policies than anybody else in the industry. They know these things inside and out.

We work with them to make sure they're serving you guys as best they can, that they're not hawking you a bunch of whole life policies or anything you don't need. But every now and then I get some feedback from them. One of them sent me an email recently, and said he helped implement a disability insurance policy for a resident that had resisted at first to go through with the application, but ultimately agreed getting the policy would be in the doc's best interest.

Wednesday, the doc called this person back. This is about three months after getting disability insurance. This is a resident, I think early 30s, to say he's going in for surgery on Friday. Turned out he had been diagnosed with cancer and was hoping it would all resolve itself within six months, but he was going to have to make a disability insurance claim.

The point of the email that was being sent was that nobody thinks this is going to happen to them. Nobody thinks they can get disabled. We all think we're Superman, but look around. You're taking care of lots of people in their 20s and 30s and 40s that get disabled. Whether it's from a cancer diagnosis or whether it's falling off the Grand Teton, it does happen. And imagine how grateful you would be to have that disability insurance in place, especially early in your career, before you have any sort of a significant nest egg, especially if you've got to live off it long-term.

Now, hopefully this doc's only living off of it for a few months while doing surgery and chemotherapy, et cetera. But it could become a long-term disability. And it's good to get that coverage in place when you're young and healthy and it's cheap and you can still get it. Because once you have a diagnosis like this, it's much, much harder to get disability insurance in place.

The agent wrote to me, “I'm so passionate about what I do every day, and this just makes it so evident that our work together is so valuable. As always, I'm really grateful for our partnership, which allows me to help as many physicians as possible.” So, yeah, get your disability insurance in place.

INTRODUCTION AND CHARACTERISTICS OF ENGINEERS AS INVESTORS

Okay, we've got Chris Davin here today. This is a Friends of WCI episode, which I love doing because I get somebody else to bat around with and to argue with and to help answer your questions with. Chris Davin, I'll introduce him a little more in just a second when I get him on the call.

But Chris was a speaker at WCICON25 as well as a previous one. If you want to be a speaker at WCICON, first of all, let me tell you, you don't have to know as much as Chris to be a speaker. Chris really knows his stuff, as you're going to realize as we get into this podcast.

But we're calling for speakers now. This is for WCICON26. It's in Las Vegas at mid-March next year. We're taking applications from now until June 15. You apply at wcievents.com. If you really want to speak, here's the secret. Put in for more than one talk. If it's only one talk, and we already got somebody giving that talk, or we don't want that talk, or we think somebody had given the talk better than you, we're not picking you. But if you give us choices, two, three, four different talks, you have a better chance of being selected as a speaker.

It is a competitive process. About 80% of applicants don't get selected. And I'm sorry about that. I wish I could have all of you come speak at WCICON. But it's just there's limited space, there's limited time. We want to change it up a little bit every year but we also want to get the really top notch, best rated people back from time to time as well. But please do apply and we'll take a very serious look at your application.

I had somebody that I had on the podcast not long ago, he's like, “I've applied five years in a row and still haven't been selected.” And it's true. Sometimes you don't get selected for a while. But we hope to get you there eventually, especially if you're a great speaker with a great topic that we want to get out to White Coat Investors at WCICON.

Okay, let's get Chris on the line. This is a long episode already. But I think we go into so much good stuff, you're going to love it. I apologize in advance if we spend too much time on this episode out in the weeds. But I think we spent enough time on basic stuff too that will be beneficial to everybody.

All right, this is another one of our Friends of WCI episodes. And we've got somebody here to help me to explain things to you, to help me answer your questions. We have Chris Davin, Chris, welcome back to the podcast.

Chris Davin:
Thank you very much.

Dr. Jim Dahle:
For those who don't know, Chris, Chris has been a WCICON speaker a couple of times. He's been on the podcast before. What number was that one Megan? 359 I think it was, about a year ago, talked about gotten to all kinds of fun stuff in the weeds, talked about Roth versus traditional contributions. We'll reference a little bit of that stuff today.

But what you need to know about Chris is that Chris is not a doc. He's married to a doc, yes, but he's not a doc. He is an engineer, which comes with its entirely different set of strengths and weaknesses. Docs, we probably deserve our terrible reputation as do-it-yourself investors.

That's probably not the case for engineers. And the reason why is investing is actually an engineering problem. That's what it is, you're trying to optimize it to be good enough. Not perfect, necessarily, but good enough.

And so, the engineering mindset lends itself really well, I think not only to just being a competent investor, but in particular, being a competent do-it-yourself investor. Engineers are almost always very comfortable with spreadsheets. And frankly, if you're not comfortable with spreadsheets, maybe you shouldn't be managing your own money, at least the very basics of a spreadsheet. I'm not talking about designing some fancy high powered one. I'm just talking about a little bit of financial calculations in the spreadsheets, basic multiplication and addition, and keeping columns straight, and those sorts of things. I think it's pretty important to portfolio management.

Chris, what do you see as the weaknesses of being an engineer when it comes to personal finance and investing?

Chris Davin:
Oh, geez. You're really putting me on the spot. Yeah, sometimes I think you can make better the enemy of good enough. I think that is possible. I will say in engineering when we're solving engineering problems, that's a tendency that we have to fight as well. I see that all the time people are building hardware, and they want to keep testing it and testing it. Not everybody, typically, younger engineers have that I think, as you get older, you tend to, over time, learn when the times you really need to test the heck out of something and when it's okay to just kind of let it go out the door.

But I think that's certainly a risk. Maybe something else I would say is along the same lines is like getting hung up on doing things that may not have the biggest impact overall on the portfolio. For instance, if it's rebalancing on a really strict schedule. Maybe that would be example, or maybe having too many asset classes in your portfolio, having a small value and having a small growth and having a Europe international, have an Asian international, have an emerging markets and have 2.5% of this class and 5% of that class. It can kind of get a little bit too complicated.

I think that in general, for everybody too, not just engineers, there is a tendency to kind of tinker and make things more complex over time. If you have three asset classes, and you add a fourth and you add a fifth, and then once you've handled that, then you come back in a month, and you're like, “Well, geez what do I want to do now? I'm going to add a sixth one.” I think there is definitely that tendency as well.

Dr. Jim Dahle:
And all of a sudden, you're up to 13. And clearly, you've made it overly complex. Yeah, for sure. That's what I'd say. Engineers tend to like to get out into the weeds tend to get into the details, maybe a little too much. Fair warning for this episode, we're going into the weeds today. We'll try to pull it back every now and then. If this is your first White Coat Investor podcast episode you've ever listened to, recognize that not all of them go this deep into the weeds. And so, I'll try to at least make you understand where we're at when we leave the pathway to go talk about what's off in the weeds.

And keep in mind that the basics remain the same. You need to save a reasonable amount of money, fund a reasonable plan reasonably well, and you just stick with it in the long term. Those are the basics. But if all we ever talked about was the basics “Don't carry 30% credit card debt”, there wouldn't be much to talk about on this podcast. So we're going to get a little bit out into the weeds today.

INCORPORATING, S CORPS, AND BUSINESS STRUCTURE CONSIDERATIONS

Chris did an awesome presentation at our last WCICON. This is available by the way, in our Continuing Financial Education 2025 class. That was spectacular. Covered all the details you need to know about business taxes. If you've thought about being a sole proprietor, you're thinking about an S Corp, those sorts of issues. This presentation is excellent, highly recommend it.

In that presentation, you referenced a little bit of rule of thumb I've thrown out there from time to time, which is that if a doc doesn't have at least $100,000 in distributions, as an S Corp. Money, profit from your S Corp above and beyond what you're paying yourself as a salary is probably not worth the hassle of incorporating. And you thought maybe even that figure was a little bit too low, especially once you consider the 199A deduction. Share your thoughts with us about incorporating, why it gets so overblown, oversold, and maybe how people ought to be thinking about it.

Chris Davin:
Yeah, I will throw some numbers at you in a minute. But as part of my own decision making for my own financial life and for my family's, and then also in sort of preparing the talk, I did some research on incorporating. And if you go online, there's a lot of places where they really strongly recommend incorporating, like it's this great thing there's a lot of kind of really vague kind of hand wavy references to tax savings without really being too specific about what it is.

I think there's maybe kind of the implication that some of the income would be income tax free, which is not true. All the income from your incorporation is ultimately taxable as income. The only potential tax savings is that any distributions that you take are payroll tax free, which probably for most doctors, if you're above the social security wage base, you're only talking about 2.9% or 3.8% savings. Again, for your $100,000 distribution, that's about maybe $3,800, which is not nothing. But there's a whole bunch of other costs that sort of outweigh that.

I don't know, I found a lot of places where people would say things like, “Oh, when you're incorporated, it just makes your business sound so official. You can be so and so, INC. And people respect that, and they're going to do more business.”

If you're an emergency doctor, nobody cares whether you're incorporated or not. People don't care about your tax structure at all. This is just really an issue. So you should pick the option that will A) save you most overall taxes, including the payroll taxes and a couple of other things I'm about to mention. And then there is value in simplicity. Not having to do a balance sheet, not having to deal with payroll. There's some real value in having things be kind of simpler.

Certainly for some situations if you're able to take two $300,000 distributions save 3.8% and all of that, and then there's no sort of offsetting downside, I'd say it's probably worth the extra complexity. But for a lot of doctors, I don't think it is.

And then the other thing I'll say is, depending on the state that you're in and the rules, you may not have a choice. I think in California, my spouse, she has to be incorporated as a personal medical corporation, which is a type of S corporation. She doesn't have a choice to be a sole proprietor. I would recommend to her that she would be a sole proprietor if that were an option, but it's not.

There's this payroll tax savings on the distributions, which is a small benefit, but you got to weigh against the extra cost of hiring an accountant to do a separate tax return. And the tax return is more complex. If you make over $250,000, I think you have to maintain a balance sheet, which is kind of an extra step, an extra time, which means extra money to get that right.

I think my wife, back when she had a professional accountant here, again, it's Los Angeles, so maybe the prices are a little higher, but she was paying about $4,000 to have an accountant do bookkeeping and corporate taxes. And then that was not even the payroll cost. And a payroll service a year costs $500 or $1,000. Right there, your $3,800 of payroll tax savings is gone, and you're actually in the hole.

The other thing a lot of people don't realize is that this 199A deduction, which is part of the Trump Tax Cuts and Jobs Act, that is typically smaller for an S corporation. If you're a sole proprietor, you get that deduction on your whole income, whereas if you have an S corporation, you only get that deduction on the business profit. And that deduction is worth quite a bit.

Let's be conservative and let's say somebody is in the 24% tax bracket, and the deduction is 20%. 20% and 24%, that's like 4.8%, we can maybe call that 5%. So let's say you have $300,000 of income, you've got $100,000 distributions, and $200,000 of wages, you're gaining the payroll tax savings, which is again, let's say $3,800 on the profit, but you're losing 4.8% on the $200,000 of wages that you're paying yourself in addition to all those other downsides.

So, for a lot of people, it's not that good of a deal. Now, you can find cases where people are phased out of that deduction, not getting the deduction anyway, then it kind of tips back the other way. It can kind of go both ways. But I think one of the things that I wanted to challenge is this idea that there's all this money that can be saved by incorporating, and it's this great thing.

