Today, our friend Chad Chubb is joining us for our next Friends of WCI episode. Since it is Roth season, we answer more of your Roth questions. We cover Roth IRAs, conversions, and contributions. We also talk about the difference between wants and needs—particularly around things like cars or, in Jim’s case a big ol’ F250. Before wrapping up, Jim and Chad debate the merits of living like a resident.
When Is an IRA with Pre-Tax Money in It Too Big to Convert to a Roth?
“Hey, Dr. Dahle. My wife and I are both physicians who recently finished residency. My question is about the Backdoor Roth. My wife currently has about $30,000 in a traditional IRA and about $5,000 in her Roth. I’ve been told that I could open another traditional IRA and then be able to Backdoor Roth from there, but that doesn’t make any sense to me, as she would still have $30,000 in her first IRA at the end of each year.
My other thought was to convert it all into the Roth and then take the hit over the $7,000 this year. But I would love to hear your thoughts on what you would recommend. I know you said in your podcast that anything small would be simple—just take the hit—but anything higher, just keep the IRA. But I feel like I’m kind of in the middle.”
Dr. Jim Dahle:
One thing I think we ought to point out at the beginning is that IRAs are all individual. The “I” in IRA stands for individual. This is always separate. You have your own IRA, your spouse has their own IRA. When you do a Backdoor Roth, you each have your own Form 8606 in your taxes. If you file a Married Filing Jointly tax return, there are two 8606s on it if you’re doing two Backdoor Roth IRAs. I think that’s important to keep in mind. But I think the question that’s really being asked here is when is an IRA with pre-tax money in it too big to convert? When should you be looking at trying to roll it into a 401(k) or maybe not doing a Backdoor Roth IRA for that person? What do you think? How would you advise on that, Chad?
Chad Chubb:
It’s actually crazy to me how often we hear that advice, “Oh, just open up another IRA.” There must be some source out there that is not giving good advice. It’s not as simple as that. You don’t want to do that. The number could really be argued about in numerous contexts in terms of where they are. The first item I got out of this caller’s notes was it sounds like they finished training in 2023. To the listeners, remember that last year of training is a really good year to think about making that conversion because that’s your last low-income year to make that conversion in there.
From our side of it, the number we generally use is usually around $20,000. It’s not perfect, but we say less than $20,000 you usually don’t have to think about it. More than $20,000, getting in that range of $30,000 for his wife here was right in that area where you’d want to run the numbers. A lot of times it’s, “Do you have the cash to cover the tax bill?” If you convert that $30,000 number over there—and let’s just assume we’re saying 30% tax bracket—there’s a $10,000 tax bill there. Do you have the cash to cover that? It’s not going to be this individualized bill at the IRS. It’s going to kind of come out in the wash with your tax return. But you don’t want to withhold when you do that conversion because 1) it affects compounding interest and 2) a sneaky little tax penalty is in there as you actually do get that 10% penalty for pulling that out to actually pay the taxes.
It depends on the situation, on the income, but they’d be right around that number where I think it’s really worth a conversation and an analysis of do they actually convert it, take the tax hit now, and move on? Obviously, we can talk about the other options they have in there, but for us, it’s right in that sweet spot where it depends, but you could actually do the math. Compared if it’s like $100,000—heck, even $50,000—you’re probably always leaning toward getting into more qualified money and not triggering that tax hit.
Dr. Jim Dahle:
I think it’s important that we point out “tax hit” sounds bad. You’re just prepaying the taxes; the taxes are going to get paid. You’re just basically doing a Roth conversion. It’s not all bad. Yes, you have to pay taxes this year, but you also now have a bigger Roth IRA. That’s not a bad thing most of the time. I think a conversion is a great option for just cleaning stuff up and having it be real simple, wiping it out. But you have to be able to afford the taxes. If you don’t have $10,000 sitting around to pay taxes on a $30,000 conversion, this isn’t an option for you. For somebody right near the beginning of their career, this might not be a very attractive way to clean it up.
On the other hand, if you’re 58 and you’re a multimillionaire and you have $400,000 in cash sitting around in your money market fund, what’s another $10,000 in taxes to just do the Roth conversion? No big deal. Knock it out. In fact, you might feel that way about a $200,000 Roth conversion to clean it up. But at a certain point, you have to keep in mind the benefit of being able to do Backdoor Roth is not that big. You don’t want to do an inadvisable Roth conversion you wouldn’t otherwise do just to be able to do that for a few more years. Because the other factor is, how many years are you going to be able to do a Backdoor Roth by cleaning this up?
If you’re cleaning it up when you’re 33, you might get 30 years’ worth of Backdoor Roth contributions out of this. If you’re 63, maybe you’re not willing to do a lot of hassle and not willing to pay a lot of taxes that you otherwise wouldn’t pay. There are a lot of factors that go into this. People would love it if I could just say, “Yeah, $35,000 or less, convert it; $36,000 or more, don’t convert it.” But it’s just not that simple. The right answer is going to be different for everybody.
Chad Chubb:
It always comes back to “it depends” in personal finance, which always bothers me. But unfortunately, a lot of times, it is “it depends” because there are so many unique factors that go into their situation on how that affects things. Knowing the tax bill I think is half the battle. You can even argue with them just finishing up training ideally, they’re still in the lower income years of their accumulation years coming. There are a lot of good things that would lean toward it could be a good time for a Roth conversion, but you still want to run the numbers.
Dr. Jim Dahle:
It’s a great time to do it the year you’re coming out. A lot of times people only have a little, tiny IRA or 403(b) they’re trying to clean up. It’s $2,000 or $3,000, and they can probably afford that tax hit. But there are so many good things to do with your money when you come out of training. You just don’t have enough money to do them all. This might be one of those things that just doesn’t become a high priority for you. You have to do what you can do there.
More information here:
How to Fix Backdoor Roth Screw-Ups
Difference Between Mega Backdoor Roth and Roth Conversions
“Hi Dr. Dahle. I was wondering if you could clarify the Mega Backdoor Roth vs. Roth conversions for me. I think I’m missing the big picture on the difference between the two. I have pre-tax solo 401(k) money that I can convert to Roth 401(k) money in my solo 401(k) plan that I have through E-Trade. And my company this year just amended our retirement plan to allow for Mega Backdoor Roth contributions.
I was wondering why I would do one vs. the other. It seems that I can just do the Roth conversions with my E-Trade solo 401(k) account, and if I start to do the Mega Backdoor Roth contributions through my company, then I would have a separate account and have to track that. And it just seems like it would be some added work without any difference, but I might be missing something regarding the difference between the two.”
Dr. Jim Dahle:
I actually think this is a topic where there are a lot of people confused out there. There’s a Backdoor Roth IRA, there’s a Mega Backdoor Roth IRA, and there are Roth conversions. Help us here, Chad, help us build a framework that will allow people to understand the differences between these things.
Chad Chubb:
I actually had to go through the Speak Pipe a few times there just to make sure I was following everything he said because even the wording when someone is saying, “Hey, these are my options,” you want to make sure that you’re hearing them properly. In short, one of those is a tax-neutral event. One of them is a taxable event. Roth conversions are the taxable event. This is the confusing part because a Backdoor Roth IRA is technically a Roth conversion, but you’re doing it ideally with after-tax dollars, which then makes the basis over. So, it’s a tax-neutral event.
I’m going with this first point. The first point is the current 401(k) plan that allows for Roth conversions. That is going to be fully taxable. If you have $50,000 in your 401(k) and then you convert it over—that $50,000 over to your Roth 401(k)—that’s $50,000 of taxable income. Maybe that is a good plan. But there’s a lot that comes into “it depends.” But we love Roth conversions; we love Roth conversions with all of our heart. They can become one of your biggest tax savings. But usually that doesn’t get exciting until you are just about retired or right up until about those RMD years. There’s a really beautiful time in there where you can really take advantage of Roth conversions.
On the other side of it, there’s the true Mega Backdoor Roth. But on that actual conversion there, inside of it, we’re doing the actual after-tax 401(k). That’s where it’s different. When you have a plan that truly allows after-tax contributions inside of your 401(k), this is not a tax deduction. It’s after-tax dollars going in and then they allow the feature to either convert it to a Roth 401(k) or ideally they’ll let you actually transfer it out to a Roth IRA. In this example, that conversion for the most part is tax-neutral. That’s where there’s a big difference, because a Roth conversion is completely taxable. A true Mega Backdoor Roth IRA, if your 401(k) plan allows it, for the most part, we’ll call it a tax-neutral event. While they can easily get confused, there are drastically different game plans and tax consequences that come with them.
Dr. Jim Dahle:
I think what people don’t get is a Backdoor Roth IRA is something you do with your IRA. A Mega Backdoor Roth IRA is something you do with your 401(k). Terrible name. I didn’t come up with that name, by the way. It was there before I got to it. But basically it’s something you do with your 401(k). Even though it says IRA, it’s a 401(k) thing. If you can keep that much straight, that will help you a great deal.
A Roth conversion is just a movement from one account to another account. The destination account is always going to be a Roth account. The originating account kind of depends a little bit. Most of the time, when it’s an IRA, it’s going to be a traditional IRA, a rollover IRA, some sort of mostly pre-tax IRA that can also have after-tax money in it. But within a 401(k), you often have three sub-accounts. My 401(k) here at The White Coat Investor has three sub-accounts. It has a pre-tax account, it has a Roth account, and it has an after-tax account. The Roth conversion there when I’m doing a Mega Backdoor Roth as I do every year in that 401(k) is I move money out of that after-tax account into the Roth account. Remember, after tax, it’s great that when you take it out, you don’t pay taxes on the original contribution. But you have to pay taxes on all the earnings. If you get into a Roth account, then you don’t pay taxes on the earnings either. That’s the real benefit.
Keeping all that straight I think is a little bit tricky if you don’t talk about this stuff and write about this stuff every day. I’m not surprised that people are getting confused about it. And the rules are different for Mega Backdoor Roth IRAs and the contributions there and how it works as opposed to a regular Backdoor Roth IRA. It’s hard to keep it all straight. We try to have tutorials up that’ll walk you through it every time you need to do it. It helps if you’re doing it in one fell swoop every year, too. But I know that can be hard for people to make all the contributions at one time during the year.
What else can we say about the Mega Backdoor Roth, Chad, that hasn’t been said?
Chad Chubb:
I think there is a unique opportunity in there because he did note that there was a solo 401(k). Keep an eye on your solo 401(k) platform, too, because there are some solo 401(k) platforms that are much more flexible. We use Fidelity quite a bit. Fidelity’s solo 401(k) model is a real cookie-cutter model. If you really want to customize it, you can, but you can even get into there where you’re doing a Mega Backdoor Roth through your solo 401(k).
There’s a lot of unique things to do in there. If you get cranking up, if that 1099 income is really high and you are doing a Mega Backdoor Roth for the full $69,000 for this year, if the 1099 income is really good, you do all that as after-tax. If you wanted pre-tax contributions, we lost them; now we get Roth dollars. You can kind of layer in a cash balance plan that can get you some more pre-tax dollars in. It depends on your situation too. For our docs in California, we’re trying to do as many pre-tax things as we can. That’s one thing to keep an eye on.
