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White Coat Investor Podcast
WCI #408: Roth IRAs, 457(f)s, and Other Retirement Account Questions
00:51:04
Today we are answering your retirement account questions. We talk about Roth IRAs and the pro rata rule, we talk about self directing your solo 401(k). We discuss 457(f)s and 457(b)s. We talk about when to do Roth contributions and 401(k) contribution...
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- [00:00]
Dr. Jim Dahle
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.
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Megan
This is White Coat Investor podcast number 408. This episode is brought to you by SoFi. Helping medical professionals like US bank borrow and invest to achieve financial wellness. Sofia Sofi offers savings accounts as well as an investment platform, financial planning and student loan refinancing featuring an exclusive rate discount for med professionals and $100 a month payments for residents. Check out all that SoFi offers at whitecoatinvestor.com SoFi loans originated by SoFi Bankna NMLS 696891 advisory services by SoFi Wealth LLC. The brokerage product is offered by SoFi Securities LLC. Remember Finra SIPC investing comes with risk, including risk of loss. Additional terms and conditions may apply. All right, as you're listening to this as this podcast drops, we're all in San Antonio at the conference, so I'm guessing all the people at the conference aren't listening to this podcast. Maybe they'll listen to it on the way home or something. But this is for those of you who aren't at the conference. I suppose you got to get your dose of White Coat Investor in this week as well, but we're all busy down there and having a lot of fun. It's always great to be at conference to talk to you personally and hear about your challenges, hear about your triumphs. I love it. It's one of my favorite parts. I talk about the speaking gigs I go around and do from time to time at med schools or residencies or to county medical societies or what. And I hate to travel, right? Being in the airports and the hotels and all that. Don't like it one bit. But I do like being there with you just because it helps me keep that personal connection. I spend so much of my time hanging out in this podcast studio with Megan and Megan's great, don't get me wrong, but it's not the same as having 30,000 of you there together with us. So it's good to keep it real sometimes. Thanks for what you're doing out there. Those of you on your way home, those of you who are working out or on your way into work or walking the dog or whatever. If you had a bad day, I've been there and it's rough. It's rough. So if no one told you, thanks for all the sacrifices you made in your life, let Me be the first today. Before we get into your questions, I wanted to talk about something that came across the news this morning. We're recording this in early February, right? We gotta get all this knocked out before we go to the conference. It's actually February 6th as we're recording this. And yesterday the news came out that Senators Josh Hawley and Bernie Sanders are trying to pass a bill in the Senate, which is interesting. These two are not on the same side of the political spectrum, right. But they're trying to pass a bill in the Senate that cuts credit card interest rates to 10%. They basically are like, hey, it's highway robbery. Be charging people 24% and 29% on credit cards. And at first glance you think, oh yeah, lower interest rates, that's good. Now people aren't getting hosed on their interest rates and going into terrible credit card debt. But you gotta keep in mind that changes like this aren't all positive. The downside is that you may not be making much money loaning unsecured debt at 10%. And so those who are in this business get out of this business, right? If they. It takes loaning money at 16% to make a profit because of the number of defaults you see in a particular segment of the population. You basically say, well, I'm only going to loan to the most credit worthy people if I can only charge 10% and all of a sudden there's a lot less credit available. So I'm not a fan of loan sharking or anything like that. But I do recognize that there are risks when it comes to unsecured debt and some people don't pay you back. Years and years ago I had some investments in peer to peer loans and a lot of those ended up being in the 19% range. And people thought it was a great deal because they were going from 29% to 19%. But it was interesting to watch those notes over the years and how many of them defaulted and I ended up having acceptable returns. I think I had returns of around 10%. But I think the average interest rate on the loans that were made in that peer to peer lending portfolio was more like 20%. And there's just so many people that defaulted on their loans. That's what it took. You had to charge those sorts of interest rates. So if this sort of a bill passes, you're going to see less credit out there. Maybe you'll see more original origination fee type stuff where they can make it up on the fees if they're not making on the Interest. But you won't see as many people with 25%, 30% debt out there. So there's pluses and minuses both ways. It'll be interesting to see if that passes Congress this year. All right, let's get into your questions. This one's coming from John, who's a military doc. Thanks for your service, John.