It's really more of a specialized thing. There's probably a relatively small percent, maybe, I don't know, 20%, 30% of doctors would actually save money by incorporating if I had to just make a wild guess. The majority, I would suspect, would probably be just better off as a sole proprietorship.

Dr. Jim Dahle:
Yeah, it's probably even lower than that, given how many docs are employees. You're just talking 20 or 30% of the self-employed.

Chris Davin:
I'm talking self-employed, yeah.

Dr. Jim Dahle:
Totally agree with that. And I think most people, if you are making enough money that an S Corp makes sense, you're probably making too much money as a doc to get the 199A deduction. You're probably phased out of it, would be my guess for most people.

The other thing people get hung up on with these corporations is they think there's some big liability coverage there, that they're going to keep themselves from getting cleaned out in a malpractice suit. Don't forget, malpractice is always personal.

Chris Davin:
Yeah.

Dr. Jim Dahle:
Forming a corporation does not help you reduce your malpractice risk at all. Maybe it reduces some unusual business risk, but let's be honest, if you're an independent contractor, it's just you. You don't have a lot of business risk. The only risk you've got is your malpractice risk, and that incorporation isn't going to help with that.

Chris Davin:
Yeah, it can get a little more complicated if you're talking about a non-medical field, if somebody is starting some other general business making things. But I do think it's worth pointing out that I think it's true, at least in most states, maybe all, that you can create an LLC, and that will provide you that liability protection. Again, it doesn't protect from medical malpractice, but if you're selling some other product or whatever you're doing or investing in real estate or whatever, and you want to have some extra liability protection, you can create an LLC, which will give you that protection.

An LLC is you have the option of being taxed as a sole proprietor or as an S corporation. Those are sort of two separate things, so you get to pick which one you want. The tax structure is independent from the business structure.

ROTH VS PRE-TAX CONTRIBUTIONS: HOW TO DECIDE

Dr. Jim Dahle:
Yeah, absolutely, I totally agree with that. The last time we had you on the podcast a year ago or so, we talked about Roth contributions and Roth conversions, and you mentioned in an email you sent to me recently that you wanted to add a few more factors to that discussion, maybe a little bit more nuance to it.

So, let's go through a little bit more on this topic. And granted, this is a topic that's out in the weeds. Because this is probably the most complicated thing in personal finance. When you consider all the factors that go into affecting your Roth versus pre-tax contributions or whether you should do a Roth conversion, most of the time it's basically the same question.

But people send me emails all the time with some trivial amount of detail about their financial life and go, “Which one should I do?” They just don't realize how complicated this decision is. So, walk us through very briefly kind of typical physician choices. Sometimes it is obvious what to do. Sometimes it requires a calculation or a lot of guesswork to figure out what to do. But walk us through typical physician choices of maybe when to be thinking about doing Roth contributions.

Chris Davin:
Yeah. Well, let me say, I think you're right that it is the most complex decision in personal finance. I can't think of anything more complicated just because it folds in so many inputs from your whole life.

You're basically tax planning for your entire life, all the way through retirement and the end of your life, and then even estate planning if whatever money you leave to your heirs. You're trying to make predictions about your tax situation over many decades, and then potentially your heirs who may not even be born yet, or maybe they're in diapers now. You don't know whether they're going to end up being investment bankers or teachers.

And then you also have to consider where you're staying, where you're living. State taxes are a factor, your investment performance, how can you predict what kind of investments you're going to have and how they're going to perform over decades.

So yeah, it is a very complex problem. And I think that's one of the reasons why I like it. But that also makes it the most difficult problem that I can think of in personal finance. I think you're right about that.

I was on a year ago and we went through for about an hour in a lot of detail, including a lot of math. And I was thinking about, after that, ways to try to maybe make it a little simpler, or maybe add a couple rules of thumb that I think would be applicable to a typical doc that doesn't necessarily fall into one of those categories where it's really obvious, “Oh, you're in the military, you're a military doc, you check all the boxes. You're a resident of a tax-free state, half of your income is tax-free, you're getting a pension, therefore you do Roth.” If you're kind of in the middle, what do you do?

The standard advice, which I think is right, is that if you're in a residency, or even if you're in medical school or whatever, if you have a second career and you have some money to convert, I think that Roth in those low-income years is correct. I think that's right.

Dr. Jim Dahle:
Although there is the caveat with that, with student loan management.

Chris Davin:
Oh, right.

Dr. Jim Dahle:
We're trying to get a bunch of student loans forgiven.

Chris Davin:
That is true.

Dr. Jim Dahle:
For everything, there's an exception. There are so few clear-cut things with this issue. But for the most part, I totally agree with you, low-income years is Roth.

Chris Davin:
Yeah, that's true. I think that's about the only exception that I could think of is if you're playing games with student loans. Roth, one way to think about it that I think might be helpful is you're basically making a bet on having future income. Because if you're not going to have any future income, pre-tax is the right choice, because you get to fill up those lower brackets in the future when you're withdrawing it.

And if you're in medical school or you're in residency and you're reasonably confident that you're going to be a doctor at least for a while, I think it makes sense to take that bet and pay a little bit of extra tax now and hopefully get a bigger tax savings later.

One of the things that I mentioned last year was that there is this contributing the maximum effect where if you're up at your contribution limit, you're able to pack more money into your retirement accounts with Roth than with traditional. And that means that you have more money inside a retirement account where it's growing faster because it doesn't have tax drag versus leaving it outside of the account in a taxable account. And that over time can give a pretty substantial advantage to the Roth option, even if you have a relatively high tax rate now.

So, if you think about it, let's say you live in a high tax state, I live in California, and you have a high tax rate, that cuts both ways because the money in the taxable account gets a bigger chunk taken out every year when you're paying that high rate and paying your state taxes on all those capital gains and dividends. For higher income folks, the advantage for long stretches of time can actually tip back to Roth if you're contributing maximum.

For an early career doc, it's like, what do you do? You've got this advantage where if you pack your accounts with Roth in your 30s, you can potentially get this bigger advantage in your 60s and 70s. But the other offsetting advantage of pre-tax though, especially if you don't have any pre-tax money, there's a big advantage for those first few hundred thousand dollars of pre-tax savings. Because if you have any low income years, those can be converted to Roth at a really low rate.

And you probably know the statistics better than me, but medicine is a hard field. If you're starting out as an orthopedic surgeon at 30, there's a decent chance you might not be able to work 35 or 40 full years of that. That's a hard job. And leaning a little bit pre-tax earlier in your career to protect against the possibility of maybe not having all of that income, all those millions of dollars you could calculate out, having that materialized for whatever reason, you're disabled or you burn out, or you just get fed up with the field and go just to become a science teacher or something like that. There's a significant percentage of docs do that.

One of the big tensions in my mind, especially for early docs is, “Do you make this big bet on having this full career of income and maybe getting a slight advantage by doing Roth? Or do you go pre-tax to protect yourself against the possibility of maybe not all that income coming in?”

I think it makes sense to do pre-tax at least for the first, certainly five years, maybe 10 years. Another advantage of doing pre-tax early in your career is that that's when you have the biggest need for cash. Not only are you contributing to retirement accounts, you're probably paying off student loans, at least for a while, most likely. You're saving up for a house. You've got probably young kids, maybe they're in daycare, that adds some expense.

By doing pre-tax early in your career, that tax savings, you can use that. Maybe you're not saving in a taxable. Maybe you're using it to do those other things like pay down student loans, which is basically a tax-free return because student loan income interest is not tax deductible. I think it makes sense to do pre-tax early in your career. I can't say necessarily how many years, whether it's five or 10 or 15, but that checks those boxes for me anyway. I think that the balance favors sort of doing that.

Dr. Jim Dahle:
The other thing I love about it is the optionality. Once it's in Roth, it's in Roth. You put it in pre-tax, you got some flexibility, you have some optionality. You can always do a conversion later. It gives you those options.

The other thing, those of you out there, don't email me saying, “Hey, student loan interest can be deductible.” Chris is right. Most of the time for attending docs, it is not deductible. It might be deductible for you a little bit while you're a resident, and if you don't have a high income. But for most doctors, most of you out there listening to this, your student loan interest is not deductible. That is correct.

Chris Davin:
Yeah. For early attending docs, especially if your marginal tax rate, if it's in the 30s, if you're in one of the 30% brackets, or maybe in 24%, but you've got a 5% state tax rate. If you're able to save $0.30 on the dollar for every dollar you put into your pre-tax accounts, I think that's worth doing.

And again, we can come up with exceptions. Somebody has an early career and they already have half a million of pre-tax money. Maybe that argument doesn't apply. But for the typical doc, I think getting a bunch of pre-tax savings, saving some sort of multiple six-figure amount in pre-tax, then when you're 40 or 45, then you run the numbers on the Roth, because the advantage of leaving it in Roth for 25 years versus 35 years is not that big. You don't get a lot of extra benefit for that extra 10 years. Then maybe you're in your 40 or 45, you've got a house you can afford, you're stable in your career, you've paid off your student loans, you're more stable.

Then you're in a better position to make that decision. “Do I want to make the bet of putting $30,000, $50,000, $70,000, $100,000 a year into a Roth account and pre-paying all those taxes and making that bet on whether I want to have this big multimillion dollar portfolio by the time I'm 70?” I think that's probably the best time to do it.

Dr. Jim Dahle:
Yeah, absolutely. There are times though where Roth is surprisingly good. People don't expect it to be quite as good as it is in certain situations. Let's talk about a few of those.

Chris Davin:
Yeah, I gave an example. This was at last year's WCI talk. I ran through the numbers in a lot of detail, and I took what I thought was a typical case where the numbers showed that Roth actually had an advantage that you might not see if you just looked at the context.

The example I gave was a couple living in California high-tax state, basically the highest-tax state in the country, planning to retire in a low-tax state, no pension, they were in their 40s, they'd saved well in their pre-tax accounts. At age 45, they had $1.5 million. This is a dual-income couple, so they had a pretty high limit.

One of the spouses was an independent contractor, the other one was an employee. So they had about $1.5 million of pre-tax account by the time they were 45. And if you apply the rules of thumb, you'd say, “Oh, geez, this is obviously a case for pre-tax.” No pension, very high-tax state now, tax-free state in retirement.

But when you start to go through the math of it, there were a bunch of factors that kind of added up that really shrunk that benefit, one of which was that the $1.5 million that they already saved very diligently during the first, let's say, 15 years of their career, that will grow, and that will fill up all the lower brackets. This couple, when the time they retired at maybe 65, they were already going to be in the 24% bracket just from their pre-tax savings and their Social Security, and they were in the maybe the 30-some percent bracket now.

That already shrinks the benefit by eliminating all those lower brackets. Then you add in IRMAA, which was 5%. I went through the details. I won't do it again here, but people can listen to the other podcast. For people who retire with, I think for married couples, it's between about $200,000 and $400,000 of taxable income, which is typical for a doc. Then you pay an extra 5% Medicare premium when you're retired.

And then there's this contributing the maximum effect, which knocked another maybe 10% off of that. So, you think you have this huge gap. This couple had, I think, a 44% marginal tax rate. But Roth was almost the best choice. I think maybe pre-tax had a 3% or 4% advantage when you include all of these factors.