I think 401(k)s are getting so much better, whether it’s just from the actual investment lineup or now us seeing more and more after-tax options. With that, we’re even seeing auto Roth conversion features. It’s pretty much saying as soon as you put the money into the after-tax, it’ll convert it automatically. As Jim noted there, that’s ideal because you want the growth to occur on the Roth side. You don’t want to put it in the after-tax and then it’s growing and then you do the conversion because that growth is still taxable. We’ve seen this with some of the Kaiser groups where they’re now putting in that automatic Roth conversion feature. If the 1099 income is there, really keep an eye on customizing a really neat solo 401(k) for yourself. But if you do have the option through work, see if they have that auto conversion feature because that can take one thing off your to-do list and also probably give you a little bit extra tax arbitrage in there with the auto conversion.
Dr. Jim Dahle:
This is definitely a part that trips some people up because the cookie-cutter off-the-shelf, Vanguard/Fidelity/Schwab solo 401(k)s generally don’t allow these. You have to get a customized one. We’ve got a list of people under the retirement accounts tab at White Coat Investor that can help you do this. It’s not that expensive for a solo 401(k); it might be a few hundred bucks to set it up and like $100 or $200 a year to maintain it. It’s well worth it if you want to do Mega Backdoor Roth contributions. But it’s not typically a feature from the typical places you would go to open a solo 401(k) and not want to pay fees on it. It’s going to cost you something to add this feature. If you have employees and it’s no longer a do-it-yourself 401(k) situation, it introduces some additional testing to your 401(k).
We not only have testing to make sure we’re not discriminating against our lowest-paid employees when it comes to the employer match stuff, but we also have additional testing when it comes to the Mega Backdoor Roth IRA contributions that Katie and I are doing. We’re the only ones at the company doing these, but there’s an additional test that sometimes requires us to make additional contributions to our other employees. It can get really complicated. I’ve even heard it argued that a Mega Backdoor Roth even in a solo 401(k) is not a do-it-yourself project. I think if you’re really into this stuff, you can still do it as a do-it-yourself project, but if this isn’t your hobby, you probably need some professional help to do this.
More information here:
Mega Backdoor Roth IRA Conversion in Your 401(k) or 403(b)
Can You Do a Backdoor Roth for 2023 If You Have Not Contributed Yet?
“Hi Dr. Dahle. I was wondering if it’s still possible to do a Backdoor Roth for 2023 if I haven’t made my contribution yet? I’m planning to make my contribution in February 2024.”
Dr. Jim Dahle:
I think this one’s actually got a correct answer to it. Let’s talk about that and let’s also talk about the merits of doing it late and whether you should do it late and all that stuff because there’s an awful lot of people out there doing these contributions late.
Chad Chubb:
In short, yes, you can still do it up until your tax filing deadline, April 15 of this year, you can still make the contribution. I always say that the contribution is the important part. That’s the deadline you’re trying to follow. The conversion has no deadline. You can do the conversion whenever you want. It brings in our 8606. I always say when you start to do a Backdoor Roth, either do the Google search or read the White Coat tutorial walking you through the 8606 or make sure your accountant knows that you did that. Probably one of the most commonly missed tax forms we see even with accountants is 8606.
In defense of your accountant, if they didn’t know that, they’re not going to file the 8606. If they didn’t see that 1099-R coming out of the backdoor or out of their IRA to the Roth, 8606 comes into play. You can still do it up until April 15 of this year. Then, we can even get into next on the merits of you do it first thing in the year or you do it later in the year.
Dr. Jim Dahle:
One thing to keep in mind: even if you do a tax extension—which I’m having to do with my taxes these days, now that I’ve got all these private real estate investments that send me a K-1 in July—and you’re not filing your taxes until October 15, your deadline for your IRA contribution is still April 15. You can’t do it in August for the prior year. This drives me nuts, though. So many people don’t do it in the calendar year and then get confused when it comes time to get their 8606s done. I do mine the first week of January of the year you’re doing it for. This is the first money I save for retirement every year is my HSA and my Roth IRAs. Why do so many people do this late, Chad?
Chad Chubb:
It’s funny too because we actually have a day that we call Backdoor Roth IRA day for our practice. It’s usually January 3; it depends on where the holiday falls. It’s actually amazing. We have a pretty equal split of about half of our clients who will get it done within a few days right there. But then the other half, we’re checking in again right now because we don’t want them to miss that opportunity. Because as you said, there’s no extension on that extension. We’re checking now with a lot of clients to make sure they get them done if they haven’t done it yet for 2023. Ideally, we try to aim earlier in the year; we tell our clients this, too, because we want the extra year of compounding growth with that tax-free money.
There are certain years where waiting until later in the year might make sense, so you don’t have to clean anything up. But I think in most circumstances, especially when you hit your rhythm and you’re in your attending phase—hopefully nothing divorce-wise or anything comes into play there—early in the year is where we try to aim for it. But I think there’s an asterisk there on my favorite word of the day. Again, it depends where it might make sense a little bit later in the year.
Dr. Jim Dahle:
I love your phrase “hitting your rhythm” because what happens is you come out of training, and you have all these great things to do with your money. You haven’t done an IRA contribution for that year yet, and you have to figure out what to do first. You say, “I have this $13,000 credit card debt at 28%.” Do that first. That’s what you’re doing in July and August.
Now it’s September and you’re like, “Well, I don’t really have an emergency fund. Let’s build that up.” That’s September and October and now it’s November and you’re like, “Oh, if I don’t get money into the 401(k) they’re letting me use, I’m not going to be able to use it.” They probably won’t let you use the first year anyway, but maybe you put money in the 401(k) in November and December. Then in January, you’re like, “Oh, there’s an HSA, maybe I should do the HSA.” So, you put some money in the HSA that month, and all of a sudden, now you’re starting to make student loan payments. Now you’re doing the student loan thing, and before you know it, it’s February or March or April and you still haven’t done your IRA for the year. That year you make a late contribution.
The next year you don’t want to do that again. The 8606 was a pain. Now you do it in December. And maybe the year after that you’re doing it in July and the year after that you’re finally getting to it in January because you’re in your rhythm. I think this happens to a lot of people where they move their IRA and their HSA and their 401(k) contributions earlier and earlier and earlier in the year because they’ve become wealthier, they have better control of their income, they’re making more, and they have fewer good uses for their money. There are no more 28% credit cards to pay down, and they can do it earlier and earlier in the year. I definitely encourage people to do it during the calendar year.
I think the worst time to do it, though, is not after the first of the year. The worst time to do it is the last week of the year. So often people get burned; they get the contribution in, they don’t get the conversion done, and now they’ve got this, especially if they’ve been doing them for a number of years, now they get a prorated transaction and that really makes your paperwork complicated. You can still clean it up the next year most of the time, but if you want to keep your paperwork straight, do it all in the calendar year. It just makes it a lot easier.
Chad Chubb:
You always hit that backlog with the custodians at the end of the year. Even if you’re thinking there is enough time, there’s always a backlog because everyone else is doing it at the Vanguards, the Fidelities, the Schwabs. You get that in there, which is why it’s more likely to have that small delay and it’s always just enough that it pushes to the 1st or 2nd. One thing to note, too, I always call this the golden window for Backdoor Roth because you do have the opportunity if cash is available where you can take care of a 2023 and a 2024 at the same time. If you’re playing catch-up and trying to get into that rhythm, you do have that sweet spot right now where you can really get both of them going at one time here.
Dr. Jim Dahle:
I think it’s important to emphasize what you said at the beginning. The contribution has a deadline; the conversion does not. As a general rule, you should do the conversion as close to the contribution as you can, but there’s no deadline on a conversion. You can do a conversion at any time. It just ends up on the paperwork for whatever year you do the conversion. But the contributions are where the deadlines are.
More information here:
The Backdoor Roth IRA When Life Is in Flux (and Why to Beware a Contribution in January)
How I Failed and Then Mastered the Backdoor Roth IRA
To learn more about the following topics, see the WCI podcast transcript below:
- Spousal IRA and Backdoor Roth
- Needs vs. Wants
- Pre-Tax or Roth?
- Live Like a Resident
Milestones to Millionaire
#160 — Dermatologist Pays Off Student Loans in Less Than a Year Despite Getting Hosed by Private Equity
This dermatologist paid off his student loans and built his net worth to $150,000 just one year out of training. Not only did he accomplish all of that but has started the process of creating his own practice after learning that the clinic he worked at was selling to private equity. He shared his thoughts about the impact of private equity on young doctors and the challenge of learning how to build a practice as you go.
Finance 101: Physician Mortgages
When considering buying a house, it’s crucial to be sure both your professional and personal life are stable. Do not even think about purchasing a house until both of those aspects are stable. This stability not only ensures a better investment but also reduces the risk of financial loss. Transaction costs associated with buying and selling a house can be significant, averaging around 15% of the house’s value. If the house doesn’t appreciate enough to cover these costs during the time you live in the home, substantial losses can occur.
For newly graduated doctors, cash may be limited due to various financial commitments like student loans, car loans, or building an emergency fund. In these cases, a physician loan can be beneficial. These loans often allow for a lower down payment without requiring private mortgage insurance.
When considering how much home to buy, keep the mortgage to no more than two times your gross income to avoid being “house poor.” You want to maintain enough cash flow to be able to continue investing, saving, and building wealth. Keeping housing expenses—including mortgage, taxes, insurance, and utilities—to less than 20% of gross income will make it more likely that you can continue to build wealth.
While home ownership is often advantageous in the long run, it’s crucial to approach it with caution and not jump into ownership before you are ready.
To learn more about buying a home, read the Milestones to Millionaire transcript below.
Today’s episode is brought to you by SoFi, helping medical professionals like us bank, borrow, and invest to achieve financial wellness. SoFi offers up to 4.6% APY on their 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 https://www.whitecoatinvestor.com/Sofi. Loans originated by SoFi Bank, N.A., NMLS 696891. Advisory services by SoFi Wealth LLC. The brokerage product is offered by SoFi Securities LLC, Member FINRA/SIPC. Investing comes with risk including risk of loss. Additional terms and conditions may apply.
WCI Podcast Transcript
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 357 – Roth IRA’s, conversions and backdoor contributions.
Today’s episode is brought to you by SoFi, helping medical professionals like us bank, borrow and invest to achieve financial wellness. SoFi offers up to 4.6% APY on their 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 are originated by SoFi Bank, N.A. NMLS 696891. Advisory services by SoFi Wealth LLC. The brokerage product is offered by SoFi Securities LLC, member FINRA/SIPC. Investing comes with risk, including risk of loss. Additional terms and conditions may apply.
That might be the longest disclosure statement I’ve had to do on an ad on this podcast ever. I guess that’s what happens when you’re doing banking and investing and brokerages, but such is life out there I suppose. Compliance is a big deal for all financial firms.
All right, this is a Friends of WCI episode and our friend today is Chad Chubb. Welcome to the episode, Chad.
Chad Chubb:
Thanks, Jim. I’m excited to be here, always excited to chat with the WCI nation, so I’m excited to get into it.
Dr. Jim Dahle:
Yeah, it’s good to have you here. For those who don’t know, Chad has been a speaker at WCICON before. As a profession, he is a financial advisor. He’s advertised with us for I don’t know how many years. Do you know how many years, Chad? How long has it been?