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John
Hello, Dr. Dali. This is John from the Southeast. I appreciate the opportunity to get help with the question that I have. Thank you for all that you do. I am an active duty military surgeon. I am one and a half years out from training. My question is about the backdoor Roth IRA and the pro rata rule. I currently max out my Roth IRA and a spousal Roth IRA every year through Vanguard as I am under the income limit for a direct Roth ira. As a military physician, my wife currently has no earned income. However, I plan to exit the military when I finish my commitment. In another two and a half years, I anticipate an increase in income that will put us over the income limit for a direct contribution to a Roth ira, which will mean performing a backdoor Roth IRA every year. My concern is that I also already have money in a Vanguard Traditional IRA. This money is rollover money from previous 401 s. Most of it is a rollover from my civilian residency 401. I rolled this over because I preferred to have the investment options at Vanguard. I now have $64,000 in this traditional IRA actively invested. I read your blog post on backdoor Roth IRAs. If I understand that blog post correctly, in order to avoid the pro rata rule when performing a backdoor Roth IRA, the traditional IRA needs to have a balance of $0 by the end of the year of the conversion. Is this correct? If so, what should I do with this traditional IRA money now? Plan for my eventual need for the backdoor Roth ira. My thought is that I could do a Roth conversion now and convert this amount in my traditional IRA to my Roth IRA over the next two years, using cash to pay the taxes on that conversion. Alternatively, could I roll this traditional IRA money to my federal tsp? I currently max out my yearly Roth contributions to my TSP as well. Would this fix my issue with my current traditional IRA balance and allow me to perform a backdoor Roth IRA when I need it? Perhaps I could do a combination of the two options to get rid of this traditional IRA balance. Any help is greatly appreciated. Thank you.
- [07:07]
Megan
Okay, good question. A lot of people have to deal with this pro rata issue. I mean the backdoor Roth IRA Concept itself is very simple, right? You can't contribute directly to a Roth ira, so you stick it in a traditional ira. You don't get a deduction because you make too much and you have a retirement plan at work. Then the next day you move it to a Roth ira. It's an indirect Roth IRA contribution, a backdoor Roth IRA contribution. If that's the only thing you had to worry about, it would be a whole lot more simple to explain to people. But because of the way the IRS taxes Roth conversions, and this is demonstrated in IRS Form 8606, conversions are prorated. So the balance of all of your SEP IRAs, simple IRAs, and traditional IRAs is considered when you do a conversion and it's prorated. And so, in essence, in order to do what you're trying to do, which is an indirect Roth IRA contribution, you gotta do something with all your SEP simple and traditional IRA money first, or at least by the end of the year that you do your conversion step in, and there's really three options, right? Option one is don't do a backdoor Roth IRA. You know, you got some $600,000 traditional IRA and you want that traditional IRA. Okay? Well, the backdoor Roth IRA process really isn't for you. The second option is to just roll it into a 401. And the tsp is essentially a 401. They do accept IRA rollovers. You can roll this into the tsp, no problem. You can wait until you get out of the military and you can roll it into your new 401. Just be aware there might be a year before you can for you're eligible to use it. You can roll it into a 401 or 403 at a new employer, no problem at all. So that's one option. The nice thing about that option is the paperwork's a little bit of a pain. And it might take two or three weeks or something like that to complete the rollover, but there's no taxes due on it. That's the nice thing about rolling a traditional IRA or a SEP IRA into a 401 or solo 401 or 403. The third option, and the one I think you should take as a military doc, if you can afford the tax bill at all, is to convert it all to a Roth ira. That's what I would do if I were you, John. And I could come up with the taxes to pay on that $64,000 of income. Now, especially in a year you deploy or something, your taxable income is Even lower. That'd be a great year to do a Roth conversion. You might be able to do this Roth conversion, you know, 12% or something like that, and that's a no brainer. You're going to be a surgeon making lots of money when you get out of the military. You're going to be in high brackets for most of your career and probably a moderate bracket even in retirement. So if you can do a conversion at 10, 12, 22% while you're in the military, this is going to be a great move for you. So that's what I'd try to do. I'd try to do a Roth conversion of it. And starting next year, you can do Roth conversions in the TSP, but I'd probably just do it in your Roth IRA move a little bit over there every year, maybe 20 or 30 thousand dollars a year, $20 or 30 thousand dollars next year, and whatever's left the year after that, and you're there, you've done the Roth conversion and you won't regret having another $64,000 in your Roth IRA. You're doing the right thing, by the way, making Roth contributions in the tsp. Those are almost always the right thing to do for anybody in the military. You will usually be in a higher tax bracket down the road. And even if you stay in the military, your you're going to have a pension or something filling up those lower brackets when you get into retirement. And so you're going to want that Roth money anyway. So military folks, Roth is almost always the right move. Great time to do a Roth conversion though. Okay, the Champions program is ending soon. What is the Champions program? These are the White Coat Investor Champions. These are first years, first year medical, dental or other professional students. And we need one from each class in the country. All you have to do is go into your dean and get a paper sign saying, hey, there's 98 students in my class and I'm actually a student in good standing there. That's it. You send that in to us with your mailing address. We send you a book, a copy of the White Coat Investors Guide for students