Now, Roth was still a little bit behind, but then you add the possibilities. This is what I walked through in the second part of that. I said, “Okay. Well, this couple's married. If one of those spouses dies early, which statistically there's a decent chance of that, the surviving spouse has to take all that money and all those RMDs on a single bracket scale. That completely wipes out the benefit.

The Tax Cuts and Jobs Act, that was scheduled to have tax rates go up starting in 2026. We don't know, I think, what's going to happen with that. It may or may not happen, but that was going to wipe out that benefit. Or if this couple retired basically to any income taxing state, aside from Florida, Texas, or Washington, maybe. I forget all of them. But any state that taxes income, typically, the rate is about 5% or more. That 3% or 4% benefit for pre-tax would be wiped out if they decide either to stay in California or to live in any state that taxes the income.

I said, yeah, pre-tax is still the best. The benefit is small, but basically, if any of these contingencies materialize, that flips over to Roth being the better. The way that I like to do it is I try to make it somewhat simpler. I try to separate it. I say, okay, run an analysis for your baseline case. Make the simplest assumptions you can. If you don't have a plan on which state you're going to retire, assume you'll retire on the state you're in. Run those numbers and see where that gets you.

And then go through and look at the cases where you've got something that leans heavily in one direction. Like the tax bracket. If you're married, you can't get better tax brackets. You can only get worse if one spouse dies. If your plan is you retire in a tax-free state, you can't retire to a negative tax state. You can only go up.

Look at those differences where if something changes, it will push you in one direction. If all those are leaning in one direction, then you might want to lean that way. As I said, it's complicated, but this is the best way that I could think of to try to simplify it and be a little bit more systematic about it.

Dr. Jim Dahle:
Yeah. Sometimes people start getting fixated on ratios, percentages of money they want in Roth versus pre-tax. That doesn't matter so much, though. It's really about the dollars when you start actually getting into the numbers and the calculations of trying to figure this out, doesn't it?

Chris Davin:
Yeah. Last year, we went through some common misconceptions, which I hope was helpful to people. It was certainly helpful to me when I was learning it to think about this is what you're not supposed to do. This is the way you're not supposed to think about it.

You mentioned you get a lot of questions about what's the right percentage of “Should I have 80% in pre-tax, 20% in Roth?” Our answer, which I think is correct, is that there is no correct ratio. Again, maybe I hope this might help some people understand the concept a little better. The better way to think about it is what is your absolute number of dollars of pre-tax money that you carry into retirement?

Because if you think about it, what really matters as we went through this last year is that the future tax rate matters. It's the percent that you pay. It's the rate that you pay in the future versus the rate that you pay or save now, depending on which retirement account that you choose.

The calculation for that is the tax bracket, which is based on absolute number of dollars. So and so dollars is $22, $24, $32, $35, and so on. It's not the percentage that you have that's pre-tax, it's the absolute number of dollars.

One of the maybe simplest ways to think about it is however pre-tax balance that you carry into retirement, take 4% of that, that's your taxable income, you can add in any guaranteed income you have, subtract the standard deduction, and then look that up on the tax bracket scale, and that will tell you what your future tax rate is.

For people that have, for instance, if they have a big pre-tax balance, they've been big super savers, or if they had money from an earlier career or whatever, or if they had investments that did really well in their pre-tax accounts, and they're carrying this huge balance in, then that should be a sign that you should lean more toward Roth or maybe do more Roth conversions.

On the other hand, if you haven't been great about saving pre-tax, your investments haven't done really well or whatever, if you're carrying a small dollar amount in, then you should probably lean more towards saving pre-tax. But the point is that calculation of basically your future income versus the tax brackets, that's where the rubber meets the road, really. That's what generates your percent that you pay, and that's really what matters the most for trying to decide which one is best.

Dr. Jim Dahle:
You've mentioned before the Social Security tax torpedo. Explain what you mean by that.

Chris Davin:
This is maybe one of the more complex aspects of this. There's a calculation of how much Social Security income that you have, which is taxable when you're retired. The calculation is a little complex. There's multiple steps to it.

The bottom line is that if, for whatever reason, you enter retirement with no other taxable income other than Social Security, Social Security is basically tax-free. I don't even know if you have to file a return or not, but you definitely don't pay any tax.

As you start to add in other income, for instance, coming from a pre-tax account or if you have part-time income or yield from your investments, real estate income, et cetera, then not only do you pay tax on that income, but you also pay tax on a percent of each dollar of Social Security tax. You get this range. If you're single or married, there's a range for both of them where you pay a really high tax rate as the Social Security that you pay gets phased in. That range is pretty significant. Hang on a second. Let me look it up.

Dr. Jim Dahle:
To be fair, this is a relatively less well-to-do retiree problem. Hopefully, most White Coat Investors are wealthy enough, have enough taxable income in retirement that 85% of their Social Security income is going to be taxable no matter what. This problem is for those who have some amount of taxable income less than that during their retirement years.

Chris Davin:
That's the maximum. That's right. That is 85%. For most White Coat Investors, it's probably not going to be an issue where you're just basically so far above this range that you're just going to pay the 85% no matter what. Then that spike, you can think of it as averaging out over a much wider range of income.

I have run some cases, though, I think for people who are higher income, where you can actually hit it, especially if you're single. It's easier to hit it if you're single than if you're married. If you're single, just for context, if you have anywhere between about $30,000 or $50,000 of other income, if you're single, that's non-Social Security income. That puts you right in that spike. Even if you're a little bit above that, if you're at $50,000, $60,000, $70,000, that's not really a great place to be tax-wise because you're still paying that big spiked rate on that big chunk of income for basically every year that you're in retirement.

Let's say if you're a single doc and you don't have a huge pre-tax account, let's say because you've been an employee your whole career and you've only contributed the $23,000, $23,500 per year, maybe you didn't get a big match. If you're not bringing this huge pre-tax balance in, the range, that $30,000 to $50,000, if you take 4%, that's about $750,000 to $1.3 million. If you enter retirement with a pre-tax balance around that range, you're going to be in or around the spike. A doc can hit that because it's not about your total income, it's about your pre-tax balance.

In that case, the right move is to do a bunch of Roth conversions, get that pre-tax balance down, and then you can come in right under that spike. You're not paying that rate. And then most of your income in retirement is going to be coming out of your Roth account. You can actually get a significant benefit by doing that.

I think this is just something to be aware of. Usually the right time to check it is maybe 5 or 10 years before you retire. Look at your pre-tax balance and see if you're going to be hit by that.

Some of the factors that are in that calculation are also not indexed for inflation. Depending on what time length you're talking about over time, more and more of that income, that spike gets bigger and bigger and gets a little bit lower and lower on the income. It may, over time, become less of a problem for high-income docs, but we don't know. Maybe the factors will eventually be indexed for inflation, or that will be updated. It's just something to be aware of.

Dr. Jim Dahle:
Yeah, for sure, and something that most people don't realize exists until they're caught in it. They're like, “Why is my marginal tax rate 60%? This is bizarre.” It's because you're caught in one of those little areas in the tax code where you really do have a marginal tax rate that is that high.

Chris Davin:
Or if you're slightly above it, too, that can actually be even more, I'll say, dangerous because your marginal tax rate on each dollar might be pretty low, but what you don't realize is there's this big spike below you where you would get a pretty significant advantage. It's like thousands of dollars a year of extra income after taxes by converting a bunch and getting under that rate. You might not see it if you're just a little bit above it.

Dr. Jim Dahle:
Yeah, for sure. All right. What about an independent contractor? Do you have some thoughts on how people ought to think about their pre-tax versus Roth contributions when they're an independent contractor?

Chris Davin:
When you're an independent contractor, there's an additional layer that goes onto this, which is that you've got this interaction between employee contributions and employer contributions, which can be taxed at a different rate.

I gave an example in my business taxes talk where if you are affected by the 199A deduction and you contribute money as the employer, you are losing that deduction because you're reducing your business profit. You basically only get 80% of the benefit of contributing pre-tax as you would if you did it, for instance, out of your paycheck.

If you're in the 35% bracket and you contribute your $23,000 or $23,500 out of your paycheck, you get to save the full 35% in taxes on that. But then if you contribute out of the business, which let's say it's your 25% of your wages, your business contribution, you only save 27%.

You can get cases if your pre-tax versus Roth calculation is pretty close, if they're about equal in value, you can decide to do your business contributions basically as a mega backdoor Roth instead of coming directly out of the business in order to avoid losing that benefit.

Now, just because you get a little bit less of a benefit by doing that doesn't mean always you shouldn't do it. If a pre-tax is very clearly the best option for you, then even saving a little bit less might still be better than Roth if you have basically very little pre-tax money.

But as your pre-tax income starts to rise and as the balance between pre-tax and Roth starts to get more even, the first thing that you would want to take out are those business employer contributions. And you can switch those to Roth first by doing mega backdoor Roth, and then you can still get pre-tax by doing it out of your paycheck.

Dr. Jim Dahle:
Yeah, that's a great point. And it's not just for independent contractors. Katie and I found this out for us in the White Coat Investor. We do mega backdoor Roth contributions because we basically lose 199A deduction for any pre-tax ones, employer ones we do. So we don't do them. We do our entire contribution.

My entire 401(k) contribution for the White Coat Investor 401(k) is mega backdoor Roth. $70,000 this year, mega backdoor Roth, the whole thing because of this reason. If the 199A deduction is affecting you, this is absolutely something to pay attention to.

All right, Chris, we have a decent disagreement on this topic, and I think it would benefit the audience for us to explore more about our disagreement.

Chris Davin:
Yeah, sure.

Dr. Jim Dahle:
You're a big fan of doing a calculation to determine whether and how large of a Roth conversion to make or whether to do Roth or tax deferred contributions. In fact, you put together a calculator. We'll link to this in the show notes. You should all check it out. He's got this cool calculator he's put together. It's a spreadsheet, as you might not be surprised, but it's pretty handy.

But my problem is I'm not sure the calculation is even worth doing a lot of the time because the calculation is so hard. Anybody that's been listening to this, their head's swimming. Because there's so many factors going into this, and the factors are not all equal.

The most important thing, the first question you got to ask yourself about this question is “Who's going to be spending this money?” And what tax bracket are they likely to be pulling out of the account in? And a lot of us, a lot of the calculators assume it's you spending the money, but that's not always the case. In fact, it's often not the case for all the dollars.

If people are only taking out about 4% of their portfolio a year, on average, they're leaving a portfolio behind to heirs that is 2.7 times what they retired with. Somebody else is spending most of that money. Somebody else is paying the taxes at a different tax bracket.

If you're leaving it to charity, doing Roth contributions is stupid. You're paying taxes on money that would never be taxed. And so, I think a lot of times people don't know who's going to be spending the money, much less what bracket they're going to be in. Whether it's their spouse in a lower bracket or a higher bracket, themselves in a lower bracket or higher bracket, their heirs in a lower bracket or higher bracket, charity.

And without knowing that, I'm not sure the rest even matters all that much. Clearly there's cases where it's obvious to do one or the other. The other times, I'm not sure it matters. I don't think you can get it right, even doing that calculation. But I want people to hear you make the case for doing the calculation with the best assumptions you can come up with.