Chad Chubb:
We started in 2016.
Dr. Jim Dahle:
Yeah. Wow. 8, 9 years by now. He has been around a long time. He knows White Coat investors well, and we’re going to work together to answer some of your questions today.
Okay. Let’s start with a question, I think we’ll begin with. You guys have asked a lot of questions lately about backdoor Roth. It’s that kind of a season. I don’t know how many backdoor Roth questions come into me every day here at the White Coat Investor. Certainly tons of people on our articles about backdoor Roth. Chad mentioned he’s got a video on his website that has had 15,000 views on it about backdoor Roth in the last month. There are plenty of people out there trying to sort this out. Let’s take our first question from Steven.
SPOUSAL IRA AND BACKDOOR ROTH
Steven:
Hey Jim. I have a question about backdoor Roth IRAs. I contribute to mine annually and my wife is no longer working, but we file taxes jointly. I was going to contribute to my own Roth IRA through the backdoor and then also to hers as well. Since we’re filing jointly, I believe this is legal, but I wanted to pick your brain just to see what your thoughts were. I look forward to hearing your response. I appreciate it.
Dr. Jim Dahle:
All right. Well, normally on this podcast when we have our Friends of WCI episode, we love controversial topics that don’t have a right answer. I don’t think this is one of those. Chad, you want to knock this one out of the park? This one’s served up pretty well.
Chad Chubb:
Yeah, I was looking, I wanted to fight, I wanted to get into it right away. We’re going to take it easy to start. Yeah, this one was an easy one. Nothing too crazy here, but yes, this all passes go. The official name is the spousal IRA. There’s no such account as a spousal IRA. You just open up a traditional IRA, but you are able to do this. So, if you are the primary income earner and you have a spouse that is not earning income, you can still do the backdoor Roth IRA. One of those really good financial planning topics that you don’t want to miss. So, that’s an easy one. That’s all clear.
Dr. Jim Dahle:
Yeah, you have to have enough income not only for your own IRA contribution, but their IRA contribution. Not usually a problem for White Coat Investors. All right. What kind of issues are there if they’re not married filing jointly? If they’re doing married filing separately?
Chad Chubb:
Yeah, this is the big one where we always say the student loan issues come in real quick here, in terms of when you use that married filing separately and your income limit is smashed down on this one. That’s the one where the late income limit is now $10,000. Anytime you get into married filing separately, we pretty much say it opens up you’re guaranteed to do a backdoor Roth now. It’s one where you don’t even have to really think about it, at least in the physician community. But that’s the main one that we want you to keep an eye on, is once you do married filing separately, usually in terms of student loan planning, the backdoor Roth is going to come in here as your main go-to because that income limit is so low now.
Dr. Jim Dahle:
Now you can still do a spousal IRA based on your spouse’s income.
Chad Chubb:
Well, we’re saying here the spouse doesn’t have income.
Dr. Jim Dahle:
I’m saying if you’re doing married filing separately and you don’t have much income, maybe you don’t have enough to make a full contribution, but you can still make it off your spouse’s income, can’t you?
Chad Chubb:
The spouse does not have any income in this example, but you’re still doing married filing separately?
Dr. Jim Dahle:
Yeah, exactly.
Chad Chubb:
It would still be our $10,000 limit. Right?
Dr. Jim Dahle:
Well, the $10,000 limit is what it phases out. The deductibility of the contribution phases out over $10,000.
Chad Chubb:
Correct.
Dr. Jim Dahle:
But I’m saying you can still make the contribution even without both spouses having income.
Chad Chubb:
Yeah, yeah. Correct.
Dr. Jim Dahle:
It’s just not deductible. So, you can still do it.
Chad Chubb:
Yeah.
QUOTE OF THE DAY
Dr. Jim Dahle:
Okay. Our quote of the day today comes from Mary Callahan Erdoes, who said, “Investing is not as complicated or as daunting as we make it out to be. The simplest approach can be the most effective.” I find often is the most effective, especially when you consider that 90% of personal finance is behavioral and not financial. Simplicity is underrated. It’s underrated when it comes to managing an investment portfolio.
All right. Let’s take another backdoor Roth question. This one from JC.
WHEN IS AN IRA WITH PRE-TAX MONEY IN IT TOO BIG TO CONVERT TO ROTH?
JC:
Hey, Dr. Dahle. My wife and I are both physicians who recently finished residency. My question is about backdoor Roth. My wife currently has about $30,000 in a traditional and about $5,000 in her Roth. I’ve been told that I could open another traditional IRA and then be able to backdoor Roth from there, but that doesn’t make any sense to me as she would still have $30,000 in her first IRA at the end of each year.
My other thought was convert it all into the Roth and then take the hit over the $7,000 this year. But I would love to hear your thoughts on what you would recommend. I know you said in your podcast that anything small would be simple, just take the hit, but anything higher, just keep the IRA. But I feel like I’m kind of in the middle. I would love to hear your thoughts. Thank you.
Dr. Jim Dahle:
All right. Well, there’s a little controversy here. This one’s not quite as cut and dry. One thing I think we ought to point out at the beginning is that IRAs are all individual. That’s what the “I” in IRA stands for is individuals. This is always separate. You have your own IRA, your spouse has their own IRA. When you do backdoor Roth, you each have your own form 8606 in your taxes. If you file a married filing jointly tax return, there are two 8606s on it if you’re doing two backdoor Roth IRAs. I think that’s important to keep in mind.
But I think the question that’s really being asked here is when is an IRA with pre-tax money in it too big to convert? When should you be looking at trying to roll it into a 401(k) or maybe not doing a backdoor Roth IRA for that person? What do you think? How would you advise on that, Chat?
Chad Chubb:
Yeah, yeah. It’s actually crazy to me, Jim, how often we do hear that advice on, “Oh, just open up another IRA.” There must be some source out there that is not giving good advice. JC nailed it. It’s not as simple as that. You don’t want to do that. The number could really be argued about in numerous contexts in terms of where they are. The first item I got out of JC notes too was it sounds like you finished training in 2023. To the listeners, remember that that last year of training is a really good year to think about making that conversion because that’s your last low income year to make that conversion in there.
From our side of it, we’re always looking at, the number we use is actually usually around $20,000. It’s not perfect, but we say less than $20,000 it’s usually you don’t have to think about it. More than $20,000, getting that range of $30,000 for JC’s wife here was right in that area where you’d want to run the numbers. A lot of times it’s “Do you have the cash to cover the tax bill?” If you convert that $30,000 number over there, and let’s just assume we’re saying 30% tax bracket, there’s a $10,000 tax bill there. Do you have the cash to cover that? Now it’s not going to be this individualized bill at the IRS. It’s going to kind of come out in the wash with your tax return. But you don’t want to withhold when you do that conversion because one, it affects compounding interest, but two, kind of a sneaky little tax penalty is in there as you actually do get that 10% penalty for pulling that out to actually pay the taxes.
It depends on the situation, on the income, but they’d be right around that number where I think it’s really worth a conversation, an analysis of “Do they actually convert it, take the tax hit now and move on?” Obviously we can talk too on the other options they have in there, but for us, it’s right in that sweet spot where it depends, but you could actually do the math. Compared if it’s like $100,000, heck, even $50,000, you’re probably always leaning towards getting into more qualified money and not triggering that tax hit.
Dr. Jim Dahle:
I think it’s important that we point out “tax hit” sounds bad. You’re just prepaying the taxes, the taxes are going to get paid. You’re just basically doing Roth conversion. So, it’s not all bad. Yes, you have to pay taxes this year, but you also now have a bigger Roth IRA. That’s not a bad thing most of the time.
And so, I think a conversion is a great option for just cleaning stuff up and just having it be real simple, wiping it out. But you got to be able to afford the taxes. If you don’t have $10,000 sitting around to pay taxes on a $30,000 conversion, this isn’t an option for you. For somebody right near the beginning of their career, this might not be a very attractive way to clean it up.
On the other hand, if you’re 58 and you’re a multimillionaire and you got $400,000 in cash sitting around in your money market fund, what’s another $10,000 in taxes to just do the Roth conversion? No big deal. Knock it out. In fact, you might feel that way about a $200,000 Roth conversion to clean it up.
But at a certain point, you got to keep in mind the benefit of being able to do backdoor Roth is not that big. You don’t want to do an inadvisable Roth conversion you wouldn’t otherwise do just to be able to do that for a few more years. Because the other factor is, “Well, how many years are you going to be able to do a backdoor Roth for by cleaning this up?”
If you’re cleaning it up when you’re 33, you might get 30 years’ worth of backdoor Roth contributions out of this. Whereas if you’re 63, well, maybe you’re not willing to do a lot of hassle and not willing to pay a lot of taxes that you otherwise wouldn’t pay. So, lots of factors that go into it. People would love it if I could just say, “Yeah, $35,000 or less, convert it. $36,000 or more, don’t convert it.” But it’s just not that simple. The right answer is going to be different for everybody.
Chad Chubb:
Always comes back to “it depends” in personal finance, which always bothers me. But unfortunately a lot of times it is “it depends” because there’s so many unique factors that go into their situation on how that affects things. But yeah, knowing the tax bill I think is half the battle. And you can even argue too, with them just finishing up training ideally they’re still in the lower income years of their accumulation years coming. So, there’s a lot of good things that would lean towards it could be a good time for a Roth conversion, but you still want to run the numbers.
Dr. Jim Dahle:
Yeah. It’s a great time to do it the year you’re coming out. And a lot of times people only have a little tiny IRA or 403(b) they’re trying to clean up. It’s $2,000 or $3,000 and they can probably afford that tax hit. But there’s so many good things to do with your money when you come out of training. You just don’t have enough money to do them all. And this might be one of those things that just doesn’t become a high priority for you. So, you got to do what you can do there.
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All right. A lot of our questions that we have on the Speak Pipe for this episode are not terribly controversial. So, we’ve decided to add a few topics into this Friends of WCI episode that hopefully we can get some controversy on. And this next Speak Pipe Megan was about to throw away. She’s like, “Hey, you got your first troll comment on the Speak Pipe.” And I said I actually really like that. Let’s play that. And there’s a few topics I’d like to talk about with this one. So, let’s go ahead and play this one. I don’t think Chad’s heard this one. I gave him some of the other Speak Pipes, but he hasn’t heard this one. So, here we go Chad.
NEEDS VS. WANTS
Speaker:
Hey, Dr. Dahle. Why does a blogger need an F-250? Thanks.
Dr. Jim Dahle:
All right. Why does a blogger need an F-250? I think this is a reference to my new car. My Sequoia finally was on his last legs at 278,000 miles. And so, the car, the truck I had ordered about 20 months before finally came in with pretty good timing to the time I needed to get rid of the Sequoia. I sold the Sequoia to somebody that came by the house and bought it. And indeed I do now have an F-250.
And he is asking “Why does a blogger need an F-250?” Well, I think the implicit criticism there is that a blogger does not need an F-250. But I thought this would be a great launching point to talk about wants and needs and the importance of taking care of the planet. So, Chad, why does a blogger need an F-250?