for every single member of your class. Now, they're not all going to read it, but a lot of them will. And even if only half of them read it, you've probably saved each of those classmates something like $2 million over the course of their career. And that really adds up in a hurry, right? That's $100 million of value you've provided to a typical med school class. That's a lot for just signing up and passing out a few books. If you send us a picture with you and some of your classmates in the books, we'll even send you some WCI swag so you can apply for this whitecoatinvestor.com champion. The deadline's coming up. March 16th is the deadline. We just need time to print the books and get them shipped out to you before class ends. Otherwise you're going to be a second year and you're no longer going to be eligible for this free giveaway. This free giveaway is for first years only. So if nobody has handed you a copy of the White Coat Investors Guide for Students yet this year, there probably isn't a champion in your class. So sign up. Be the champion. We'll send you the books. You'll be a hero. You'll provide literally $100 million worth of value to your classmates. That's pretty awesome. So sign up for that whitecoatinvestor.com champion. Okay, let's talk some more about retirement accounts. My question is, if you do decide to self direct your solo 401k, should you have three sub accounts? If you're going with a traditional brokerage like Fidelity, would you recommend or should you have an after tax account? So obviously you're going to have the Roth component, you're going to have the pre tax traditional component. But should you also have a after tax that then you convert to Roth? Is that an essential step or can you just do directly to Roth? Okay, this might be the easiest question I've gotten on this podcast so far this year. The answer is yes, you want three accounts. Now you might not need three accounts depending on what you want to do with that solo 401k, but we've got a bunch of employees here at the White Coat Investor and we don't have. It's not a solo 401k right, because we got employees. It's a regular Ariza 401. But we have set it up such that everybody in the company has three sub accounts. Your traditional or tax deferred account, your Roth account, and your after tax employee account. Now last I checked, I think Katie and I are the only ones using that after tax employee account. My entire contribution for 20, 25 $70,000 went into that after tax employee contribution account and then the next day it was moved to the Roth account. This is known as the mega backdoor Roth ira and it's unfortunate that's the name because it has nothing to do with an Iraq. The backdoor Roth IRA process has to do with IRAs. The mega backdoor Roth IRA process has to do With 401s, but it's basically a way to put a whole bunch of money into a Roth account in your 401. And if you're using a solo 401, why not have it set up so you can do a mega backdoor Roth ira? I don't understand why anybody would not want some features in their 401 that they could have. You know, our 401 s also has, you know, a loan provision. I don't know anybody's actually taken a loan out of their 401k, but you could if you wanted to. And there's no harm in having that feature, just like there's no harm in having the mega backdoor Roth IRA feature in your Solo 401. Now that's not usually what it's called when you're talking to the 401 provider. You basically want to ask, can I make after tax employee contributions number one? And number two, can I do in plan conversions? That process is called the mega backdoor Roth IRA process, but that's kind of an informal name. But yeah, no reason not to do it. So have three accounts. If you want to do a mega backdoor Roth IRA contribution, you can't just stick it directly into the Roth sub account. You need all three of those sub accounts to do it. So yes, make sure it has those. And you know, if you're going just straight to Schwab or straight to Fidelity, you're trying to get this out of a cookie cutter plan, that might not be the best route. You know, the longer I do this, the more I think it's worthwhile hitting up one of the companies on our recommended retirement account and HSA page. Right. These people are used to doing this. They have people come to them every day, white coat investors, every day that they're setting up solo 401ks for that have these features. And yes, getting a customized Solo 401K is probably going to cost you a few hundred dollars the first year and one or two hundred dollars every year after that. That is nothing compared to the benefits you're going to have from having this customized 401k instead of the cookie cutter plan you're going to get at Schwab or Fidelity. You used to be able to go to Vanguard. Vanguard's basically sent all this business to a census. I'm not hearing great things about that. So I think if you must have a cookie cutter plan, probably Fidelity or Schwab's the place to go. If you just can't stand to spend 100 or $200 a year on fees in this account, then I guess that's what you gotta do. But I think you're probably better off getting a customized plan from some of the people on our list. Okay, we're going to talk some more about 457F accounts, which I think we've mentioned before on this podcast, but let's listen to the question.
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Anthony
Hey, Jim, this is Anthony. I'm a sports med doc calling from the Midwest, calling to see if you could shed light on details of 457F plans. I had a 457B previously, but my hospital is no longer a 501C3 and the new option is a 457F in addition to a 401K. The limit with the 457B was 23,000. The new limit for the 457F is 50,000. I don't have all the details of the plan other than that. And just from doing a little bit of research, it sounds like 457F plans can be quite variable, and some of the rules of them are basically almost up to the employer and how they want to set up the plan. But anyways, I just wanted to see if you might be able to speak generally about 457F plans again. I thought the 457B that I contributed to before was a good idea, but it sounds like the 457F may be a little bit different. I thought about possibly just taking that money and putting it in a taxable account instead. But any, any information you might have or any insights you have, be greatly appreciated. And thanks for everything that you do.