Chris Davin:
Yeah. I would probably separate it also into older folks who are either about to be retired or are already in retirement, and then younger career folks. I think you can make a pretty strong case that if you're older, if you're within five years of retirement, or you're in retirement, you're doing Roth conversions every year.

Let's say you're even trying to come in under one of those IRMAAA tax spikes, using some software, for instance, converting up to the top of your current bracket, so you're getting a little bit of extra Roth money at a relatively low rate. Doing that shorter range planning, I think you can make a really strong case that you should be using some sort of software for that.

And in fact, I'd even go further, and I'd say that if you have basically seven-figure retirement accounts, and you're not comfortable doing that on your own, I think you could get benefit by hiring a per-hour financial planner, a good one like the ones that are on your website, a CFP or a CFA, to help you with that. Because I do think that there is some real benefit by doing that.

Now, again, we still don't know, for instance, what tax rates are going to do. There's still some uncertainty in it. But in my opinion, for that kind of shorter-range planning, if you're over 60 with a few million dollars of IRAs, I think it's worth it to really put some time into doing some planning for that.

Where in my mind it gets maybe a little more controversial, and this is probably where we have more disagreement, would be for younger folks. If you're 35, 40, 45, and let's say you have a couple of young kids, you don't know what their tax situation is going to be like. You're a good saver, but you have no idea whether it's safe they're going to be living in, what their income is going to be, what their tax rate is going to be. Maybe you don't know how much you're going to be leaving the charity.

Do you just take a guess? Do you do a 50-50? Do you use one of the rules of thumb? Or do you sit down and spend a few hours going through the numbers and trying to do this sort of long-range tax planning? I like the number approach, and that's what I did for me is I sat down and actually not only did I use the tool, I built the tool. I'm happy to share that with your listeners who want to go give it a try.

Dr. Jim Dahle:
Again, the link is in the show notes, so check out the tool he built. It's pretty impressive.

Chris Davin:
I think there's some factors for me that make me lean more in that direction. One of which is, of course, I'm an engineer, so I'm comfortable with numbers and spreadsheets. That's sort of what I do every day.

The second thing is that being a little more systematic about it, you can catch things that you maybe miss if you're not using a tool and you're just kind of using rules of thumb. Like the example I gave earlier with IRMAA, 5%. Those can kind of add up to give you sort of some surprising results.

Then I like the idea of going through the exercise, getting an answer, and then doing that and not necessarily having confidence that it's the right thing, but more doing it as the process. Maybe an example I would give, like I talked about rebalancing earlier. Some people will say, “Well, I'll rebalance once a year, or I'll rebalance when my bonds go plus or minus 5% from whatever that threshold is.” Then they track in a spreadsheet, and when their bonds are 25% or 15%, then they rebalance.

I don't think it's a mistake to do it that way, unless you're thinking that you're necessarily optimizing and getting the best answer. I think there is some value in having a process and doing the process, taking the information you have, getting an answer, and doing it every year that way, not necessarily convincing yourself that you've been able to accurately predict the future, but just that it gives you a way to get at that number.

I like the idea of having that and feeling like I've folded in the best information that I have right now, and that I've made not necessarily the correct decision, but the best decision that I can do. That, I think, has a lot of appeal for me.

Dr. Jim Dahle:
Yeah. One of my partners has taken a different approach. He's like, “I have no idea.” He has literally his entire career split his contributions between Roth and tax deferred. He's like, “I'm going to be wrong with half of it. I don't know which half.” But that's basically the approach he's taken his entire career. The longer I go, the longer I do this, the longer I think about this question, the more wisdom I think there might be in that approach.

Chris Davin:
Yeah, there is. Some of it comes down to, “What do you want to spend your time doing?” I have obviously taken this on as a hobby. I've spent a lot of hours, if you add up all the nights and weekends that I've spent learning about this over at least 10 years by this point. It's a lot. It's a lot of time. I could have done, if I decided to forget it, I'm just going to do 50-50, and I'm not going to worry about this. We got climbing mountains or whatever with that time.

Dr. Jim Dahle:
Not necessarily recommended on this podcast, by the way.

Chris Davin:
Yeah, yeah. I saw the video of your accident on the 911 call. It was terrifying. I'm very glad you recovered as well as you did from that. But yeah, I get a kick out of it. I think that there were some other things too, like for instance, my wife and I live in California. It's very expensive. Our budget is actually pretty tight, even despite having a decent income, just because of housing costs and child care costs and things. That motivates me, I think, to lean a little bit more in the optimized direction. I get a lot of satisfaction out of it.

But I'm not sitting here thinking at my age that I have been able to definitely deduce what the best option is in the future. I think that would be a mistake, to think that you've been able to correctly predict what tax rates are going to be, and that when I make my traditional Roth choices this year, that I've definitely figured out what the right one is.

I think it's more of like, A) I've folded in all of the things that I can think about that could potentially impact this. I've put all of that knowledge, and I've made the best predictions that I can, and this is the result that I have. And then every couple of years or whenever we have a major change in our financial life, I'll go back and reevaluate those. That's the method that works for me.

Dr. Jim Dahle:
I wanted to share something with the audience that you taught me in our email exchanges in preparation for this podcast. Something I didn't know previously, which is good. I've been doing this for a long time. I don't learn a lot of new stuff every year, let's be honest. Sometimes I forget stuff and I relearn it, but this was something I'm pretty sure I never knew before that I just learned a couple of weeks ago from you.

That is under the SEPP program. This is the Substantially Equal Periodic Payments, basically the early retirement exception for getting to your retirement account money before age 59 and a half.

Under this program, you don't pay the penalty. You don't pay that 10% penalty for getting your retirement money out. But what I learned is that you do have to pay taxes, not just on the tax deferred money that you pull out, but on the Roth earnings you pull out before age 59 and a half. Those don't come out tax-free. The Roth principal comes out first and comes out tax-free, but once you get into the earnings before age 59 and a half, those earnings aren't tax-free.

I think it's important that people realize that if they're planning on that being a major part of their pre-age 59 and a half funding. I don't think that's a big part of people's planning, hopefully. Most people are usually leaving the Roth money for a little bit later and using 457 money and taxable money and that sort of a thing. It's one reason to be careful not to get into your Roth earnings before age 59 and a half, for sure.

Chris Davin:
Yeah. I think just in the spirit of, again, trying to take this super complex problem and make it simpler, I think if you look at the early retirement scenario, really all of the factors line up that pre-tax is the right choice for that, both that you're able to get money out of those accounts more efficiently. Of course, pre-tax account, you do have to pay taxes on it coming out, but you didn't pay tax going in. Whereas Roth, you pay tax going in and then you pay tax on the growth coming out, even if you use a SEPP.

The other big factor is that the earlier you retire, the bigger the spread between your income when you're working and your income when you're retired, just because you've got less opportunity for growth and savings. The earlier you retire, the more pre-tax is the right thing to do. If you're planning on retiring, I would say earlier than age 55, where you're really going to need that early access to your money, pre-tax is the right way to go. That's maybe a way to make it simple.

Dr. Jim Dahle:
Plus, it gives you a lot more years before Social Security to do Roth conversions, that optionality we talked about earlier.

QUOTE OF THE DAY

All right. I think we have beaten that horse to death between the two podcasts we've done about it. Let's do our quote of the day today. This one comes from Jim Quick, who said, “Knowledge is power. You hear it all the time, but knowledge is not power. It's only potential power. It only becomes power when we apply it and use it. Somebody who reads a book and doesn't apply it, they're at no advantage over someone who's illiterate. None of it works unless you work. We have to do our part. If knowing is half the battle, action is the second half of the battle.” I love that quote.

All right. Let's take a question from a listener. This one's from Suzanne, who's got a question about mega backdoor Roth.

ADVANCED TAX PLANNING: MEGA BACKDOOR ROTHS, 401(K) RULES, AND PTET

Suzanne:
Hi, Dr. Dahle. Thank you so much for your podcast. It's incredibly helpful and one of the few places I found clear and accurate info on more advanced retirement planning topics. It's been a huge help on my FI journey.

Quick question. My husband has a solo 401(k) for some self-employment income. He maxes out his employee deferral at his W-2 job. And in the past, he's used the solo 401(k) for employer contributions and a mega backdoor Roth. He just switched to W-2 employers and his new workplace plan allows a mega backdoor Roth.

If he maxes out up to the $70,000 limit at his W-2 job between employee, employer, and after tax contributions, can he still do a mega backdoor Roth in his solo 401(k)? I know the $23,500 employee deferral is per person, but is the $70,000 overall limit per person or per plan? I've seen conflicting info out there and would love it if you could clarify it for me once and for all. Thanks so much.

Dr. Jim Dahle:
Well, this is so refreshing, Chris. We've been arguing about something for the last 45 minutes that doesn't necessarily have a correct answer. This question actually does. And so, that's reassuring. Yes, you only get one employee contribution. You're $23,500 this year if you're under 50. That's all you get no matter how many 401(k)s you have access to.

But the other limit, the total contribution limit, that $70,000 limit, you get for every plan you have access to that belongs to an unrelated employer. And that can be filled up with employer contributions, employee contributions, or after tax employee contributions, the one you use for the mega backdoor Roth IRA process. So, yes, you absolutely can do it in two 401(k)s if both 401(k)s allow it, which is usually the issue. I've got two 401(k)s. One of them doesn't allow mega backdoor Roth contributions, so I can't do them, unfortunately. You have anything else to add on that one, Chris?

Chris Davin:
Yeah, it might just be worth mentioning the unrelated condition. The reason that that works in this case is because you think about the two employers. One is, let's just say the hospital where this doc is working. The other one is the doc himself because he's self-employed. Because those are different entities, then you get separate limits.

Where you run into trouble, for instance, let's say this doc had two separate businesses that they both own. Even if the businesses are unrelated in the sense that they're in completely different fields, because they're both owned by the same person, you only get one $70,000 limit for both.

If this doc has one LLC for making his fishing lures, and then the other one for doing moonlighting in an urgent care clinic, different fields, but because they're both owned by him, you only get one limit.

That also applies to spouses. If you're married, for instance, you and your spouse are not allowed to have separate businesses and then hire each other so that you can get a $70,000 limit in both plans for both spouses.

The rules are called the controlled group rules. They're actually really complicated because they're all these familial relationships. But to make it simple, if a group of businesses are owned by either you or people that are closely related to you, then the limit applies to the totality of those businesses.

Dr. Jim Dahle:
Yeah, absolutely. Unrelated employers. It is important. The terminology and understanding what the terms mean matter.

Chris Davin:
Yeah.

Dr. Jim Dahle:
When we were preparing for this, you mentioned that I haven't talked about PTET on the podcast in years. I actually felt kind of bad about this because this is a really important deduction to me. Lots of people should be using this deduction. Would you mind reminding people what the PTET deduction is and who it applies to?