Chad Chubb:
I was going to say, listen, what I know about you, I know you’re an outdoorsy guy. I know you’re skiing, you’re rock climbing. To me, slam dunk, you need an F-250. Next question, let’s move on. Trying to bring in the soft side of money with the hard numbers. I can’t answer the exact question for you in terms of why you need the F-250. I think it comes down to the question that we get quite a bit, especially knowing that match week is literally coming up next by the time this goes live, that conversation of, “Hey, I finally got my big kid paycheck. I want to go get something fancy.”
And from our side of it, we usually say especially early on, you’ll have that time, that day will come. It’s probably just not yet. Especially referring to our younger physicians just getting fired up and finding that proper balance of “Yes, you’re a physician, yes, income has skyrocketed, but these are decisions that can have longer term effects.”
For us it’s always finding that sweet spot where it’s reliable, can make you happy, safe. And then we always will come back to and say it’s a deeper goals and values conversation. The advisor that I think does great with this is Daniel Wren, where he always loves to go a little bit deeper in those goals and values. If you love cars and you are a car collector and that’s something that you love, that could be a number that grows as we go forward. And that’s okay.
But the beauty about money and numbers in general is they’re true. That’s the number that we have. This is the money coming in, this is the money going out and this is what we’re going to build around. Whether it’s your F-250, a brand new Toyota Camry, whatever would be, I think everything has a reason for it. You just got to make sure that you understand the deeper goals and values behind it.
Dr. Jim Dahle:
Yeah. We do have needs. Down in my garage, and this studio is over my garage. Directly below me, we have four vehicles. We have a wake boat that lives inside the garage during the winter. We have a 2005 Honda Civic that my daughter drives to high school. Drives her and my son to high school in. We have a 2016 Sequoia and we have a 2023 F-250 down there. That’s what’s in my garage.
What does my family actually need? Well, we probably need a 2005 Honda Civic. That’s probably what we need. And if they’ve had 200,000 miles on it, that’s fine. That is our need. Everything else is a want. We don’t need three cars. My son and daughter can ride the big yellow limo. When I go to the hospital, it’s only six days a month. My wife can get by. She could Uber, she could ride her bike, she could walk to the places she needs to go. The other days of the month, we could share that 2005 Honda Civic. It’s not a need. Let’s not kid ourselves. The vast majority of the things we purchase in our lives now are not needs. And it’s important that we don’t let yesterday’s luxuries become today’s necessities. They don’t have to.
At the same time, you can’t take it with you when you go. There’s no benefit in being the richest guy in the graveyard. If you want something and you can afford that thing you want, not just afford the payments on it, but actually afford it, you can walk in there and pay cash for it, knock yourself out. I’m perfectly fine with it. Spend your money on what you want.
Now, why did I buy an F-250? Well, I’ve always wanted a truck and this is the first truck I’ve ever bought, number one. Number two, I’ve always wanted a new car and I’ve never driven a new car. I’m 48 years old and I’m driving a new car for the first time in my life. So, that’s pretty cool. It’s got all these great features. As I’m coming up to the curb to park it, it slams the brakes on even when I don’t want it to. It’s got these great safety features. It’s got all this cool stuff. It’s got satellite radio and it’s got all this other cool stuff. It puts some fancy shocks on it. It’s got this cool off road package. It’s something I’ve always wanted to have is to have a truck.
What am I actually going to use it for? The reason I need the truck is because I need to be able to put the raft in it. I don’t have a trailer and I couldn’t put the raft inside and on top of my Sequoia and take everybody going rafting with it. That’s the closest thing to a need of why I have a pickup truck.
I also happen to drag a wake boat five to seven hours one way over multiple mountain passes when I go to the lake. And this is going to work a lot better than that Sequoia is to tow that wake boat full of camping gear and other stuff. Those are the main reasons I bought it. Are they needs? No, that’s all totally recreational stuff I don’t need to do.
I think the other consideration with spending, and particularly when you’re wealthy as we now are, is that you can have a pretty significant impact on the planet. You can afford to have a big impact on the planet. And I think an undercurrent sometimes in the FIRE community, Financially Independent Retire Early community, is that maybe we have some responsibility there. Chad, how do you weigh in your responsibility to the planet with your wants?
Chad Chubb:
Yeah, it’s a unique example to plug in there, but we were a one car family for almost an entire decade. Now we got to Tampa. Tampa is a little bit more spread out. We were in Philly before, but it was easy. We bought the Jeep Wagoneer, I call it the tank because it keeps my three young boys that are all in car seats safe. And I never thought of anything else besides being safe. And I don’t know if you saw this on Twitter, I think it was last week, but essentially a guy had a Wagoneer. His wife and son were in a car crash and the cops pretty much said if it wasn’t for a Wagoneer, a car of that magnitude, not just a Wagoneer, that they were pretty much unharmed.
And it was amazing, though. Because when you read through the Twitter comments, it started to take this kind of evil turn to it where everyone was more about, “Well environmentally if everyone buys these larger cars, is that the offset?” And it’s kind of weird because there’s those moments where you’re not even thinking that way and then it has that effect.
And bringing it back, that was just a personal example of the car, but also to your deeper question in there. From our side, at least in the financial planning realm, we try to spend a lot of time getting into our clients’ deeper goals and their values. In particular, their values, goals is one of those things that we build together.
I think as a financial planner, our goal is to always guide our clients. If their goal is to be extremely conscious of environmental issues. We can even get into portfolio builds in today’s world. Whether that’s from a car perspective or they want to be the next Taylor Swift and they’re flying private jets all over the place, our goal is to really just meet them at their values and then help them build their plan.
I don’t think personally in 12 years of doing this, I’ve ever told a client or brought up environmental factors. And maybe that’s my fault as an advisor. Personally, I’ve never thought of that. And even coming into this question when you said that, it’s something that I never thought about in terms of the advisor side. Obviously from our personal family side, we think about it. I don’t have the best answer or the best response to say, “Hey, we’ve changed anyone’s viewpoint, good or bad, on that topic.” Because as the advisor, we just want to guide them to their points of concern, goals, values, and then from there build. I think you have given me something to think about, though, as we build these plans going forward.
Dr. Jim Dahle:
Yeah, the world is becoming wealthier. Even people we would call the lower class in the United States, they have a life that kings of 200 years ago would envy. They have the world’s accumulated knowledge on a six inch device in their pocket. They live in an air conditioned house or apartment or whatever.
As the world becomes more wealthy, as it will presumably continue to do, and more and more people are able to drive F-250s because they can afford them more and more people are able to get a net jet subscription and fly around the planet. There are consequences to this. We can’t all have six cars and be driving and burning up all the gasoline the world has ever produced. There are limits and you have to consider what responsibilities you do have to the planet.
I obviously love to spend a lot of time outdoors and probably lean more toward the environmental issues and I am a big fan of saving this planet that I care about so much. But it’s definitely something that is worth thinking about, worth talking about and worth considering and applying that value to your decisions. But guess what? An electric truck was not going to get me five hours towing a boat. The technology just isn’t there yet.
So, it was either going to be something like another Sequoia or an F-250. That’s what you get. I’m not quite willing to get rid of the wake boat and not willing to not travel around this wonderful American West that we have and see cool stuff. I guess we’ll deal with that as it comes.
All right, let’s get back into something less controversial. Let’s talk about this question from Steve about Mega Backdoor Roths.
DIFFERENCE BETWEEN MEGA BACKDOOR ROTH AND ROTH CONVERSIONS
Steve:
Hi Dr. Dahle. I was wondering if you could clarify the mega backdoor Roth versus Roth conversions for me. I think I’m missing the big picture on the difference between the two. I have pre-tax solo 401(k) money that I can convert to Roth 401(k) money in my solo 401(k) plan that I have through E-Trade. And my company this year just amended our retirement plan to allow for mega backdoor Roth contributions.
I was wondering why I would do one versus the other. It seems that I can just do the Roth conversions with my E-Trade solo 401(k) account and if I start to do the mega backdoor Roth contributions through my company, then I would have a separate account and have to track that. And it just seems like it would be some added work without any difference, but I might be missing something regarding the difference between the two. Thanks for any input you have and thanks for all you do.
Dr. Jim Dahle:
I actually think this is a place where there’s a lot of people confused out there. There’s a backdoor Roth IRA, there’s a mega backdoor Roth IRA, there are Roth conversions. Help us here, Chad, help us build a framework that will allow people to understand the differences between these things.
Chad Chubb:
Yeah, I actually had to go through Steve’s Speak Pipe a few times there just to make sure I was following everything he said because even the wording when someone is saying, “Hey, these are my options”, you want to make sure that you’re hearing them properly.
In short, one of those is a tax neutral event. One of them is a taxable event. Roth conversions are the taxable event. And this is the confusing part because backdoor Roth IRA is technically a Roth conversion, but you’re doing it ideally with after tax dollars, which then makes it the basis over. So, it’s a tax neutral event.
I’m going with this first point. The first point is the current 401(k) plan that allows for Roth conversions. That is going to be fully taxable. If you have $50,000 in your 401(k) and then you convert it over that $50,000 over to your Roth 401(k), that’s $50,000 of taxable income. Maybe that is a good plan. Ideally. It’s not perfect. There’s a lot that comes into “it depends.”
But we love Roth conversions, we love Roth conversions with all of our heart. And they can become one of your biggest tax savings. But usually that doesn’t get exciting until you are just about retired or income stop right up until about those RMD years. There’s a really beautiful time in there where you can really take advantage of Roth conversions.
On the other side of it, the true mega backdoor Roth, which when I saw this question Jim come in, I got super excited. You probably do not remember this, but my first guest post to White Coat Investor 2017, the mega backdoor Roth IRA. This is one of my favorite topics. So, I was excited to get this one.
But on that actual conversion there, inside of it, we’re doing the actual after tax 401(k). That’s where it’s different. When you have a plan that truly allows after tax contributions inside of your 401(k), this is not a tax deduction. It’s after tax dollars going in and then they allow the feature to either convert it to a Roth 401(k) or ideally they’ll let you actually transfer it out to a Roth IRA.
In this example, that conversion for the most part is tax neutral. And that’s where there’s a big difference because a Roth conversion is completely taxable. A true mega backdoor Roth IRA, if your 401(k) plan allows it, for the most part we’ll call it a tax neutral event. While they can easily get confused, drastically different game plans and tax consequences that come with them.
Dr. Jim Dahle:
Yeah, well said. I think what people don’t get. A backdoor Roth IRA is something you do with your IRA. A mega backdoor Roth IRA is something you do with your 401(k). Terrible name. I didn’t come up with that name by the way. It was there before I got to it. But basically it’s something you do with your 401(k). Even though it says IRA, it’s a 401(k) thing. So, if you can keep that much straight, that will help you a great deal.
A Roth conversion is just a movement from one account to another account. The destination account is always going to be a Roth account. The originating account kind of depends a little bit. Most of the time when it’s an IRA it’s going to be a traditional IRA, a rollover IRA, some sort of mostly pre-tax IRA that can also have after-tax money in it.
But within a 401(k) you often have three sub-accounts. My 401(k) here at the White Coat Investor has three sub-accounts. It has a pre-tax account, it has a Roth account and it has an after tax account. And so, the Roth conversion there when I’m doing a mega backdoor Roth as I do every year in that 401(k) is I move money out of that after tax account into the Roth account. Because remember, after tax, it’s great that when you take it out you don’t pay taxes on the original contribution, but you got to pay taxes on all the earnings. If you get into a Roth account, then you don’t pay taxes on the earnings either. That’s the real benefit there of doing that.