- [18:06]
Megan
Yeah, great question. You know, you could always invest more in taxable. That's always an option. You know, some people run into this or they're like, oh, I maxed out my retirement accounts. I guess I got to buy a whole life insurance now. No, you can always invest more in taxable if you don't like your retirement accounts or you've already maxed them out, a taxable account is a perfectly reasonable way to invest. It's our largest investing account, so we obviously think it's fine. It does have some tax benefits of it. It's obviously very flexible, which is nice. Okay. But we're going to talk about 457 F plans now. As a general rule, this is for all you podcast listeners out there, particularly what I call exclusive podcast listeners now here at the White Coat Investor. We offer all kinds of stuff. There's a blog, there's newsletters, there's podcasts, we have a conference, we got online courses, we got these online communities, right? There's all these things out there. But as a general rule, if you have something complicated, if you have something that's completely new to you that you've never heard of, the White Coat Investor resource you want to look at is the blog. It's just easier in the blog format to include lots of details with lots of links and really get into the weeds on it. So you can check that out by going to whitecoatinvestor.com and if you're on a laptop or you're on a regular computer desktop, the box is in the upper right and you just type in 457F and you'd be surprised what will pop up. Chances are very low that you have a question that I have never written a blog post about. Okay. And that is the case for 457F as well. The blog post is called deferred compensation plans. 457B, 457F and 409A. Now, lots of you are familiar with 457Bs, right? They're either governmental or they're non governmental. The governmental ones are better because you can roll them into an IRA when you leave or into another 401. The non governmental ones you got to be more careful about. You got to make sure the employer is stable and the investment options and fees and the distribution options are okay, but those are deferred compensation plans. However, there is a less well known cousin of the 457 and this is called a 457F plan. It is also a non qualified deferred compensation plan. However, it's a plan where all the contributions are technically made by the employer and none by the employee. It's usually just for a select management group or for highly compensated employees like docs. Involves money that is paid to the employee at the time of retirement is sometimes called a supplemental executive retirement plan or SERP. With the 457 F plan, the benefits are taxed when they vest, not when they're paid out. This makes it an ineligible 457 plan. And 457F plans may have higher contributions than a 457 plan. Like you mentioned, yours does. It has a $50,000 limit. In fact, it's possible to defer 100% of your compensation into a 457F plan. Where I don't think you can do that with a 457. The taxation is a little bit different too. When each tranche of your 457F plan is vested, you're taxed on it at ordinary incomes, tax rates and also usually including payroll taxes. Although gains on that money can still be deferred, the vesting occurs whenever, and I quote from the irs, substantial risk of forfeiture goes away. That means the benefits are no longer conditioned upon the future performance of substantial services. That's when the tax bill is due, not when the money is actually received. So that can be a bit of phantom income, right? That's hard to deal with tax wise if you don't have enough other income or assets to pay the bill. The plan is also required by the IRS to carefully define retirement. And that usually means name and age or a date, not just a vague whenever they leave employment. So these plans can actually be set up as a defined contribution plan, which is most common, or as a defined benefit plan. And sometimes academic institutions will use a 457F to kind of restore benefits to a highly compensated employee that it cannot provide in a qualified retirement plan due to non discrimination testing. So there's a lot of concern that these plans were going to be changed by Secure Act 2.0. But as near as I can tell, the final version of The Secure Act 2.0 didn't change these plans at all. So like 457Bs every 457F is unique. You need to read your plan document. They typically allow the highly paid employees to defer this compensation until they retire dire or are disabled. But exactly how and when it is distributed is highly variable and may or may not work for your life and your financial plan. Okay, so it's got a lot of cool benefits, it's got low cost than many other plans, it's easier to administer than many other plans. It can help attract and retain executives and highly compensated employees. It gets pre tax treatment and tax protected growth similar to 401s. There may be a potential tax arbitrage between the tax rate at contribution and when it vests and you pay the taxes, etc. So should you use it well? Read the details, read your plan document. Every one of these is unique. The devil's in the details. So go get the details. I can't tell you any more about your particular plan, but as a general rule chances are good you're going to want to use this thing. This is probably going to work out better for you than investing in taxable, but that depends on the Details of the plan. Go get the plan document and read it. Okay. Our quote of the day today comes from Franklin D. Roosevelt. Not our usual investment authority that we have on this podcast, but he said real estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, paid for in full, and managed with reasonable care. It is about the safest investment in the world. That's pretty cool to hear that quote from him. Okay, let's take another question. This one from Whitney, about 457 B's.