Chris Davin:
Yeah. The PTET acronym stands for Pass-Through Entity Tax – PTET. I think if you understand the background of this, the logic should make sense. Starting in 2018, the IRS at the federal level limited the amount that a taxpayer is allowed to deduct for what's called state and local taxes, abbreviated SALT. This is on your Schedule A, this is like your itemized deductions. Typically that would be any local taxes, like usually that's like property tax for a homeowner, and then state taxes, which if you live in an income taxing state, and most do, then your state taxes.

Those are all limited to $10,000, and that limit does not double if you're married. If you're married, you still only get $10,000. For a lot of people, especially if you're a homeowner, if you're a doc that lives in a high income tax state, that deduction gets capped at that $10,000, which is not good.

I think most states at this point, I don't know if there are any that don't, if they have an income tax, they have an option where if you are a business owner, you can pay some of your personal income tax liability through the business, and then it becomes a deductible business expense.

When I say deductible, that's at the federal level. Because when you file your federal business taxes, that's listed as a deductible tax that you pay out of the business, and then that's a deduction at the federal level. That's the idea, which is these states have a way, it doesn't really benefit them in any way, but it does benefit the business owners in those states, is that they're able to reduce their federal liability and get it back to where it was hopefully close to be fully deductible.

I live in California, and I know the calculation from California, I don't really know it that well for other states. I'm not an accountant, of course. But if you live in an income taxing state, and if that's capped, it's certainly something to look at. And it can be worth thousands of dollars, it's definitely worth spending the time to set it up.

Now, what's going to happen with tax laws and federal tax laws? We have no idea. I've heard some proposals from people in Congress about keeping the SALT limit at $10,000, doubling it to $20,000 for married folks, eliminating it completely. I don't think anybody has any idea what's going to happen with the tax laws in Washington right now. So, keep your eye out for the changes for it.

And if you haven't been doing this, it might have already been too late, I guess, depending on what tax law changes happen this year. But yeah, it's a great deduction, and everybody should be aware of it.

Dr. Jim Dahle:
Yeah, this is part of the rebellion against the limitation of the SALT deduction. Initially, it was felt by the blue states that the Trump administration, the first Trump administration was out to get them and really nailed them with this one. And so, they found a workaround, basically, so people could still deduct their local taxes. But then the Republicans were like, “We don't like paying taxes either, so let's lower our taxes.” Those states did it as well.

But if you own a business, you ought to be paying your state income taxes through the business. That's the bottom line. That's the PTED deduction. If you're just now hearing about this, and this applies to you, you really need to look this up and start doing this.

DEDUCTIONS AND COMMON TAX MYTHS: HOME OFFICE, CAR DEDUCTIONS AND THE AUGUSTA RULE

All right, let's do some more questions here. Let's take this one also off the Speak Pipe.

Speaker:
Hi, Dr. Dahle. I am currently in my second year as an attending emergency medicine physician practicing in Dallas, Texas. And I have a question regarding a prior 401(k) of my wife's from a previous employer. She is now only working part-time at a new employer as she is finishing her PhD and therefore does not receive retirement benefit options with her current new employer.

I am trying to figure out what is best to roll the prior 401(k) over to. From what I understand, the options include rolling it over to a IRA or to a Roth IRA. Are these the only two options other than taking the money out with penalty, which we're not interested in doing?

Also I was curious if it would be a better option to open a spousal IRA or spousal Roth IRA for her and rolling the money over into that given that she will not be able to contribute that much with her significantly decreased income over the next couple of years. But I was not sure if that would even be allowed given that she will still have some income outside of the home.

I appreciate any thoughts and input and also sincerely appreciate all the work that you do. It has significantly improved our financial stability over the past few years. Thank you.

Dr. Jim Dahle:
All right, Chris. I think we got a lot to clear up with this one.

Chris Davin:
Yeah.

Dr. Jim Dahle:
You want to take the first swing at this one?

Chris Davin:
Sure. Yeah. There's a few things I want to cover. First, the main thrust, is what do you do with the 401(k) at an old employer? And there's basically three options. You can either roll it into the plan at the new employer, you can roll it out into an IRA, or you can just leave it where it is.

I'll kind of go through these one by one and we'll talk about how that applies to this person. In general, I like rolling it into the new employer's plan if you can, just because there's an advantage to simplicity. It's one less account to keep track of. You could even potentially forget about the old account. It makes rebalancing easier. In general, I like simplicity wherever it can be had for a low price. And that's what I did in my previous jobs. I just rolled it into the new plan when I switched employers.

A couple potential problems here. The biggest one is that this person's wife is not eligible to participate in the plan. And my guess would be that the employer would not allow them to roll money into the plan if they're not eligible to contribute to it. It might be worth putting in a call to HR, I'm not 100% sure about that.

But even some employers who you can contribute to, they will not allow incoming rollovers. I think that's probably not the norm, but it's basically up to the plan of whether they'd let you roll it in. So, that would be one thing I would check. That's where I would expect this person to get caught up.

The other thing is if, for whatever reason, if the new plan isn't very good, if it has bad investment choices or really high fees, you would not want to roll money into that new plan. That's getting less and less common these days, but there are some bad plans out there.

I would just check and make sure that there's good investment choices and low fees. Typically, a low fee would be maybe less than a few tenths of a percent. I don't know where you would draw the line, but that's about what I would say. If you're less than a quarter of a percent of fees, that's probably good enough to roll the money in there.

The second option would be to roll it out into an IRA. Investment choices and fees are not a problem for IRAs. It’s very easy to find IRAs with great investment options and very low fees. The only issue is that if you're going to be doing a backdoor Roth IRA, then having pre-tax money in that IRA is going to interfere with that because it messes up the pro-rata calculation.

If this is Roth money, and I didn't say whether it was pre-tax or Roth, but if it's Roth money, rolling it out into a Roth IRA is probably the best choice because there's no downside for that. If it's pre-tax money, it may not be the best.

The cutoff, by the way, I looked it up, is $236,000 of modified adjusted gross income. If the couple's income is above that level, then they're going to be wanting to do the backdoor Roth IRA, and then having pre-tax money in the spouse's pre-tax IRA is not a good idea.

Dr. Jim Dahle:
Is above that level or could be in the next few years.

Chris Davin:
That's true. Yes, that's right. And then the third option is to just leave it where it is. The only downside to this is you just have extra complexity, you have this old account hanging out there. But if the old account is good, if the plan is good, it's got great investments and low fees, there's really no significant downside to just leaving it there. If it were me, I would rather leave money in an old 401(k) than roll it into a new plan and pay 1% or 2% per year on it or lose my ability to do backdoor Roth. Those are basically the three choices on there.

Dr. Jim Dahle:
Yeah. And I don't think the questioner realizes that's an option, that you can leave it. I was just on a 401(k) meeting yesterday for our partnership, I'm on the 401(k) committee for my physician partnership. We've got 20% of the people in the plan no longer work for our partnership. I think our plan, I don't know if it's an IRS rule or just our plan rule, but we can't force you out if you have more than $7,000 in the plan. We have to let you stay.

Now we can make it a little bit onerous. We can charge you some fees. I think we're actually probably instituting a fee for that 20% of people just so they're paying their fair share of the plan costs, but they probably can't throw you out of the plan. That's definitely an option. You can leave it there for a few years until your spouse gets another job with a 401(k) and can roll the money in there, or until you're not going to do backdoor Roths anymore, until you retire and then roll it into an IRA. This is an option and probably the best one for this couple, I would think.

Chris Davin:
Yeah, that would be my guess. There's a couple of other things that stuck out that I wanted to address too. One of which is the person asked about spousal IRA, and I just wanted to make it clear what that was.

A spousal IRA is not a separate type of account. It's not a separate kind of IRA. It's just the person's IRA. It's in this case, the wife's IRA. And the spousal part means that she can contribute to her IRA, sort of borrowing her husband's income. So, if the husband isn't attending, let's assume he's got a six-figure income, she can contribute the full $7,000 to her IRA using his income. And if she earns, let's say she earns $3,000 or $4,000, that really doesn't affect how much he can contribute because then she could just contribute, let's say like the $3,000 she earns, and then she would just borrow $4,000 from her spouse, and then that would go into her IRA. The same as if she didn't earn it. Basically there's no impact of her earning on what she can contribute to an IRA. She can contribute the full $7,000 either way.

Dr. Jim Dahle:
Yeah, I think people really need to understand that. Because in the 21, 22 years or whatever we've been saving for retirement, Katie did not have an income for something like eight or nine of those years. But she has made a full IRA contribution for every one of those 21 years based on my income. And so, don't forget to do your spousal IRA contributions. And if your income is high, we're talking about a spousal backdoor Roth IRA in this case.

Chris Davin:
Yeah. And then also her income and whether or not she has money in an IRA, if it's rolling it out to a Roth IRA or whatever she ends up doing, that does not impact the ability to contribute to the spousal contributions to the IRA.

The other thing that was interesting is this person did mention rolling it out into a Roth IRA. Now, I want to be clear that if the money is already Roth, I think rolling out into a Roth IRA is the right move. If the money's pre-tax, rolling it out into a Roth IRA is an option, but that then becomes a taxable event.

Dr. Jim Dahle:
Yeah. So, you got to go listen to the first 45 minutes of this podcast and figure out if that's the right move for you or not. And if it's a small 401(k), it might be, even if it's like dollar-wise, not the right move, just because it allows you to start doing backdoor Roth IRAs rather than having this prorata issue.

Chris Davin:
Yeah. There's an advantage in simplicity. I don't know where you would draw the line, if it's less than $10,000 even if you're paying not the ideal tax rate on it, to be able to get it out of the old plan, get it into a Roth IRA, it'll be tax-free forever. You can pull money out if you need it in an emergency. There's a lot of advantages to it. I think paying an extra $500 in tax compared to if you really separated out the pre-tax money and kept it separate your whole life I think it's, there's a point of diminishing returns with that.

Now, if it's $250,000 of pre-tax money, I probably wouldn't do that because that's extra taxable income. You're going to you're going to have to pay $100,000 in taxes on that. That's probably not the right move.

Dr. Jim Dahle:
Yeah. Well said. All right. So, when people are really out there trying to get business tax deductions, the ones they really want to talk about are home office deductions and deducting their cars. But there are so many misconceptions about these two deductions and so many people, frankly, cheating on their taxes with these two deductions. I think it's worth talking about what the rules actually are, how these deductions actually work and maybe pointing out where people screw them up. But why don't you talk first about… Let's do the home office deduction.

Chris Davin:
Yeah. Home office deduction, it's a good deduction. I like it. My wife takes a home office deduction and we try to get the benefit from it because she legitimately qualifies. What I covered in my talk is I think there's really three criteria you need to get a home office deduction.

The first, and I think this might, for certain specialties of doc, this might be one that catches people, is I think you need to be doing a significant amount of legitimate work in your home office for you to be considering doing this. If you're an emergency doc and all you do is maybe you check on your phone, your schedule a couple of times a week. And then maybe once a year you put in a holiday schedule request. I don't know if that really rises to the level of where I would say you would need a dedicated home office for this.

Dr. Jim Dahle:
Yeah, the IRS phraseology is regular and exclusive use. If you're using it once a year, that's not regular use.