Keeping all that straight I think is a little bit tricky if you don’t talk about this stuff and write about this stuff every day. I’m not surprised that people are getting confused about it. And the rules are different for mega backdoor Roth IRAs and the contributions there and how it works as opposed to a regular backdoor Roth IRA. It’s hard to keep it all straight. So, we try to have tutorials up that’ll walk you through it every time you need to do it. And it helps if you’re doing it in one fell swoop every year too. But I know that can be hard for people to make all the contributions at one time during the year.
What else can we say about mega backdoor Roth, Chad, that hasn’t been said?
Chad Chubb:
Yeah. I think unique opportunity in there because Steve did note that there was solo K. Keep an eye on your solo K platform too because there are some solo K platforms that are much more flexible than we use Fidelity quite a bit. Fidelity’s solo K model is a real cookie cutter model. If you really want to customize it, you can, but you can even get into there where you’re doing a mega backdoor Roth through your solo K.
So, there’s a lot of unique things to do in there. If you get cranking up, if that 1099 income is really high and you are doing a mega backdoor Roth, for the full $69,000 for this year, if the 1099 income is really good because you’re giving up, if you do all that as after tax. If you wanted pre-tax contributions, we lost them, now we get Roth dollars. You can kind of layer in a cash balance plan that can get you some more tax dollars in. It depends on your situation too. Our docs in California, we’re trying to do as many pre-tax things as we can. That’s one thing to keep an eye on.
And I think 401(k)s are getting so much better, whether it’s just from the actual investment lineup or now us seeing more and more after-tax options. And with that, we’re seeing even auto Roth conversion features. Pretty much saying as soon as you put the money into the after tax, it’ll convert it automatically. Which as Jim noted there, that’s ideal because you want the growth to occur on the Roth side. You don’t want to put it in the after tax and then it’s growing and then you do the conversion because that growth is still taxable. We’ve seen this with some of the Kaiser groups where they’re now putting in that automatic Roth conversion feature.
If the 1099 income is there, really keep an eye on customizing a really neat solo K for yourself. But if you do have the option through work, see if they have that auto conversion feature because that can take one thing off your to-do list and also probably give you a little bit extra tax arbitrage in there with the auto conversion.
Dr. Jim Dahle:
Yeah, this is definitely a part that trips some people up because the cookie cutter off the shelf, Vanguard, Fidelity, Schwab, solo 401(k)s generally don’t allow these. You have to get a customized one. And we’ve got a list of people under the retirement accounts tab at White Coat Investor that can help you do this. It’s not that expensive for a solo 401(k), it might be a few hundred bucks to set it up and like $100 or $200 a year to maintain it.
So, it’s well worth it if you want to do mega backdoor Roth contributions. But it’s not typically a feature from the typical places you would go to open a solo 401(k) and not want to pay fees on it. It’s going to cost you something to add this feature. And if you have employees and it’s no longer a do-it-yourself 401(k) situation, it introduces some additional testing to your 401(k).
And so, we not only have testing to make sure we’re not discriminating against our lowest paid employees, when it comes to the employer match stuff, we also have additional testing when it comes to the mega backdoor Roth IRA contributions that Katie and I are doing. We’re the only ones at the company doing these, but there’s an additional test that sometimes requires us to make additional contributions to our other employees.
It can get really complicated. I’ve even heard it argued that a mega backdoor Roth even in a solo 401(k) is not a do-it-yourself project. I think if you’re really into this stuff, you can still do it as a do-it-yourself project, but if this isn’t your hobby, you probably need some professional help to do this.
PRE-TAX OR ROTH?
Okay, let’s do some pre-tax versus Roth questions. This one comes from Kim.
Kim:
Hi Dr. Dahle. My white coat is actually just a lab coat, however, my husband is an MS-4 who’s applying to residency this year. We were wondering if it might actually make sense for us to make pre-tax contributions to our retirement accounts in the coming years instead of doing Roth as we traditionally have.
In 2023, I was able to do a Roth conversion to get our entire retirement savings into Roth. And now with the SAVE plan, we’re wondering if it actually makes sense to try to reduce our taxable income a little bit by contributing pre-tax rather than Roth. I’m curious to hear your thoughts on this. Thanks for everything you do.
Dr. Jim Dahle:
All right. We’re getting more and more of these questions on the Speak Pipe. We can’t answer your question. We don’t have enough information. It’s impossible to answer that question. In fact, even if I had 10 minutes with you on a call, I might not be able to answer your question.
This is the whole reason we started studentloanadvice.com is to help people like you get the right answer to the question. This is going to take an hour to sort out with someone that has full access to your financial information to give you the right answer on whether you should do married filing separately, whether you should contribute pre-tax.
Obviously, the benefit of contributing pre-tax and doing married filing separately is to make your income as low as possible. That makes your SAVE payment as low as possible, makes your SAVE subsidy as big as possible, leaves the amount that could potentially be forgiven via PSLF or via SAVE after 25 years as big as possible. But whether that’s worth any additional tax you might pay, which you probably will by doing pre-tax in a year when you’d normally do Roth and which you’d normally do by filing married filing separately instead of married filing jointly, it’s hard to say. You got to run the numbers and compare it.
Are you getting this question as often as we are, Chad?
Chad Chubb:
Yeah. Yeah. You said it perfectly. It’s one of those ones where you need all the documents and an hour plus with Andrew to walk through it because there are so many moving parts. When we speak on this topic, we usually try to come back to keeping it simple on, “Hey, if you’re going for PSLF, there’s likely a good chance that doing pre-tax is a good call. If you’re not going for PSLF, usually in those lower income years the Roth is going to make a lot of sense.”
My biggest takeaway from Kim’s question was, especially again, coming into Match Week and a whole new group of physicians entering their intern year there, is married filing separately is a whole new ballgame. And there’s analysis. We ask, when we look at our client’s tax drafts that are going for student loan forgiveness, we want to see that comparison every year from the accountant. Married filing jointly versus married filing separately. We want to see the tax number and then we want to compare that to the savings on the student loans. And then we’ll let their tax filer know, “Hey, married filing separately by a long shot or married filing jointly works here.”
And it’s amazing how so many similar situations you think on paper the tax bill wouldn’t vary that much, but then the tax bill varies quite a bit. You said it perfectly, it’s not as simple. I try to work up some basic numbers, trying to compare the 24% to the 22% tax bracket, but even there you’re making high level assumptions where I’m just trying to compare that if you had that $23,000. If you only had $23,000 that you would’ve picked to which bucket you were going to move to, I always say teamwork makes a dream work in those early years.
And then comparing it to the SAVE program, if it was that simple, it’s a 2% versus a 10% savings, but it’s not that simple. And I was just trying to figure out how can I make this digestible to a large audience on a very complicated topic. And that’s as close as I could get.
Dr. Jim Dahle:
Yeah, I used to have lots of rules of thumb that were very helpful. Things like Roth is for residents. When you’re in residency, you should contribute to a Roth account. Well, the federal student loan policy has changed such that that’s not true for a pretty significant number of people. And it’s not just those going for forgiveness programs. Just because this subsidy for SAVE can be so big. It’s all the interest that is unpaid. That can be $1,000, $2,000 a month. It’s not a small amount of money. But you also have to consider the difference between what that Roth is going to grow to over the next 20, 30, 40, 60 years, maybe 10 more as it is stretched by your heirs. There are just a ton of moving parts here and it’s very hard to get it right.
The good news is, I don’t think you have to get it all right here. So, let’s say you did a Roth contribution instead of a pre-tax contribution. Now your SAVE payment is going to be a little higher. Maybe you get a little less forgiven. But you also got money into a Roth account when you are in a very low tax bracket. And that’s really beneficial.
So, I think if we actually run the numbers here, the amount of difference these little sorts of decisions where you’re trying to optimize and make are not as big as I think we fear they are. And I think for a lot of docs down the line, they’re going to have more than enough money than they need. And this sort of thing just doesn’t matter that much.
Let me give you an example for my own life. When I was in the military 2006 to 2010, my retirement plan was a Thrift Savings Plan and there was no Roth option. It was tax deferred only. And I was in a pretty low tax bracket. I was only making about $120,000 a year and about $30,000 or $40,000 of that was tax free.
One year I think I paid $3,000 in taxes. It was the year I was deployed. And meanwhile I’m saving money in a tax deferred account. I don’t know what it was. A 15% bracket, maybe the 10% bracket. I don’t know what it was. It was really low. I’m never going to be in that bracket again.
Clearly this was not the optimal thing. If I could have done Roth, maybe I would’ve even been better off saving in a taxable account than that tax deferred account because it’s like this reverse arbitrage of tax rates. But it doesn’t matter. I’m going to have enough money. And I’ve decided the money sitting in those tax deferred accounts is going to be used for charitable contributions.
So, it doesn’t matter that much for most of you out there, you’re going to end up with more than enough. You don’t have to optimize every single little thing. And some things are really difficult to optimize and this is one of them.
Chad Chubb:
Yeah, it’s one of those ones where just listen to Kim’s note. She’s financially savvy, she’s thinking through it, she’s putting money towards savings. That’s probably the most important part of all that. She cares about her financial situation for her and her husband. She’s saving. And while there might be “Well, we could have saved a little bit here, made a little bit here”, as long as she keeps that foundation and keeps it growing, we’re probably never going to look back to this episode and say, “Kim, if you would’ve changed it by that much you’d have retired 15 years earlier. We should have changed that.”
Take those victories, let those continue to compound. There’s always going to be, “Well, we could have done this or done that.” Personal finance is a lot of keep getting those small victories year after year after year and you’ll be in a good spot.
Dr. Jim Dahle:
Yeah. And for sure. Kim, you’re paying attention to this? Your husband’s an MS-4? You’re going to win. Just the fact that you’re asking this question, do you realize how much financial sophistication and education it takes to get to the point where you can ask this question? You’re a winner. You guys are going to be so rich. I can tell that just now from the fact that you’re asking this question at this stage of life. So, congratulations on that.
LIVE LIKE A RESIDENT
Dr. Jim Dahle:
All right, let’s introduce a little bit more controversy to this episode. Just because the Speak Pipes I don’t think naturally do it today. Let’s talk for a minute about “live like a resident.” This is a mantra I’ve had and I’ve been throwing out there since probably the first month of the blog. Since 2011 I’ve been telling people “live like a resident.”
This is a huge key to building wealth. Front load your wealth building activities. When you come out of residency, keep a lifestyle that’s about like what you had as a resident and use that difference between your resident lifestyle and your attending income to do all these great things like pay off your student loans or save up a big down payment or max out your retirement accounts, to do a Roth conversion, build an emergency fund. All that stuff you have to do, you now have more money to do it with if you’ll just live like a resident.
People don’t like to be told to “live like a resident.” And the truth is, lots of docs can still be successful without living like a resident. What do you think about this phrase, Chad? Where is this bad advice? Are there people that shouldn’t live like a resident? Should we make it less dogmatic somehow? What do you think the merits of that phrase are and how beneficial is it to doctors if they’ll do this?