- [24:41]
Dr. Jim Dahle
Hi Dr. Dahl. I just wanted to start off by thanking you for all that you do. I grew up in a family that wasn't so great with money and so I've learned almost all that I know from you and references to others who are very knowledgeable in this financial space. I'm currently a mid career pathologist and previously separated from a state university where I invested in a 457B for three years. At the time of separation, I had two options. One was to start dispersing the investment and the other was to kind of kick the can down the road and delay that disbursement. I chose the latter option and kicked the can down the road to 2046 when I'll be 60 years old. Our current financial goals are to be financially independent by the time I'm 55. And so I'm trying to figure out what to do with that account. The options would be to disperse it now over an infinite time period. They said that there's no upper limit at which I can disburse that money. The current balance is about $82,000. Or to take the can further down the road and wait until it's about to be disbursed and decide then if I wanted to delay that disbursement until the age at which I would be required to take money from that account. I would love to hear your thoughts and thanks so much for all that you do.
- [25:54]
Megan
All right, Whitney, good question. I don't think I heard anywhere in it. The most important piece of information I needed, which is whether this is a governmental or non governmental 457. If it's a governmental, this is the first thing you need to go find out if you don't know already. If it's a governmental 457, you have all kinds of options. Not only can you roll it into another 457, but you can roll it into a 401 or an IRA or whatever. There's lots of choices. Okay. The only reason you might not want to roll it into another retirement account is if you want to spend it before age 59 and a half. Now, the beautiful thing about a 457 is it's really awesome for early retirees because there's no age 55 or age 59 and a half rule. If you retire at 50 and your 457 gives you access to the money, you can spend it at 50, no penalty whatsoever. And so that's a real benefit of 457. Now, non governmental 457 can't be rolled into an IRA or a 401. You're stuck with whatever options they give you. And those options aren't always good. Sometimes the only option is like the year you separate, you have to take all the money out of the 457B. So it's this big, huge income and tax bomb. And that's obviously not ideal. So most of them offer at least something besides that. And I can't quite tell what your options are. It sounds like you've got an option to annuitize it forever, which maybe isn't the best thing, especially since it's not actually your money and it's available to the creditors of your employer. Maybe you don't want to stretch this thing out until you're 85 or whatever. Right. Generally, you want to get this money relatively early in case something happens to your employer. So 457B's tend to be money that you spend relatively early in retirement. So I don't like that option. But if you're going to retire early, it sure would be awesome if you could get to some or all of it, you know, relatively early before age 59 and a half, so you don't have to worry about all the exceptions to the age 59 and a half rule. So I think you really need to dive into the details on this 457. Is it governmental or not? And what are your options really? And when will you spend this money if you can get access to it in the way you would like, for example, if you could spread it out over five years from age 53 to age 58, boy, that sounds like a great way to take 457 money out. Now, yours is only like $80,000, I think you said, and so maybe you'd spend the whole thing in a year, so maybe taking it all out the year you go into retirement, fine, you know, and that's just the first money you spend of your retirement money. But you got to dive into the details of all of those options and, and make A decision. The principles are you want to get the money relatively soon because it's not your money, it's technically your employers, that government, governmental 457Bs and non governmental 457Bs are treated differently and that you know you can get to it before age 59 and a half without any penalties. And so when you know those principles, you can probably choose from the available options, the one that's best for you and your particular situation. Hope that helps. Our next question comes from Mike. Hey Jim, this is Mike from the Midwest.
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John
I've got a question about solo 401 contribution limits when you have a 403.
- [29:26]
Megan
At your W2 job.
- [29:27]
John
I know you've addressed this before and I apologize for bringing it up again, but I'm getting conflicting answers from various CPAs, both of which actually are recommended on your website. And I just wanted to hear from you what exactly the rule is. I do well make about 400 in a W2 job and about 400 in a 1099 job. And my former CPA was under the impression that because my 1099 income was so high, I could contribute beyond 46,000 into my solo 401k, which I have done in years past. My current CPA seems to think, no, those limits are still combined even though your employer contribution at roughly 20% would exceed 46,000. I'm not sure what the rule is on that, and I would very much appreciate your clarification. Thanks so much.