Chris Davin:
Right. Again, the idea is that this is meant to be a substitute for an office that you would rent. So, would you go and rent an office for that? If the answer is obviously not, you probably shouldn't be taking a home office deduction. But there's a lot of cases where people would have a legitimate use. Even if you're an emergency doc, let's say you call patients the next day or if you're doing webinars or if you're doing admin work or if you're doing telemedicine, any of those things, that would definitely put you over the line where you would want your own office for that.

The second thing is it has to be your principal place of business. So, if you have a dedicated office you can use somewhere else, the IRS doesn't want you also deducting a home office. And then, there's this regular and exclusive condition. I don't know where you would draw the line for that. But maybe a couple of times a month, something like that would maybe be regular.

Dr. Jim Dahle:
Well, this is the fun part about the audit lottery. You get to roll the dice and hope you get lucky with the auditor. Clearly, every day is regular use. Every week is probably regular use. Once a month, you got to say this with a straight face to the auditor sitting in front of you. That's not as easy as you might think it is. I think the bigger problem is actually the exclusive use.

Chris Davin:
That's right.

Dr. Jim Dahle:
That means you can't use this space for anything else.

Chris Davin:
Yeah. Right.

Dr. Jim Dahle:
If your kids are doing homework in it, that's not a home office.

Chris Davin:
Right. Yeah. Or any sort of common area. The kitchen table, the couch, the breakfast bar in the kitchen, none of that. Those don't qualify as home offices. And then if you only have one desk that the whole family uses, then that would not qualify.

But you can deduct part of a room. For instance, let's say you have a big spare bedroom. You have a desk on one side, your spouse has a desk on the other. You guys both work from there. You can draw an imaginary line down the middle of the room and you can each deduct your half of the room. And that's your exclusive use home office for each of you. So you can do that. That's legitimate.

Dr. Jim Dahle:
Now, there's two ways to do this. One is the easy way to do it. The other way is the hard way, but might be worth more money. Let's talk about what those two ways are and how to decide between them.

Chris Davin:
Yeah. Well, let's do the easy way first. The easy way is you can just deduct $5 per square foot per year and up to 300 square feet. So you can't deduct a huge room or multiple rooms and call that your office. But if you have a bedroom, 150 square feet, you can deduct $5 per square foot per year for that. And that's really simple. You don't have to basically show any proof of the expenses for that. You do still have to meet the criteria that we just mentioned a moment ago. But if you do, then there's really no additional accounting involved.

Dr. Jim Dahle:
Yeah, it's a $1,500 deduction. Super easy.

Chris Davin:
Yeah, that's right. If you want to do the actual cost method, you basically have to add up all the costs for the house and then you prorate them over the square feet for the whole house of the square foot for the office divided by the square foot for the whole house.

Those would be things like you can't deduct your mortgage principal payments, but you can deduct your mortgage interest if you have a mortgage. You deduct a percent of your property tax, homeowners insurance, utilities, maintenance. Even if you have a house cleaner, you got somebody who comes in once a month, once every two weeks, cleans the house, they're cleaning the office. You can deduct a percent of that. You add all those costs for the year, do the square foot proration and then you can deduct that.

Dr. Jim Dahle:
Also depreciation is also a cost in there, but it has to be recaptured later when you sell the home.

Chris Davin:
Yep. Depreciation is calculated on the home office deduction form. Actually there's a little complexity here. If you're a sole proprietor, you have a home office deduction form that you attach to your Schedule C and there is a calculation at the bottom, which is the deduction for the depreciation.

In our family, my spouse has an S corporation and it gets a little more complicated to do the depreciation with an S corporation because the S corporation doesn't own part of the house. And this was something that our accountant back when we had a full time accountant, we sorted out.

If you read the IRS publications, there is an exception where if you keep really good records, you don't have to recapture depreciation. And for our family and with our accountant, we went through and decided that the complexity of trying to deduct that depreciation and then having to recapture it later was not worth it for us.

So, what we did is said, “Well, can we just not deduct the depreciation and then not recapture it?” And that was what we decided to do. I'm not 100% sure every accountant in the country is going to tell you that that's okay. The big risk, by the way, is that for depreciation in general, what the IRS says overall is that even if you don't take it to begin with, you still have to recapture it, even if you didn't take it, which is terrible because basically you're recapturing taxes that you never saved in the first place.

But there is an exception where it says if you keep really good records and you can show that you didn't take it, which we keep good records, then you're able to not do that. But some people may want to take the depreciation deduction. And then if you do, then you have to recapture it. So there's a little bit of complexity there. But that's the choice that we made.

Dr. Jim Dahle:
Yeah. Every time I look at that, I go simplified looks better.

Chris Davin:
Yeah.

Dr. Jim Dahle:
Even if it's less money. The other thing, too, is there's this other awesome real estate related deduction out there that's dramatically better than the home office deduction, which is your business renting your home from you for up to 14 days a year. And you can rent your home to anybody for up to 14 days a year. This is the masters rule or the Augusta rule. They name it after the town where the masters is. You can rent your house out for 14 days a year and you don't have to pay taxes on the income from that rental.

And what people do is they rent their house to their business 14 days a year and they get a deduction for the business, but they don't get that income on the personal side. And typically that's dramatically larger than the home office deduction. Now it has to be legitimate rental, legitimate use, legitimate price, all of that sort of stuff. But if you can qualify for that, it's way better than a home office deduction.

Chris Davin:
The Augusta rule is definitely good. I would say we don't do any of that in our family. Part of the reason is that under current tax law, entertainment expenses are not deductible. I've talked to my spouse about if her group has an event or a party or a holiday party or any sort of gathering. Can we have it at our house, have her business rent it and then basically pay us personally for that, which would not be personal income. But any entertainment expenses are not deductible.

So, if you're going to do it, it has to be for a business purpose for business meetings or for something like that. We have not come up with a situation where we could with a straight face say yeah, her S corporation really needed this four bedroom house to rent for a week or for however long for a business purpose. So, we haven't done it that way.

Dr. Jim Dahle:
Yeah, you just start having the WCI staff over once a month for a meeting.

Chris Davin:
Yeah, I guess that's an option. My standard for what I'm willing to do tax wise as far as aggressiveness is what I would be willing to explain to an auditor with a straight face why I did it that way. All the deductions that I've talked about that I've been willing to take. And for some of them, there is some gray area there. And I am comfortable calling a gray area in my favor when I think I have a specific reason why. But so far the Augusta rule rental for us has not met that bar. So, we haven't done it.

Dr. Jim Dahle:
Yeah. But it sounds like you are actually doing the calculation to do the more complex way to calculate the home office deduction.

Chris Davin:
Yeah, that's right. Yeah, we do. And in preparation for my WCICON talk, I went and calculated what the square foot cost would be. And again, we're in Los Angeles, a high cost of living area. It was like $20 a square foot. It was four times what the standard rate was.

Dr. Jim Dahle:
Yeah, you're getting a lot more than the $1,500.

Chris Davin:
That's right. Yeah.

Dr. Jim Dahle:
Okay, let's change to the cars. Everybody wants to buy a Ferrari and write it off. Explain why doctors cannot buy a Ferrari, drive it to work and home and write it off.

Chris Davin:
Yeah. There's a few things to get clear here. First of all, I think one thing I'll say up front is that the IRS looks at a car as a mode of transportation. What some people try to do is they put advertising on their car. They'll buy a Ferrari, they'll get a magnetic sticker that says whatever business LLC and they'll stick it on the side and say, oh, I'm advertising my business. And then they deduct a $300,000 car or whatever.

That's not allowed. The IRS does not treat a car as anything other than you getting from point A to point B.
Dr. Jim Dahle:
You can deduct the sign you put on the car, though.

You can deduct the sign you put on the car. That is true. But I don't think that's what most people want to get when they do that. What you can deduct or whatever the deductible expenses for the car are, and then it gets prorated from your business miles. And I'll talk about that in a second. But whatever your business miles are divided by the total mileage for the car, that's what you can deduct. Your gas, your insurance, your registration, your maintenance, your repairs, washing the car, tolls. All of that can get prorated over whatever business miles that you have.

Before I talk about deducting the price of a car, let me just talk about those business miles. Any sort of commuting, what the IRS considers commuting is travel from your home to a work site. That is never deductible because basically they say wherever you choose to live, that's a personal choice. If you want to live really close to your work, if you want to live really far away, that's a personal choice. Your commute is not deductible even if you're an independent contractor.

It's only deductible between work sites. If you go from your home to Hospital A, you go from Hospital A to Hospital B, Hospital B, home at the end of the day. Only the mileage between Hospital A and Hospital B counts as deductible mileage. The rest of it is personal mileage. That's the context. And that's surprising to many people.

Dr. Jim Dahle:
And there's an actual wrinkle to that as well. Both of those work sites have to be in the same industry.

Chris Davin:
Oh, that's right. Yeah.

Dr. Jim Dahle:
Yeah. You can't go from your job as a doc to your job as a podcaster. That's not legit.

Chris Davin:
Yeah.

Dr. Jim Dahle:
Interestingly enough. There's a lot of nuance to this. I've looked into a lot and I basically don't deduct miles. I basically don't.

Chris Davin:
There's also nuance with what is considered a regular job versus an irregular job. If you get a temporary assignment for six months and it's in the next town, I think if it's less than a year, they give you a little more leeway as to driving that work site if it's meant to be temporary. If it's like a temporary work site. So there's a lot of complexity with that.

Dr. Jim Dahle:
Yeah, that you got to look at a different deduction. It's the travel.

Chris Davin:
That's right.

Dr. Jim Dahle:
Work travel deduction up there, not your work car deduction, essentially.

Chris Davin:
But I think for most docs going between hospitals probably would be one. The big exception is that if you have a legitimate home office and again, we talked a few minutes ago about what that counts as. But if you have a legitimate home office that counts as a work site.

Dr. Jim Dahle:
Assuming you work there.

Chris Davin:
Yes.

Dr. Jim Dahle:
That day that you're deducting the mileage.

Chris Davin:
Right.

Dr. Jim Dahle:
That means you go to the home office, you do some work, you drive to the hospital, you do some work, you come back to the home office and you do some work. Then you can deduct those miles. But if you just come home and wrestle with the kids on the living room carpet, that drive home is not deductible.

Chris Davin:
I actually I'm not sure about that.

Dr. Jim Dahle:
Not that the IRS is going to be able to prove what you did.

Chris Davin:
Yeah, they're not going to they may not be able to prove it. I have heard both ways. I would be interested in maybe this is a homework assignment, but maybe I'll go see if I can find a citation for that one way or the other. I'm not 100% sure.

Dr. Jim Dahle:
It seems pretty hard to call it a work site. That you're driving to a work site if you don't do any work there. That's why I'd have a hard time to try to argue that one with an auditor with a straight face.

Chris Davin:
That's fair. Yeah. I think what people really want to deduct is the cost of a car which is basically depreciation. And so there are pretty low limits on what you can deduct. Let me also say, too, I'm not an accountant. The rules for depreciating a vehicle are pretty complicated. There's different amounts you can depreciate per year. There's bonus depreciation. Even in my case, I'm a hobbyist who's been doing this for a decade. I consulted an accountant what was an appropriate amount to deduct for a car and how that depreciation gets deducted? This is an area where I'm not really comfortable doing it myself.