Chad Chubb:
Yeah. And again, I’d love to fight you on this one, but since I quote this line and quote you in whether it’s blog posts, speaking engagements, YouTube videos, I think we put you in all of them with this sentence that you’ve created. I don’t know if you’ve copyrighted this one, but I hope you did.
We always come at it in a little bit of a different way in the sense of “Tell your money where to go first.” And we call it top down budget. And I didn’t come up with that term, but I’ve always liked the idea where, hey, if you get your new attending salary, obviously, we have the mortgage and expenses, we got to eat food, so we have groceries. But if you’re maxing out your 401(k), you’re doing your backdoor Roth, you’re getting X dollars into your joint taxable account every year, you’re putting some money away for the kiddos in the 529 plan. And the longer term outlook looks good because again, we’re sitting here in our 30s, there’s a lot of assumptions to say, “Hey, is that plan sick or not?” We’re going to have a lot of course corrections. There’s a lot of life in there.
I almost like to force that upon our new attendings as opposed to trying to nitpick the budget because we’re all humans. If it sits in our bank account long enough, we’re all going to go buy F-250s because it sits there and you want to spend it. We’re humans. We want to go spend that money.
We try to say, “Hey, put that money to good use at the start so that you almost don’t see it.” And some things are easier said than done. The 403(b), the 457(b), they literally won’t hit your actual bank account. But then the joint account, the 529 plan, those are things that they sit there. So, the sooner you can get them out, the better.
I wish I could argue with you on the “live like a resident”, but I think it’s important. And I think it brings in the importance, too, of just understanding your cash flow and budgeting. When we talk about one of the best foundational pieces of advice you can give both today, but also for decades to come. Whatever you’re spending is just knowing what you’re spending money on, money coming in and where it’s going. That puts you so far ahead of so many individuals in this world. Just knowing that.
And that’s where I think “living like a resident” is so powerful because if you go up to $300,000 a salary, but you’re still trying to live like you were at $60,000 or $65,000, that’s really powerful. And there’s always going to be some lifestyle creep. And we’ll tell our clients that, too. That’s normal. It’s okay.
Now, this is where we don’t want you to have the biggest house in the neighborhood. We don’t want you to have the most expensive car yet, and we’ll always come back and say “You’ll have that day.” If that is something you value and you really want to put time and effort to the biggest house because your family creates all the memories in the kitchen and the backyard, we’ll make that work. But you got to understand that today is your chance to get ahead on a lot of things, whether that’s student loans, whether that’s just getting the market or the stock market going in terms of compounding interest.
I think the term is beautiful. It’s straightforward, it’s easy, but I think the deeper meaning to that, too, is just understanding how to even live like that, which comes back to the word that not many of us love, but budgeting is so vital, and that’s where I think “live like a resident” has such a profound effect.
Dr. Jim Dahle:
Okay. “Live like a resident” is not a prescription for your entire career. The idea is not that you’re a 56-year-old attending spending $70,000 a year. A few people get that wrong. They leave a lot of money to their heirs. But when is enough, enough? How do you know it’s time to exit your “live like a resident” phase?
Chad Chubb:
Yeah. Probably the simplest way to look at it would probably be bad debts. Did you build up any credit card debt throughout your training years because you just needed some extra wiggle room? We work with a lot of academic physicians, so PSLF is a big part of the financial plan. That’s a number built in there.
But I can tell you for our physicians with private loans that is one where in a perfect world, we either know when you come out of it, we either know we’re going for PSLF or we know we’re going for aggressive payoff. And if we’re going for a five year, even a 10 year, or coming back to that five or even shorter, that would be a time where if you can get that bad debt out of your way, I think that would be a good time where you can open it up a little bit. That would be probably the easiest description of when can you loosen it up a little bit.
And I also agree with your last note there. You can also take it too far. I joke with our clients “the day that I tell you, you don’t need to actually max out the 457(b) plan because now we’re starting to hit some serious RMD issues down the road because it’s too much pre-tax” or “Hey, we can actually maybe turn back some of the risks because we don’t need grand slams anymore. We’re okay with singles and doubles the rest of the way out.” Those are all really good signs coming from your financial planner. I think it depends on a case by case basis, but I’d say at the very onset, the sooner we can get any bad debts out of the way, that probably gives a lot more wiggle room on the discretionary spending.
Dr. Jim Dahle:
Yeah, I’ve always thought of it generically as a two to five year period, but the only real thing that I can think of out there that marks the end of it for lots of people is to have the student loans gone. And that’s not necessarily a five year thing. Some of those, it’s a seven year thing. For most of them, it shouldn’t be longer than that, though. And if you were in training for six years, it might only be a four year thing before you get PSLF.
But I think there’s very few docs that won’t benefit from doing it for a year or two and that will regret that. You’re only putting things off for a little bit longer and it just makes everything else the whole rest of your life so much easier to front load all those financial activities.
Plus, I’ll promise you this. It’s cool. There’s still time to do fun stuff with your money in your 40s and 50s. It’s not like you’re an old dried up fogey at 51. I’m still doing lots of cool stuff. I’m almost 49 years old. It’s not like you can’t do stuff that you can only do at 32 when you’re 45. That stuff is still going to be available to you.
All right. By the way, we have a Physician Freedom Summit coming up. This is put on by Dr. Param Balandapani. I always have trouble with her last name, but Param is putting this on. And I participated in it. It’s a three day summit. It’s free, it’s online. She’s calling it the Physician Freedom Summit. It’s March 7th through 9th, which means it’s starting today. You can sign up for that at whitecoatinvestor.com/freedom. Totally free to you. My talk in it is about common mistakes wrecking your finances. So, check that out.
All right, let’s take another question off the Speak Pipe, Chad.
CAN YOU DO A BACKDOOR ROTH FOR 2023 IF YOU HAVE NOT CONTRIBUTED YET?
Speaker 2:
Hi Dr. Dahle. I was wondering is this still possible to do a backdoor Roth for 2023 if I haven’t made my contribution yet? I’m planning to make my contribution this month in February, 2024. Thank you.
Dr. Jim Dahle:
Okay, I think this one’s actually got a correct answer to it. Let’s talk about that and let’s also talk about the merits of doing it late and whether you should do it late and all that stuff because there’s an awful lot of people out there doing these contributions late.
Chad Chubb:
Yeah. Not much to fight over here. In short, yes, you can still do it up until your tax filing deadline, April 15th of this year, you can still make the contribution. I always say that the contribution is the important part. That’s the deadline you’re trying to follow. The conversion has no deadline. You can do the conversion wherever you’d want. It brings in our 8606. I always say when you start to do backdoor Roth, either do the Google search. Jim, I think you have a great one where you’re walking through the 8606 or make sure your accountant knows that you did that. Probably one of the most commonly missed tax forms we see even with accountants. And I think it’s because we do the backdoor Roth and we assume it doesn’t trigger any tax documents.
In defense of your accountant, if they didn’t know that, they’re not going to file the 8606, if they didn’t see that 1099-R coming out of the backdoor or out of their IRA to the Roth. 8606 comes into play. You can still do it up until April 15th of this year. And then we can even get into next on the merits of you do it first thing in the year or you do it later in the year.
Dr. Jim Dahle:
Yeah. One thing to keep in mind, even if you do a tax extension, which I’m having to do with my taxes these days, now that I’ve got all these private real estate investments that send me a K-1 in July. Even if you do your tax extension and you’re not filing your taxes until October 15th, your deadline for your IRA contribution is still April 15th. You can’t do it in August for the prior year.
Now this drives me nuts though. So many people don’t do it in the calendar year and then get confused when it comes time to get their 8606s done. I do mine the first week of January of the year you’re doing it for. This is the first money I save for retirement every year as my HSA and my Roth IRAs. Why do so many people do this late, Chad?
Chad Chubb:
It’s funny too because we actually have a day that we call backdoor Roth IRA day for our practice. And it’s usually January 3rd, it depends on where the holiday falls. And it’s actually amazing. We have a pretty equal split of about half of our clients will get it done within a few days right there. But then the other half, we’re checking in again right now because we don’t want them to miss that opportunity. Because as you said, I would say there’s no extension on that extension. So, we’re checking now with a lot of clients to make sure they get them done if they haven’t done it yet for 2023. And it’s amazing. It’s truly split between the two. Ideally we try to aim earlier in the year, we tell our clients this too because we want the extra year of compounding growth with that tax free money.
Your team just had that great post on where things can go wrong. So, there are certain years where waiting till later in the year might make sense, so you don’t have to clean anything up. But I think in most circumstances, especially when you hit your rhythm and you’re in your attending phase, hopefully nothing divorce wise or anything comes into play there, early in the year is where we try to aim for it. But I think there’s an asterisk there on my favorite word of the day. Again, it depends where it might make sense a little bit later in the year.
Dr. Jim Dahle:
Yeah, I love your phrase hitting your rhythm because what happens is you come out of training, and you got all these great things to do with your money. You haven’t done an IRA contribution for that year yet and you’re like, “Ah, what do I do first?” And you’re like, “Well, I got this $13,000 credit card debt at 28%.” Well let’s do that first. That’s what you’re doing in July and August.
And now it’s September and you’re like, “Well, I don’t really have an emergency fund. Well, let’s build that up.” That’s September and October and now it’s November. And you’re like, “Oh, if I don’t get money into the 401(k) they’re letting me use, I’m not going to be able to use it.” They probably won’t let you use the first year anyway, but maybe you put money in the 401(k) in November and December.
And then January you’re like, “Oh, there’s an HSA, maybe I should do the HSA.” So, you put some money in the HSA that month and all of a sudden now you’re starting to make student loan payments. Now you’re doing the student loan thing, and before you know it, it’s February or March or April and you still haven’t done your IRA for the year. That year you make a late contribution.
The next year you’re like, “Well, I don’t want to do that again. The 8606 was a pain.” So, now you do it in December. And maybe the year after that you’re doing it in July and the year after that you’re finally getting it to January because you’re in your rhythm. I like that phrase you use, “in your rhythm.” And I think this happens to a lot of people where they move their IRA and their HSA and their 401(k) contributions earlier and earlier and earlier in the year because they’ve become wealthier, they got better control of their income, they’re making more, they have fewer good uses for their money. There’s no more 28% credit cards to pay down and they can do it earlier and earlier in the year. I definitely encourage people to do it during the calendar year.
I think the worst time to do it though is not after the first of the year. The worst time to do it is the last week of the year. Because so often people get burned, they get the contribution in, they don’t get the conversion done, and now they’ve got this, especially if they’ve been doing them for a number of years, now they get a prorated transaction and that really makes your paperwork complicated. You can still clean it up the next year most of the time, but if you want to keep your paperwork straight, do it all in the calendar year. It just makes it a lot easier.
Chad Chubb:
Yeah. And you always hit that backlog with the custodians at the end of the year. So, even if you’re thinking like, “Oh, there’s enough time there”, there’s always a backlog because everyone else is doing it at the Vanguards, the Fidelities, the Schwabs. You get that in there, which is why it’s more likely to have that small delay and it’s always just enough that it pushes to the first or second.
And one thing to note too, I always call this the golden window for backdoor Roth because you do have the opportunity if cash is available where you can take care of a 23 and a 24 at the same time. If you’re playing catch up and trying to get into that rhythm, you do have that sweet spot right now where you can really get both of them going at one time here.