- [30:20]
Megan
Okay, good question. First of all, a few few comments on our sponsors and our recommended lists and those sorts of things. If you have a situation like this where two people that we recommend are telling you different things, we'd love to get an email about it. We're probably not getting rid of that sponsor. What we're probably doing with them is educating them. And yes, sometimes we have to teach CPAs things. Sometimes we have to teach financial advisors or insurance agents things. Things. That's okay. We don't mind doing that. We want you to get a fair shake on Wall Street. And the truth is, so many of these little rules that affect high earners are not that well known. So we're not just teaching you as the end user, consumer doctor, whatever. We're also teaching your advisors. There's lots of advisors that listen to this podcast. And I'm not claiming I know everything or I always get everything right, you know, if you've been listening to this podcast for a while, you've heard me do corrections. We do corrections a lot because I screw lots of stuff up. But this is something we've been looking at very carefully for many, many years because it affects a lot of docs. It doesn't affect a lot of non docs, but it affects lots of docs. And these are the rules. When you have multiple 401 s and the place to go to really read these again, go to the blog, go to the search box. Whitecodeinvestor.com says search WCI and put in something like multiple 401k and the post will pop up that will give you all these rules of how all these 401 s work together. But here's the basics of the rules. The first one is that you only get one employee contribution, okay? This is often called an employee deferral, even though it can be either Roth or tax deferred. Okay? In 2025, if you're under 50, that amount is $23,500. You get one of those no matter how many employers you have, no matter how many 401s and 403s, et cetera, that you're eligible for, you get one of those, okay? And you can split it among multiple 401s if you want, but you only get $23,500 total. The second rule you got to know is that each of these 401 s at a different employer, an unrelated employer, including if one of those employers is you, right, you're self employed. You're paid on a 1099. It's you and your solo 401k. Each of those gets a separate 415c limit in 2025. For those under 50, that limit's $70,000. That's the total of contributions, employee or employer contributions, 70,000 total. That limit is separate in each 401k. However, there's a unique rule when it comes to 400 and 3s in this regard. Your solo 401 and the 403 that your employer offers, you actually share the same 415c limit, the same $70,000 limit. So if you put 23,500 in your 403 and your employer matches another $6,500, so you put $30,000 in there, you can only put $40,000 into your solo 401k. Even if you make $400,000 self employed, that's all you can put in there. And I'm sorry, I don't write the rules, I just tell you what they are. And if you want more details on all of that, you can go to multiple 401 rules, which is our blog post. There's links to IRS sites. Yes, I understand that sometimes you have to teach this to your cpa, and that's okay. We've got the links there that'll help you teach that to them. But that's the way the rules work. So you can use multiple 401s, but when there's a 403 in the mix, you got that additional weird little rule that might limit how much total you can put in there. Don't forget, though, you can always invest more in taxable. Okay. You don't have to stop saving for retirement just because you maxed out all your retirement accounts. You don't have to go buy some crappy index universal life insurance policy. You don't. You can just invest in a taxable account. And if you do that tax efficiently, it's not that bad. Okay, next question. Let's talk about Roth IRAs for kids. Hey, Dr. Dali, thanks to you and the WCI team for all that you do for our community. I've read and heard posts about how parents are trying to get Roth IRA money for their children, and sometimes they get a bit creative about what counts as earned income. Do you know if children can get audited by the irs?
- [35:01]
John
And if they do, are parents going.
- [35:03]
Megan
To be ensnared by the process as well? Thanks. Any taxpayer can be audited. There certainly is no rule that says if you're under 18, you can't be audited. So I think that answers the question you asked. But let's talk about this a little bit. You know, one of the hardest things to do at White Coat Investor is to turn down money, right? There are people that come and offer us money. They want to buy an ad from us and pay us. And, you know, after we pay our business expenses, that becomes either bonuses for employees or profit for the owners. It's a beautiful thing. We like it when people offer us money. But despite that, we sometimes turn their money down. And the reason why is because we don't agree with what they're doing. We don't feel like they're a good match with our community. We don't really support how they do business. And I had to recently do that with a company that helps parents set up Roth IRAs and do tax paperwork for their kids. And the problem I had with how the company did business was that they tried to push their clients to claim their children's chores were earned income. Right. Kids do the dishes, okay? We're going to pay them for that, right? So they set up a W2 and a W3 and W4 and I9 and an employment contract and a time card and pay them for dishes or pay them for cleaning the room or whatever. Well, that's really not how the IRS views that. Okay? They've got to do real work, not household chores. Now, maybe there's a little bit of gray there. If you were paying somebody else to do that work, first you're paying a housekeeper, and now your kids are taking over for the housekeeper. Maybe there's a little gray there. But certainly as a general rule, you shouldn't go pay your kids for chores and claim that's earned income. That can then go into a Roth ira. Now, if they're going over to your neighbor's house and cleaning their house, if they're raking leaves or they're mowing lawns or they're shoveling driveways or whatever for the neighbors, I think that's fine, right? Generally, household employee income is usually below the amount that the neighbors have to file Schedule H on. So babysitting money and lawn mowing money, that sort of stuff, that's earned income by not watching your kid, not mowing your lawn. Right? That's chores. That's just the expectation for the kids to be living there. Right? So I would not claim that as earned income. Now, does this get audited very often? I doubt it. Maybe it never gets audited. I don't know. It can be audited. It's still cheating on your taxes. But how often it actually gets audited, I don't know. But the cool thing about hiring your kids to do legitimate work, right? Whether they're models for your business or whether they come and file paperwork at your clinic or clean up the clinic or whatever, those sorts of things. You do all the official paperwork, W2, W3, W4, I9, employment contract, time card, all that stuff. As long as your business is not a corporation and the only owners of the business are their parents, they do not pay payroll taxes on those earnings. So they don't pay Social Security or Medicare tax. And they're probably not earning enough that they're going to owe any income tax, either federal or state, on that money. And it is earned income. So it can then go into a Roth IRA and never get taxed again. It's an awesome deal to hire your kids, but you got to pay them a fair price and they have to do real work. You can't pay them $400 an hour to come in and file paperwork in your clinic. Okay? You gotta pay the going rate for filing paperwork in your Clinic what you can hire somebody else for to do that work and you gotta do all the paperwork. Hope that's helpful. I think it's great for kids to leave home with some money in a Roth ira. They might have five decades for that money to compound before it actually gets spent. Maybe even longer. I mean, it's a great thing to do. Just follow the rules. The rules aren't that complicated. Don't bend them too much. I wouldn't spend a lot of time worrying about audits on that topic. But still, you should follow the rules, right? You're not supposed to be cheating on your taxes. Okay, next question comes from Zach.