But in general, there is a limit. I think as of 2023, it was $20,200. That was the maximum that you could deduct as the depreciation for the first year. And then that decreases years after if it's just a regular car.

Dr. Jim Dahle:
We should pause for a second to point out, like with the home office deduction, there's an easy way and a hard way to do this.

Chris Davin:
That is true. Yeah.

Dr. Jim Dahle:
The easy way is the IRS gives you a number per mile of business miles driven. That's your deduction. If you're driving a Ferrari, you might want to do the other method, though.

Chris Davin:
Yeah. The deduction for mile in 2025 is 70 cents a mile. So whatever business miles you deduct, you can ignore all the other costs. You can ignore prorating your expenses over personal business miles. You can just deduct 70 cents a mile. That includes a depreciation deduction, which, by the way, has to be recaptured when you sell the car. I think that is maybe not terribly well known.

Dr. Jim Dahle:
Even if you're taking the standard mileage.

Chris Davin:
Even if you're taking the standard mileage. 33 cents of that 70 cents is a depreciation deduction that must be recaptured. Now, does everybody do that when they sell a car? Probably not. But you're supposed to.

Dr. Jim Dahle:
Turns out I've cheated on my taxes in the past. I did not do that when I've sold cars. Of course, I mostly drive cars into the ground. So, I haven't cheated much, but I don't think I've ever recaptured that. That's interesting. I didn't realize that was a rule.

Chris Davin:
I think so. Yeah. But if you want to do the actual cost, then you prorated over business and personal miles. And then there's this complicated depreciation deduction with a fairly low limit of what you can deduct. The idea of going and getting a $300,000 Ferrari and deducting $300,000 of your taxable income in one year that doesn't fly, that's not allowed.

I think it's worth if we're talking about this, maybe mentioning the Hummer loophole. Let me explain what that is. The Hummer loophole, a long time ago, back when cars were much lighter, basically Congress said that they don't want these limits on depreciation to apply to farm vehicles. Somebody buys a tractor to till the fields in their farm. You want to be able to deduct the whole cost of that tractor in one year. And they set a limit of 6,000 pounds, which above that you still have to deduct only the business miles and business percent of the miles. But there's not this depreciation limit.

So if you buy a $100,000 car, you use it 80% for business. In the first year, you can deduct $80,000, the full price in that first year if the vehicle was over 6,000 pounds. Well, of course, what happens over time cars get heavier, they get more stuff in them, they get more crash protection or whatever. And then now there's a lot of cars like Range Rovers and larger SUVs that you can buy that are just regular basically passenger vehicles that are above this. This was called the Hummer loophole because the Hummer was one of the first cars that was above the 6,000 pound limit.

What people would sometimes do is they would buy a car really late in the year, buy it December 15th, keep really good records, make sure they only drove it for whatever. The 80 miles they drove it in the last two weeks of the year, keep really good records, keep an iPhone and videotape the whole drive so it was clear.

And then they deduct the full price of the car in that one year. And then they would get, whatever, $100,000 deduction. That is no longer allowed as from what I can tell. There is now a limit for SUVs. You had a higher limit. For 2023, it was $28,900. That is a cap of what you can depreciate for a heavy sport utility vehicle that's over 6,000 pounds. And frankly, I think this is good tax policy because this was an area where people were cheating a lot.

Dr. Jim Dahle:
Yeah, that's a loophole for sure.

Chris Davin:
Now, the loophole still exists for pickup trucks. There's rules. I think if you can climb from the driver's seat to the passenger compartment, then that rule applies. But if it's a pickup truck, then you're still allowed to do that. I guess if you wanted to go buy some big expensive quad cab pickup truck and do this loophole, I guess it's still legal. I don't like driving big trucks, so I would not do this, even if there was a tax benefit for it. But that loophole effectively, I think the way most people used it, which is like, “Oh, I want to go buy a $150,000 Range Rover and deduct it all in one year”, you can't do that anymore.

Dr. Jim Dahle:
Yeah, very cool. Well said. Well, Chris, it's been great to have you on the podcast. Thanks for being a friend of WCI and thanks for lending your expertise to the rest of us. And you might only be an enthusiast, a hobbyist, but you've clearly done your homework on these subjects. That effort is appreciated by the rest of the White Coat Investor community.

Chris Davin:
Well, thank you. Thanks for having me on. It was fun.

Dr. Jim Dahle:
Okay, I hope you enjoyed that. It's always great to talk with Chris. He loves this stuff. I just have the utmost respect for people who are actually still teaching me stuff about the tax code, about retirement accounts. And Chris has obviously done that. He knows his stuff.

You can check out more from Chris. You can listen to that talk he referred to a few times on business taxes by signing up for Continuing Financial Education 2025. That's our online course. It's 20% off through May 9th. It includes Chris's talk. And Chris's talk by itself will probably save you the cost of the course. But it's 20% off through May 9th, whitecoatinvestor.com/courses.

If you want to be a speaker at WCICON like Chris, maybe you're too intimidated now after listening to him talk on the podcast. I don't know. But you can sign up for that at wcievents.com.

Thanks for those of you out there leaving us a five star review and telling your friends about the podcast. We got a recent one in from Tifseagles who said “Should be required listening for all college students. I found this podcast in 2024 and has made me so much more confident in how to manage my finances. The relief from this stress has improved my quality of life immensely.

Dr. Dahle and crew were so thorough in their explanations, inspiring confidence in their recommendations. The guests bring wonderful thoughts, experiences and perspectives. I wish I had this information while I was in veterinary school or even earlier. It would have made a huge difference. Thank you so much to Dr. Dahle and the WCI team for helping so many of us every day.”

He also mentions, “The recommended reading list on the website has also been awesome. And the blog complements the material in these episodes so well.” Five stars. Great podcast review. We appreciate that. That does help us to get the word out about the podcast.

SPONSOR

Now this episode was brought to you by Laurel Road for Doctors. Laurel Road is committed to serving the unique financial needs of residents and doctors. We want to help make your money work harder and smarter. If credit card debt is weighing you down and you're struggling with monthly payments, a personal loan designed for residents with special repayment terms during training could help you consolidate your debt. Check if you qualify for a lower rate. Plus, White Coat Investors also get an additional rate discount when they apply through laurelroad.com/wci.

For terms and conditions, please visit www.laurelroad.com/wci. Laurel Road is a brand of KeyBank N.A. Member FDIC.

All right, we come to the end of a lengthy episode. I hope it was worthwhile for you. I doubt any of you have a commute long enough that you could listen to this in one commute. Give us some feedback if you like these long detailed ones or not. You can shoot us an email anytime editor@whitecoatinvestor.com and let us know how we did and how you enjoyed having Chris on the podcast and what you learned or what questions you might have.

This show is run by you. We're trying to create content that helps you in your life. So if it's not doing that, we want to know about it. And if we're succeeding, let us know that too and we'll keep giving you more of the same.

Thanks so much for what you do. Keep your head up and shoulders back. We'll see you next time on the White Coat Investor podcast.

DISCLAIMER

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.

INTRODUCTION

This is the White Coat Investor podcast Milestones to Millionaire – Celebrating stories of success along the journey to financial freedom.

Dr. Jim Dahle:
This is Milestones to Millionaire podcast number 220 – Family Physician Millionaire Receives PSLF.

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We have a great interview today, but stick around afterward. We're going to talk about an asset class, long-term bonds and whether they belong in your portfolio or not.

INTERVIEW

Our guest today on the Milestones to Millionaire podcast is Brody. Brody, welcome to the podcast.

Brody:
Yeah, thanks for having me.

Dr. Jim Dahle:
Tell us what you do for a living, what part of the country you're in, how far you are out of training.

Brody:
Sure. I'm a family medicine doc. I live in the South, Southeast. And I will be eight years out of training this July.

Dr. Jim Dahle:
Very cool. We didn't even know what milestone to celebrate for this episode because you've been knocking out so many of them lately. But let's talk about what milestones you've accomplished recently.

Brody:
Sure. In December, I got PSLF. I got rid of those student loans. I've hit the 1 million net worth mark. I did that last fall/winter as well. But what I'm most excited about is how much I have invested. It's just shy of $1 million. It's at $920,000 currently.

Dr. Jim Dahle:
And if the markets cooperate. The markets have dropped at the time we're recording this. They dropped in the first part of the year. If the markets cooperate, you might be a million by the time people hear this at the end of April. So we'll see.

Brody:
Yeah. Fingers crossed.

Dr. Jim Dahle:
Okay. Very cool. Well, let's take them in order. Let's talk about PSLF. You're eight years out of training. Basically, you started counting years toward PSLF during your residency. What do you think when you started residency, enrolled in an income-driven repayment plan? This would have been back in like 2015. Nobody had ever received PSLF before at that time. Did you have a lot of faith in the program or were you skeptical?

Brody:
I think initially, I was skeptical as most people were, but I had faith that it would get carried out. I read enough to know that the reason that the bad headlines were coming out in the beginning was because most of the people that applied just didn't meet the qualifications that were clearly stated.

Now, looking back to where we are now, and I achieved forgiveness in December, I feel very fortunate. I got in just at the right time. But during the process, I never doubted it too much. I felt like it was pretty solid, the way it was written and the way it was carried out. I really benefited, obviously, from the COVID pause in payments. Like three years, I wasn't attending at that time.

Dr. Jim Dahle:
What was it? 36 months? 42 months’ worth of basically free payments you got?

Brody:
Yeah, and I wasn't attending at that time. So it was big payments that were getting counted that were zero. That was a big help. And then one thing that I combined, I kind of took advantage of, was because of where I work, I qualify for the National Health Scholarship Loan Repayment Program. I was able to get some money through that and I used the money that they gave me to pay my monthly payment. All in all, I think I took out $270,000 originally. It grew to $330,000. And when the dust settled, I actually paid about $50,000 out of my own pocket.

Dr. Jim Dahle:
Very cool. Well, you say basically you got just about everything you borrowed paid back to you, which is pretty cool. Very nice. That obviously helped the net worth, to get rid of that $300,000 plus debt. Tell us about what your net worth is composed of today.

Brody:
Mostly stock. Index funds, mutual funds. $920,000 invested. And that's separated between my 401(k) from my W-2 job. It's my solo 401(k) from my side hustles. I've got a Roth for myself and my wife. I've got a 457(b) through my main W-2 gig. I have 529 plans for four children. And then obviously, a health savings account. Between all those different accounts, that's what it's comprised of.

Dr. Jim Dahle:
Yeah, very cool. You've taken advantage of a lot of tax protective accounts. How have you chosen to balance your goals? How much you put into an HSA, how much you're putting in 529s versus how much is going toward retirement?

Brody:
The 529, I usually just try to take advantage of what my state offers for the state income tax discount, what you will. That ends up being about $5,000 per child. I contribute that. And I try to start it the first year that they're born. And then the rest goes towards, I max out the health savings account. And then the rest goes to retirement accounts.

Dr. Jim Dahle:
Now, is yours the only shovel in the household or do you have a spouse that's earning as well?

Brody:
My wife is a stay-at-home mom. She worked whenever I was in medical school and residency. And then whenever I graduated residency, we started a family and she stays at home with them. She's got a much harder job than I do.