Dr. Jim Dahle:
Yeah. And I think it’s important to emphasize what you said at the beginning. The contribution has a deadline, the conversion does not. As a general rule, you should do the conversion as close to the contribution as you can, but there’s no deadline on a conversion. You can do a conversion at any time. It just ends up on the paperwork for whatever year you do the conversion in. But the contributions are where the deadlines are.
All right. We’re getting toward the end of this episode, Chad. You have 30,000 docs out there listening to you. What pearl of wisdom do you feel is most important to distill upon them at this moment? What’s been on your mind lately?
Chad Chubb:
Yeah. This time of year with, again, match season. It’s a lot of just getting that foundation. And I think you’re one of the best advocates for it. I think in the physician world in particular and adding other high income professionals as well, we think that we have to overcomplicate things because “I make so much money, I have to do something more complicated. It can’t be this simple. I just have a qualified account through work, a backdoor Roth in this massive taxable account. I got to overcomplicate, I got to add something in there.”
You can be extremely dangerous over a very long time by just keeping it simple. And that can venture out. I know real estate is always near and dear to your heart too, and with a lot of our clients it is as well, but it’s amazing on how you can just keep it simple, build that foundation.
In terms of financial advisors, you always think of investing where I come back all the time and say ideally our biggest value add is on the tax planning side, but also why asset protection is so important and risk management is so important. And yes, no one likes to do estate documents, but they’re still really important. I often make the joke I’m honored that my clients usually have their estate documents done before their parents.
So, it’s just getting the foundation in place and then building up. Automate, automate, automate. And keep it simple. Keep it simple. I know we’ve even made the joke just kind of going through some of the different Speak Pipes, but if you’re paying this much attention right now, you’re tuning into the White Coat Investor podcast and reading the blogs and you’re collecting all this knowledge, you are going to be in a very good spot if you’re implementing a fraction of the things out there. So, keep it simple, keep working hard and you’ll be very happy with the outcome in the end.
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Dr. Jim Dahle:
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All right, don’t forget about our course sale. It ends tomorrow. All courses are $100 off, including our new CFE 2024 course. That’s at wcicourses.com. Don’t forget about Param’s Physician Freedom Summit, March 7th through 9th. You can sign up for that at whitecoatinvestor.com/freedom.
Thanks for those of you leaving us five star reviews and telling your friends about the podcast. A recent one comes in from Doug who said, “Great podcast. WCI should be required reading and listening in medical school and residency. I started listening around 2016 and have listened to every episode since and have learned so much. I am now retired from medicine and still enjoy listening and reading and learning from both the WCI podcast and blog. Thanks for the great work and helping us docs get our finances on track.” Five stars. Thanks for that great review, Doug, and congratulations to you on your retirement.
For the rest of you, keep your head up, your shoulders back. You’ve got this and we can help. Thanks again to Chad Chubb for being on here and helping us to do this great Friends of WCI episode. We hope you like these. Send us an email, tell us what you like, what you don’t like, and we’ll try to make this podcast as useful as we can for the time you’re investing in it. Thank you so much for your confidence and faith in us and the time you’re willing to spend with us. Bye-Bye. See you next time.
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.
Milestones to Millionaire Transcript
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 160 – Dermatologist pays off student loans in less than a year despite getting hosed by private equity.
At some point in our financial lives, it’ll be time to buy a home. A physician mortgage can be a good vehicle for a young doctor who’s just out of school and has a more effective place to use their money than on a big down payment.
These loans allow doctors to secure a mortgage with fewer restrictions and a lower down payment than a conventional mortgage. If you’re further advanced in your career or deeper into your journey to financial freedom, buy a home with conventional mortgage and then later on potentially refinancing that loan to a better rate with a shorter timeframe could be a great move.
Wherever you are in your financial journey, make sure you use the mortgage that will be most beneficial for you. Hop over to our recommended tab to learn more about all of your mortgage and refinancing options at whitecoatinvestor.com/mortgage. You can do this and the White Coat investor can help.
Okay, it is now by the time you hear this, I’m recording it in January, but by the time you hear this, it’s March and we have got our new Continuing Financial Education 2024 course out. And until March 8th, all of our courses are on sale for $100 off, including this new CFE 2024 course.
You can get the latest in physician wellness and financial literacy in this course. You can get it for cheaper than you’re going to be able to get it later in the year and you can check the stuff out that we did at this year’s WCICON. You can watch my two keynotes. One on the unsung benefits of index investing and one on advanced estate planning. You can see Paula Pant’s talk, how to re-engage and remotivate when burned out. And you see presentations from 30 plus other experts from WCICON24.
But if you’re interested in boosting your personal wellness, fine tuning your financial plan, investigating tax reduction strategies, living a more intentional life or planning for retirement, this CME eligible course has something for everyone. Go to www.wcicourses.com and take $100 off until March 8th.
All right, we got a great interview today. It’s pretty cool. And it took a pretty hard turn in the beginning of the interview and we explored something I don’t think we were exactly expecting to explore, which is the effect of private equity on the lives of young doctors today. Let’s get Adam on the line. Let’s do this interview and after we get done, I’m going to talk a little bit about private equity, but also let’s talk about house buying. Adam was pretty glad he didn’t buy a house you’ll find, and we’re going to talk about when buying a house is an appropriate thing to do and how to do it the right way.
INTERVIEW
Adam, welcome to the Milestones to Millionaire podcast.
Adam:
Thank you for having me. I’m happy to be here.
Dr. Jim Dahle:
Tell us what you do for a living and how far you are out of your training.
Adam:
Sure. I am a board certified dermatologist. I finished my residency training in Washington DC and I completed that in the summer of 2022. After that, I moved down to the southeast. Initially I was in Atlanta, Georgia for my first year of practice. And then after that moved out to where I’m now I’m in Athens, Georgia, and I’ve been here for about the last three to four months.
Dr. Jim Dahle:
Okay. And you had, at least financially speaking, an extremely successful first year out of residency. I congratulate you on that. You’ve accomplished two notable milestones during that year. You paid off your student loans and you built a substantial net worth. I think when you applied for the podcast it was at $150,000. I imagine it’s higher than that now.
Adam:
Mine has stayed kind of the same. And that goes into the conversation as to how things panned out with my finances. I’m from North Dakota originally, and I did both my undergraduate and my medical school there. And the great thing about staying in state and going to a state school was that it kept my debt load extremely low. I was able to get through all of my undergraduate training without ever taking out a single student loan. I’m really fortunate and that was because of academic scholarships.
And then for medical school, the University of North Dakota, relatively speaking, is affordable for medical training. My training per year was right around $30,000 on average, and I was able to combine using some savings and my undergraduate fund to help keep that burden low.
And then when I got out of training, I just prioritized paying down the debt. But the reason things have stayed the same is mostly because I’ve been trying to start my own practice and my own business. And so, that is where a lot of my funding from the last few months has gone.
Dr. Jim Dahle:
Okay, very cool. So, your total amount of debt when you came out of medical school was what?
Adam:
Total debt between things from undergrad and med school total to $70,000.
Dr. Jim Dahle:
$70,000 is like a miracle these days.
Adam:
Yeah.
Dr. Jim Dahle:
I look back and I think, “Man, if I hadn’t gone into the military, I think I could have gotten out with about $70,000 worth of debt.” But that was over 20 years ago. That was a long time ago. And you still pulled it off today despite the fact that tuition’s gone up, cost of living’s going up. You said you had some savings. Did you have a prior career or something? Where’d that savings come from?
Adam:
No. When I was born my parents prioritized our college education, so they didn’t put it into a 529, but they put aside some money into stocks and investments for my brother and I. By the time I started medical school was right around $90,000. And what I did is the first two years of medical school, I was able to get by on some of the extra scholarships I had from undergrad, and then I took some of that investment money and paid for the third year of medical school part of it anyway.
And then third and fourth year I took out that amount of loans that we talked about around $70,000 in total. And that’s how I was able to get through it. At the time there was a lot of sacrifices that were made to make that happen, but when I talked to my cousins and my family these days, it was totally the right decision. If anything, the best type of debt to have is keep it as low as possible by making those smart financial choices when you’re in the moment.
Dr. Jim Dahle:
Yeah. A combination of paying for medical school. And I think that’s what happens with a lot of people. Their family helps them to a certain degree and they borrow to a certain degree and they live frugally and maybe even work a little bit to a certain degree and they piece it all together. But still even people doing that on average, they’re coming out with $200,000. So, keeping that to $70,000 is impressive.
Adam:
Yeah, it was awesome.
Dr. Jim Dahle:
Okay. So, you got that paid off, but you also were putting money away. What was your net worth when you came out of medical school? Minus $70,000?
Adam:
My net worth was actually closer to negative $100,000.
Dr. Jim Dahle:
Okay. A little bit other debt there.
Adam:
I did. Yeah. When I was in my final year of residency, I was very forward thinking about what I wanted for a career. I knew I wanted to be part of a private practice and that’s what brought me to Atlanta, Georgia initially. What I did is DC, no matter where you live, is pretty expensive, honestly. And so, a resident salary doesn’t cover it.
My last couple months I maxed up my 401(k) while I was still a resident in those last six months and lived off the bonus money and then took out a 0% APR credit card and put a lot of expenses onto that. When I finished my residency training, it was not just the student debt, but about $30,000 in credit card debt. When I started my job, the first thing I did was paid off that 0% card. So, I never accrued any interest on that. And as soon as that was gone, I started my emergency fund and I was a little more aggressive. I didn’t get quite to six months before I started paying on the debt. I just really wanted the student loan debt gone because I think for a lot of us it just feels really heavy.
And I know we talk about golden handcuffs when it comes to having a high income, but I look at student debt and really any type of debt you have, those are also golden handcuffs because if you have to make a payment every month, you need to have income to cover those expenses.
Dr. Jim Dahle:
Yeah. Single, married, kids, anything?
Adam:
Partnered but not married at the moment.
Dr. Jim Dahle:
Partnered. Okay. This was a pretty dramatic drop in cost of living to go from DC to Atlanta.
Adam:
Yeah, we chose to live still in a part of the city that would make us comfortable and happy, but my total living costs from rent, parking, all of those things went down by about $600 on my end.
Dr. Jim Dahle:
Okay. Very cool. Well, you put a lot of money into savings in the last year. Dermatologists make good money, but not insane money. Clearly you kept your spending down. How did you do that in your first year out of residency?
Adam:
I really just prioritized creating a budget before I finished residency, knowing how I would allocate that expected salary. I knew what my rent was going to be. I had an understanding of what the splurges were going to be for me. I still have not spent a ton of money on clothing. I’ve never bought a new car. I still have the same car that I got when I was an undergraduate student. And the splurges I did have were those more experiential things.
I did go on a couple of nice vacations during my first year of work, but I would also say the most important thing that I did is that when I started at my last job, my first job out of residency, I was there to hustle. I worked hard. I got my name out there, I got busy really quickly. And that was both because I was at a good practice, but also because I put in a lot of legwork. And so, part of my success was that I was able to make a really good bonus in that first year. And that’s something that not every specialty or every graduate can even walk into depending on the type of practice you sign with. But that was one of the perks of being with a private practice that was well run.