- [39:21]
Anthony
Hi Jim, this is Zach from the Northeast. Thanks for all that you do. I have two questions for you today. The first My wife and I are both residents graduating this spring and starting a one year fellowship. Before we start our attending jobs, we we're taking about a 25% pay cut from our resident to our fellow salaries, we've done a good job saving in our 403s, putting about 10% of our income away as well as maxing out our Roth IRAs. I'm wondering if in this low tax year it would make sense to roll over our 403Bs into our Roth IRAs. I know you've talked about this a little bit before, but I was kind of unclear. On the general recommendation of note, we will be able to handle the tax burden as we're selling a house that we purchased at the beginning of residency that has about $200,000 in equity. I just want to make sure that I'm maximizing my growth long term in these accounts. The second question is in regards to short term rental tax loopholes. So I'm very interested in real estate and we'll be moving to a high cost of living area in which we'll unfortunately probably have to buy a fairly expensive house. My question is, can I purchase a house and use it as a short term rental, do a cost segregation study in order to lower my tax burden, but then plan on moving into it as a primary home the following year? Are there any rules or laws against this? I can't find anything online about it. Thank you. Really appreciate your advice.
- [40:41]
Megan
Sometimes I'm amazed how much that can be put into a 90 second speak pipe. That's like three podcasts worth of material that you just wedged into a 90 second speak pipe. Very impressive. First of all, I'm amazed that you're taking a pay cut going from a residency to fellowship. Usually fellows get paid a little more than a resident, or at least it's pretty similar. 25%. That's pretty huge. Sad for you kind of to see your salary dropping so much as you're going to a higher level of training. But anyway, as a general rule, yes, Roth for residents, Roth for fellows, Roth that year that you leave fellowship. These are good times to do Roth contributions and do Roth conversions because theoretically you'll be in a higher tax bracket throughout your peak earnings years and maybe even in your retirement years as well. The main exception to that is if you're playing games with your student loan payments, right, you're trying to keep your income low, to keep your student loan payments low, to try to get more forgiven, that sort of a thing. That might be an exception to this general rule, but the general rule is Roth. So yeah, I'm super supportive of this idea of you doing Roth conversions. It's kind of a bummer that you're having to convert it because you couldn't do a Roth 403 contribution in the first place. Maybe double check that. And maybe you could do that and make it so you don't have to convert quite as much. But yeah, try to do a conversion while you're still in these low earnings years. It sounds like you've got the cash to pay the taxes, which can be an issue for some people, not an issue for you. I'm glad your home purchase worked out. Well, a lot of times that doesn't in residency. I guess historically over the long term, it only works out that people make money about a third of the time in a three year residency and maybe half the time in a five year residency. And so that's why the general rule is if you're going to be someplace for five years or longer, you buy less than that. You rent. Obviously there are times when housing just goes crazy and you can make money in one year in a place or two years in a place. And so it's just a general rule. Other times you buy a house in 2006 and you sell it in 2015 at a loss like we did. There's no guarantee that you make money in five years either. It's just a general rule of thumb. But I'm glad it worked out for you. Obviously in a one year fellowship, if you're only going to be in that town for one year, that's probably not a great time to buy a house, no matter how much you love real estate and real estate investing. So maybe you're going to stay in that city long term, or maybe that's where you're going to start your rental empire or whatever. And maybe it works out in your case because of some sort of different circumstance. But in general, someplace you're going to be a year, it's not the time to be investing in real estate. It just takes longer than a year for appreciation to make up for the transaction costs with normal appreciation rates. Okay, you wanted to talk a little bit as well about the short term rental loophole. And we're getting into the weeds here when we're talking about this, right? Basically the loophole is being able to use the depreciation on that property against your ordinary income. As a general rule, a real estate investor that's a doctor and is practicing as a doctor can't do this. Right. The depreciation only offsets the passive income, the real estate income, the rental income. It doesn't offset your earned income. One way that people get it to offset the earned income is they qualify for real estate professional status or reps. And that basically says that you're doing more work in real estate than anything else. You know, you can't be practicing medicine more than you're doing real estate and that you're spending at least 750 hours a year doing real estate. That works out to about 16 hours a week. So it's not an insubstantial commitment to real estate to acquire this real estate professional status. So a lot of times it ends up being the spouse of the doctor that acquires this and then they use that to offset. They use depreciation from the rental properties to offset the physician's clinical income. And so that can be a really powerful combination of a real estate professional and a highly paid professional like a physician can be a really good combination. But there is this other way