Dr. Jim Dahle:
Yeah, that's definitely true. As I've transitioned a little bit in my own career, especially now with Katie, who's now an elected politician serving on the school board, as well as doing stuff for WCI, I'm definitely doing a lot more at home. And you're right, it is not insignificant. Perhaps the hardest part is the mental load of just keeping track of everything going on, which is not insignificant.

Brody:
Yeah, we have four kids under the age of eight.

Dr. Jim Dahle:
Yeah, yeah, she's got her hands full for sure. She's full on, she's in it for sure. Okay, tell us about your income since you came out of training. What's it ranged from?

Brody:
Sure, I'll start while I was in training. Typical resident salary is roughly $50,000, $55,000 a year. One thing that I do remember is that we would get paid monthly. At the end of every month, after taxes and all that, I would get a check for about $3,000. And we would make that $3,000 stretch. And usually by the end of the following month, it was down, we were running on fumes.

Dr. Jim Dahle:
Yeah. Well, you divide $3,000 by six people, that's $500 a head. It's not insignificant.

Brody:
Well, at that time, we didn't have children. At that time, it was just me and her. But I was fortunate that my program let us start moonlighting as second years. They basically said, “Hey, once you pass step three, and you can get a medical license, then you're free to start moonlighting. We won't hold you back.”

I was gung ho about starting that as quick as possible. And I live in a rural area. There's a lot of opportunities. And so I think it was November of my second year in residency. I worked my first moonlighting shift. And that particular year, my second year of residency, my income went from $50,000 to about $75,000. And then my third year of residency, because of moonlighting, I took in just over $100,000.

And then whenever I started as an attending, I kept the moonlighting going. I worked one night a week in our local emergency room as an attending. And that added about $100,000 to my family medicine clinic income. That total, my first year out was about $350,000. And then it's increased about $25,000 a year over the last eight years. And right now I will gross a little over $500,000 this year.

Dr. Jim Dahle:
Wow, very cool.

Brody:
And my secret is just side hustles. Side hustle, side hustle, side hustle. I don't do the ER work anymore. After my second child was born, I just felt like being away from home one night a week was too much. And I was starting to get burned out anyways. And luckily, I was presented an opportunity to start doing some hospice work. And that sort of has taken the place.

I do some other stuff too, consulting with an urgent care group, reviewing charts for their nurse practitioners. I'm involved in some clinical research. I got my hand in a lot of different stuff and it's worked out.

I'm fortunate that I work at a place that every year we do a yearly evaluation. And if you're doing a good job, you can get a raise of anywhere between 5 and 10%. So, I've taken advantage of that too.

Dr. Jim Dahle:
Now having that support at home, taking care of home, taking care of the kids, certainly enables you to have a little bit more freedom to take on these sorts of additional hardworking, side hustles, whatever you want to call them. But the average income for a family practitioner is like $275,000. And obviously 50% of people are below there and 50% of people are above there. You're substantially higher than that.

What would you tell somebody who's coming out of family medicine residency or is sitting there making average or even below average for family medicine? What would you say to inspire them to maybe do a few things to increase their income?

Brody:
My number one piece of advice is you have to negotiate and advocate for yourself. You have to know your own worth and present that and fight for it. If you're a new attending and you're negotiating for your first job, man, that is the best time to negotiate right then. And what I did is I had multiple different places trying to recruit me as most family docs will because we're just such in demand. There's not enough of us to go around.

I kind of had this strategy, this philosophy that I'm willing to listen to any opportunity. When somebody would call and say, “Hey, we've got a potential job opportunity. Can we take you to dinner?” My answer was always yes. And I would always hear them out and see.

And once I had it narrowed down to two or three different jobs, then the job that I ended up going with, and it's the job that I've stayed with the past eight years, they want it with all the benefits, but their salary offer wasn't quite as good. And so, I just negotiated. I basically said, “Look, the only thing keeping me from signing here is your salary is below what I have offered from other places.” Luckily, they matched it. And so then I started.

And then periodically, every two to three years, I would come back to the table to them and say, “Look, I think that my worth to the company is worth more than what you're paying me. And this is what I'm asking for.” And I just have the attitude that all they can say is no.

I think that a lot of us in the medical field and healthcare, we're not used to the financial side. And we think that by coming to the table and asking for things or trying to negotiate, we're not used to that. But I assure you that those in admin that you're dealing with, they're used to that environment and they're not going to get offended by you asking for more.

They probably are shocked when docs take the first offer that they're given. And they probably are high-fiving each other in the C-suite saying, “Can you believe that doc took that?” So, don't be afraid to negotiate for yourself and listen to opportunities when they come. And like I said, the worst they can say is no. The more leverage you have, the better though.

Whenever I would negotiate, I would always make sure that I did my homework, that I had key pieces of information that would help me make my case. For instance, I think most people don't realize, maybe they do, but a lot of people don't realize that every nonprofit has to file their taxes publicly. The 990 form is what it's called. And that's easily accessible online.

And so, if you work at a nonprofit health system or a nonprofit hospital, you can access that information and you can see what a lot of your colleagues are making. And that's a good piece of information to have if you're going to go to the negotiating table with your bosses.

Dr. Jim Dahle:
Yeah, a lot of universities have the same system. Like our local university system, I can look up what all my friends are being paid by the university. It's a publicly accessible database that works in a similar way.

Very cool. Well, it's pretty obvious. I've only been talking to you for 10 minutes here, but you're quite financially literate. You've done just about everything right. Tell us how you became so financially literate.

Brody:
I was fortunate that my third year of residency, one of my attendings mentioned your book and your website. And that's really what started my education. My family has always been pretty entrepreneurial and financially savvy, but nobody in my family was in the healthcare field.

Once I really started diving into your book and the website, it really just over time, my education built. I really find this stuff pretty interesting. Although what I would tell someone who's just getting into it, it can seem daunting at first, just all the information that you're trying to absorb at once. And my advice to them would just be, “Hey, just take it slow, read one blog post a day. And over the course of time, it'll add up.”

I remember some of the first couple articles of yours that I read, half the stuff, half the terms, I felt like went over my head. But over time, you start to slowly, gradually understand those terms and alphabet soup of different accounts. And it just comes together. And so, I wouldn't get discouraged for people that are feeling overwhelmed. Just give it time.

Dr. Jim Dahle:
Yeah, very cool. Once more, The White Coat Investor: A Doctor's Guide to Personal Finance and Investing is the entry drug to this wild universe of becoming financially literate and successful.

Well, Brody, congratulations. You've had a lot of success, multiple milestones on this call, and maybe even a millionaire in investments by the time people hear this. Congratulations to you and thank you so much for being willing to come on the podcast and share your story to inspire others.

Brody:
Yeah, thanks for having me.

Dr. Jim Dahle:
Okay, I hope you enjoyed that. I thought that was a particularly good interview. Not only did we get multiple milestones out of it, but we got to learn about the importance of negotiating and how to become financially literate and all that good stuff. I thought that was a particularly useful interview.

FINANCE 101: LONG-TERM BONDS

Now I promised you at the beginning that we're going to talk about long-term bonds. And I occasionally run into somebody who advocates for including long-term bonds, particularly long-term treasuries. These are treasury bonds, loans to the federal government of 20, 25, 30 years in your portfolio. And you can do this either using a mutual fund or an ETF or buying the bonds directly at Treasury Direct or through your brokerage. It's really the same thing, no matter how you do it.

But there are some downsides to investing in long-term bonds. The two main risks when it comes to bonds are default risk, credit risk, that the person you loan the money to or the institution you loan the money to doesn't pay you back. Well, that's pretty darn low if you stick to just treasuries.

The other main risk is interest rate risk. The possibility of interest rates going up and causing the bonds you own to be worth less because people can buy bonds that have significantly higher yields now. And that risk really showed up in 2022. 2022 historically is the worst year we've ever had for bonds. Interest rates went up about 4% that year. And so, it just devastated bond returns because this significant risk with bonds really showed up and showed up in force.

And of course, when you have short-term bonds or even intermediate-term bonds, that risk wasn't so bad. Short-term bonds lost single-digit amounts that year. Cash didn't lose anything. In fact, they were thrilled to see their yields go up. Intermediate-term bonds might've lost as much as low double digits, 10, 12%, which is a terrible year for bonds. Historically, almost never lose money like that.

But the long-term bonds got devastated. TLT is an ETF that just invests in long-term treasuries. I think its return in 2022 was worse than minus 31%. That sounds like a stock bear market to lose 31%. And to do that in what's supposed to be the safe portion of your portfolio is pretty unappealing to me and to lots of people like me that don't like seeing that sort of volatility out of the safe portion of your portfolio.

Now, the argument people make, they're all for including these long-term treasuries in their portfolio, is that when things get really bad for equities, the bonds that tend to do the best are the long-term treasuries. Interest rates often get cut. And when interest rates go down, the longer-term bonds have the best returns.

And of course, when there's a flight to quality, when there's a flight to things that people think are going to be liquid and are going to be safe, they tend to prefer treasuries. And in fact, actually prefer nominal treasuries even over TIPS.

And so, that's the theory. The theory is, well, you got to look at the whole portfolio. And when you have long-term bonds in there with stocks, maybe they provide the best opposition to stocks in that respect. And there've been portfolios that have used long-term bonds over the years. Maybe you've heard of the permanent portfolios like 25% stocks and 25% gold and 25% cash and 25% long bonds.

The theory is that each one of those assets will do well in a certain type of economic situation. The problem is the economic situation where stocks do best is actually the most common one. And so, only having 25% of your money in stocks has significant downsides in the long run.

This isn't necessarily a new idea, but I feel like the people pushing it and the discussion I'm seeing on it in online communities is a bit more prominent than I have heard for a long time.

So, if you decide to do this with your portfolio, a couple of things. One, you've got to look at the performance of the whole portfolio because this is going to be a volatile asset class. Hopefully volatile in a good way for you a lot of the time, but also at times a year like 2022 is going to show up and you're going to lose a whole bunch of money in bonds. Now, if your own individual bonds and maybe you look at it as, “Okay, well, I don't lose anything because I'm still getting the same deal by the time I get it back.” But you got to be okay with that, number one.

Number two, you got to be okay with significant inflation risk. This is another significant risk with long-term nominal bonds. When I see people getting out into these long-term treasury ladders, I prefer them doing it with a TIPS ladder. If they're trying to provide spending money for the year they turn 82 and they're buying it when they're 58 or something, I like to see that be a TIPS. So at least it's indexed to inflation because if we get 9% inflation like we had a few years ago and that persists for three, four, five, six years, that's going to take an awful lot out of the real value of those long-term treasuries.

So, be careful with that sort of a portfolio. I think it's a little bit faddish. I prefer taking my risk on the equity side. Not only do I keep the quality of my bonds high, but I tend to keep the durations, the maturity, the length of these bonds, the term risk of these bonds relatively low, the short-term and maybe some intermediate term bonds. Be careful if you decide to add the long-term bonds to your portfolio, but it's possible that that'll work out well for you in the long run.

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Okay, we'll have another podcast for you next week. Until then, keep your head up, shoulders back. You've got this. We're here to help. We'll see you next time on the Milestones to Millionaire podcast.

DISCLAIMER

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.