Dr. Jim Dahle:
It doesn’t sound though that you were entirely happy with it. You’ve now gone out and you’re starting your own practice. Tell us about that decision.
Adam:
Yeah, that was where the bump in the road happened. I knew when I finished residency that I’ve always wanted to own my own practice. Especially in dermatology, the dermatologists that I think are the movers and shakers in our field, they were all private practitioners. They owned their own practice and they were really innovative. And that’s the coolest part of dermatology.
I joined an amazing private practice, and private equity is a really big force, not just in dermatology anymore, across all specialties, unfortunately. And about 10 months into my time at the practice, I was on a partnership track that would’ve been at two years where I could have become partner, but 10 months in, they chose to sell to a private equity firm.
And so, ultimately it became a really tough decision because my contract was for two years, so I could have chosen to stay and ride out the two year contract. I had the option obviously of looking for a new job, and that’s what I did. I now work as a 1099 physician at least for this year.
And then the other thing too ultimately is that as a young dermatologist, one thing I was really suspicious, no matter where you sign, I really wasn’t that trusting of, sorry, the last generation of doctors because so many people had chosen to sell and just not be transparent about their interests. I thankfully had already started planning for some type of practice while I was still in my first job. But nonetheless, the last couple months have been a huge learning curve because it’s not only just getting comfortable being a full-time practicing attending, it’s learning to run a business, learning to create systems and just feeling your way through everything that comes with trying to start your own practice.
Dr. Jim Dahle:
You signed with this job a number of months before you started because you had to get licensed in Georgia and credentialed and all that sort of stuff. And then you were 10 months there working. When did you find out that the practice was going to be sold?
Adam:
They told me the day after they signed the paperwork.
Dr. Jim Dahle:
Which was 10 months into it or how far?
Adam:
Yeah, I think it was like May, May 4th, May 5th, somewhere. It was the first week of May is what I remember.
Dr. Jim Dahle:
Nobody mentioned it when you were interviewing it. Nobody mentioned it for months while you’re working alongside him. It was all under wraps.
Adam:
Yeah. And to be fair, when I interviewed, with every practice, one of my questions that I always asked was, “Do you intent to sell to private equity?” Of course, nobody is going to tell you that they’re going to do that. And the day before I signed my true letter of intention, I was chatting with someone at the practice and the comment they made was that we can never say we would never do it. And that gave me a lot of pause because I was like just the fact that we’re throwing that out there, it’s something that that’s concerning to me, but it is the reality of this moment in healthcare. If you’re not selling to private equity, a lot of hospitals are gobbling up private practices. But once they did that, for me, because that was so important to me and so foundational to my ethics and professionalism as a physician, it made it hard to see myself being able to stay.
Dr. Jim Dahle:
Yeah, I can understand why. Did you buy a house in Atlanta?
Adam:
No, we rented. We’re still renting because we’re trying to figure out. I think I’ve finally narrowed down where my practice will be. But again, I look at those as they’re golden handcuffs. If you buy property or buy a car, in particular, those two expenses, unless you’re paying for it straight out in cash, you have to cover that expense every month. And that’s something I’m grateful I didn’t do.
Dr. Jim Dahle:
Yeah, I can imagine. Very cool. Well, despite that rather huge bump in the road that you hit in your first year, you still had an extremely successful first year out of residency. I’ve often said that’s the most important year in the financial life of a doctor and you nailed it. And that sounds like mostly because you put a plan in place before you got there and you work the plan. What other advice do you have for somebody that’s in your situation? Maybe they’re going to graduate this summer and they want to have as successful of a first year out as you did?
Adam:
I tell all my friends universally and I know I’m fortunate because other colleagues of mine who went to the same medical school as me have substantially more debt than I do. But I tell everybody don’t buy a house and don’t buy a new car if you can. And the reason for that is those are the two biggest fixed expenses you could have. And instead try to really just prioritize, number one, what I would do differently is I probably would prioritize a little bit more of having that six months savings fund done initially because you never know what’s going to happen or change with your job. Your dream job can become not your dream job fairly quickly.
But the other thing I would say is just try to get rid of the debt. I remember even when I was making really good money around Christmas time of my first year out, and I really had my expenses under control and was saving, the debt just for me at least was emotionally. It really weighed on me. And every night you would go to bed and it just was that thing at the back of your mind. And when I paid my final student loan payment this past September, I just remember this immediate feeling of relief. And when you’re not having to think about that, it makes planning for creating the type of practice you want, the type of career you want so much easier.
Dr. Jim Dahle:
Awesome. Well, congratulations to you on your success and thank you so much for coming on the podcast to share it with others and inspire them to do the same.
Adam:
Absolutely. Thank you for having me.
Dr. Jim Dahle:
All right. I hope you enjoyed that interview. Wow, private equity. You never know when it’s going to happen. I guess it’s not private equity’s fault. A doc could sell their practice to a hospital, they could sell it to another doc, et cetera. But when you come in to a pre partner track, a partnership track, whatever you want to call it, and they’ve been talking to private equity about selling it, and don’t even mention that to you, that just doesn’t feel right to me. They tell you the day after they’ve signed the paperwork. Really? And you’ve been in a partnership track for 10 years? It seems like dirty pool to me.
But it’s something that happens out there. And the problem is, for those of us who don’t do that to our fellow docs, all the people we interview are worried about this. This is something I’ve been talking to people about. I’m on the whatever we want to call it, the recruiting committee for my partnership. And just about everybody we’ve interviewed in the last five or six years has asked about this because they’re worried about it.
Graduate residents are worried that they’re going to go into a partnership track, get paid less than they would just being an employee, and then it’s all going to blow up in a year or two years or whatever before they make partner. And it’s always been a concern that you just get hosed and they say, “We don’t want to be your partner after you do this for a year or two.” But now there’s this very real concern that they’re just going to sell out to private equity and you’re going to be stuck with your private equity overlords or stuck as an employee or basically not getting to be an owner of the practice like you were planning to eventually.
Make sure you explore that in your interviews. And docs, let’s treat each other well. It’s okay to sell if selling’s the right thing to do, but keeping your pre partners completely out of the loop, not offering them some sort of compensation for the sacrifices they’ve made, that’s not the right thing to do. Let’s make sure we’re treating each other well and not eating our young.
FINANCE 101: BUYING A HOUSE
All right. I promised you at the beginning we’re going to talk for a few minutes about buying a house. Adam was obviously super glad he didn’t buy a house in Atlanta. And my caution with buying a house is that you don’t want to buy a house until both your professional and your personal life are stable.
And obviously in this case it was still in a partnership track that didn’t feel real stable. It turned out to be less stable than he thought it was going to be. It doesn’t sound like with a partner that he was necessarily in a stable personal situation either. So, not a great time to buy a house. Thankfully he did not because chances are he would not have recovered the transaction costs of buying that house, selling it only a year later. And that’s a real problem. You can lose a lot of money.
The round-trip transaction costs for a house are about 15% total. About 5% going in, about 10% going out on average. And if that’s a half million dollar house, that’s $75,000. If that house doesn’t appreciate $75,000 in the time you own it, you’re going to lose money aside from the hassle and the time of ownership and buying and selling and all that kind of stuff.
When your life is stable, buy a house. I’m a big fan of home ownership. In the long run you’re putting some sort of a cap, some sort of a limitation on what your housing costs are. They generally do go up in value over time. Time heals all wounds in real estate. It’s the right thing to do. If you’re going to be there for longer than three, and especially longer than five years, you usually come out ahead buying a house. Less than that, it’s a gamble. And so, as a general rule, you want to make sure you’re going to be there for years before you buy.
Now, doctors in their first year out often don’t have a lot of cash and they’ve got a lot of uses for cash. They’ve got their credit card they have to pay down like Adam had, they’ve got a car loan, they had to replace that beater they bought as an undergrad or they’ve got student loans to pay down or they want to max out their retirement accounts or they want to build an emergency fund or they want to buy into a practice or open their own practice or save up a down payment.
There’s all these other things competing for your dollars, and this is where a physician loan can come in. The idea behind a physician loan is you don’t have to put down 20%, but you can still avoid private mortgage insurance. Remember, private mortgage insurance or PMI is that insurance that the lender makes you buy to cover them to cover the risk of you defaulting on the mortgage. It doesn’t actually help you at all. So, avoiding it is a good thing.
And the nice thing about a physician mortgage is despite not putting 20% down like you would have to with a conventional mortgage, you can put less than that down and still not have to pay PMI. In addition, they generally don’t require you to show pay stubs for a few months. A contract is good enough. They only look at the payment that’s due on your student loans rather the entire debt balance. And so, it just works out better for lots of docs trying to buy their first home in the first year or two out of their training.
Now, if you’ve got a down payment, if you’ve taken the time to save one up, if you didn’t have a better use for your money, great, you can just get a conventional mortgage. But that doctor mortgage makes sense for lots of people for their first home. Don’t let it cause you to buy a home before it’s the right time to buy it, but when it is the right time to buy it, it’s okay to use a physician mortgage and use that limited cash for other potentially better purposes like paying down your student loans or maxing out retirement accounts, those sorts of things.
Now, as far as how much home to buy, my general guideline, and it’s a rule of thumb, so it’s easy to find exceptions to it obviously, but don’t assume that you’re an exception just because you can think of an exception. The general rule is keep the mortgage to no more than two times your gross income. Not what you think your gross income will be someday, but two times your gross income now or in the contract you just signed, et cetera.
And what that does is that helps you to not be house poor. It allows you to have enough cash flow each month to continue to build wealth. Now in high cost of living areas, that often requires you to stretch that a little bit. That was easier when interest rates were low. Now that interest rates are kind of back to historical normal of 6 or 7%, that’s a little bit harder to do.
But when I say stretching, we’re talking three times your gross income. We’re not talking about 10 times your gross income. If you go buy a 10X house in San Francisco, don’t be surprised when it dominates your financial life and potentially even lose it because you can’t take care of it in the event that something happens to your income. So, be careful how much home you buy. Try to keep the mortgage itself to less than two times your gross income. That might require a bigger down payment, it might require more likely a less expensive house.
Other guidelines that can be useful is keeping what you spend on your house including mortgage, taxes, property taxes and insurance and utilities to less than 20% of your gross income. That’s another good guideline to follow. They’ll lend you a lot more money than that, but taking it out is likely to impede your wealth building progress. A home does help, but it doesn’t help nearly as much as putting money toward investments.
SPONSOR
All right, if you need our help with a physician mortgage, you can go to whitecoatinvestor.com/mortgage. We’ve got options there for physician mortgages, conventional mortgages, mortgage refinancing. As interest rates fall, you’ll be able to refinance through links there. Keep in mind that you marry the house and you date the rate, and hopefully as rates fall, you’ll be able to get a better deal than when you first bought the mortgage.
All right, keep your head up, shoulders back. You can do this. The White Coat Investor is here to help you. If you want to come on the Milestones podcast, you can apply at whitecoatinvestor.com/milestones. If you want your questions answered on the regular White Coat Investor podcast, go to whitecoatinvestor.com/speakpipe. See you next time.
DISCLAIMER
The hosts of the White Coat Investor podcast 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.