and there's actually a few other ways that you can use to get depreciation to actually be used against your ordinary income. But the most common one besides reps is the short term rental loophole. And it's just a much lower bar you got to get to to claim it. I think it's 100 hours during the year instead of 750. And if it's a short term rental, that's all you got to put in. You can use it to offset ordinary income. Now that may be recaptured down the line when you sell the property. But if you exchange and exchange and exchange and never sell until that step up in basis takes place for your heirs, maybe it's never recaptured. But that's basically what the short term rental loophole is. Now you also asked about taking advantage of this in a situation in which you're not going to be in the house very long or you're going to turn into a residence after a year. Boy, now you're way out there into the weeds, right? And do I know the answer to this? I'm not sure I know the answer for sure, but I don't see why you couldn't take it, right? I mean, your idea here is a pretty cool one, right? You go and you get the study done on it. And the reason people get these segregation studies on the house is they're trying to say, well, these contents of the house depreciate faster than the property as a whole. And so we're going to depreciate this over five years because they're couches or whatever, even though we can't depreciate the whole property except over 27 years, you know, and then there's all this bonus depreciation and stuff that lets you speed some of that up. But the idea is that you just get a big fat piece of the depreciation early on, you know, right at the beginning. And if you can take that and use it against your clinical income, all the better. So you're wanting to take a whole bunch of this depreciation that first year and then somehow turn the thing into a residence after that. And I think the way the rules are written on this is that you would be able to do that. There's no rule that says you can't. But in one year, boy, that's going to be spread over two tax years, Right? Because you're starting this fellowship in a July and you wanna move into it the next July. So really, it wasn't a rental for a full. Either one of those is a full tax year. I don't know that I'd try this, right. I don't think this is gonna be as big of a benefit to you as maybe you think it is. Maybe you ought to run the numbers and just see how big of a benefit it would be to you, given that you're on these relatively low fellow salaries anyway that you're trying to offset. I think you're just making your financial life a little too complicated. And I appreciate the attempt at optimization, but I don't know that I'd try to do this. Give it a second, right? You're married to another doctor. You clearly have a high level of financial literacy. You're going to be very wealthy eventually and probably pretty quickly given your desires to run this real estate empire on the side of your clinical incomes. You're probably hitting financial independence in something between five and 10 years out of training, right? You don't need to speed this up anymore. You don't need to optimize this anymore. Spend your year learning your subspecialty, right? Yeah. Do a Roth conversion. Take care of your finances. Continue to boost your financial literacy. Make plans for your real estate empire. Don't try to do all this at once and don't try to do it all while you're in residency or fellowship. This is going to work out just fine for you. You're going to die a very wealthy person and make your heirs very happy and have an awesome financial life. But it feels like you're trying to rush it a little bit too much. Take a step back. Take a deep breath. This is going to work out fine for you. And I'd probably not try to do this super complicated thing with one year in a short term rental that you're then moving into. All right? As I mentioned at the top of the podcast, SoFi is helping medical professionals like U.S. bank, borrow and invest to achieve financial wellness. Whether you're a resident or close to retirement, SoFi offers medical professionals exclusive rates and services to help you get your money right. Visit their dedicated page to see all that SoFi has to offer at whitecoatinvestor.com SoFi one more time. That's whitecoatinvestor.com sofi loans originated by SoFi Bank NA NMLS 696891 advisory services by SoFi Wealth LLC. The brokerage product is offered by SoFi Securities LLC member Finra Sipc. Vesting comes with risk, including risk of loss. Additional terms and conditions may apply. All right, don't forget about the Champions program. This thing ends March 16th. Apply whitecoatinvestor.com champion if you have not yet been handed a copy of the White Coat Investors Guide for Students and you are a first year medical, dental or other professional student. Thanks for telling your friends about this podcast. We still grow primarily through word of mouth. It really is an important way that we get this message out to doctors and other high income professionals. It also helps when you leave five star reviews for this podcast. A recent one said, awesome, where was this when I was in college? This is a much needed resource, doctor or not to get smart with money. I thank Dr. Dali and his team for putting this together and writing his books. I have a much better grasp on money and the road to financial independence and I hope to continue growing this knowledge. Every resident and medical student needs to do this, without exception. Five stars. Well, thanks for that kind review and endorsement. All right, we've come to the end of another great episode of the White Coat Investor podcast. Keep your head up, shoulders back. You've got this. We're here to help you. See you next time on the podcast.
- [50:43]
Dr. Jim Dahle
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.