Proposed Retirement Plan & Tax Rules for the Wealthy | White Coat Investor (2024)

What Is Going on with the Tax Bill in Congress?

The House Joint Committee released a document on Sept. 13 with the proposed reforms on taxation. The document was reviewed the next day by the House Committee and was then published to the world. The Committee said it's planning on going through the reconciliation process, which would essentially make this bill filibuster-proof when it gets to the Senate. And with Democrats controlling the House, the Senate, and the White House, chances are, in some form, this bill is going to get passed.

I normally don't spend a lot of time talking about bills that haven't yet been made into law, but I am making an exception for a few reasons. One, it's fairly likely that something is going to get passed. Second, almost everything in this bill is going to affect you.

President Biden has said many, many times that his priority is to not raise taxes on anybody making less than $400,000 a year. Now that's a little bit nebulous, right? There are all kinds of income out there, such as total income and adjusted gross income and taxable income. But basically, it will be $400,000 if you're single, and $450,000 if you're married. These taxes are all aimed at people making more than that. The government basically feels that higher earners are not paying their fair share and should pay more in taxes. That's the big picture that you need to understand as we go into this discussion.

It is also important to remember that this thing is just a bill and it is still a long way from becoming law. But it's good to be informed and to try to make an impact on your elected representatives. I highly recommend that you contact your elected representatives and express your probable displeasure with this bill. One of the easiest places to do that is at house.gov, click on the search bar for “Find your representative”, and send an email. I've already emailed my representative, although I'm quite confident he won't be voting for this bill.

I wouldn't make a lot of changes to your financial plans based on something that is just a bill. It's going to change significantly between now and when it becomes a law, and if it is not a change you would make normally, you really ought to think twice about whether you want to do it until it actually becomes law.

What Is Not Changing in ProposedTax Bill?

There has been a lot of talk about some changes that could happen that are not in this bill. And you should be aware of those things, one of which is an elimination of the step-up in basis in death. This basically says when you die and your grandkids inherit your house, it's as though they bought your house on the day you die. For tax purposes, they don't have a gain. They start with the value on the day you died. That is not changing. Which is good. I think it would be bad policy to change that.

Another thing they've been talking about is equalizing capital gains taxes and ordinary income tax rates. They are talking about raising both of those but decided not to equalize those. This is also good news. There are a couple of reasons why long-term capital gains taxes are lower than ordinary income taxes. One is recognizing that a lot of those gains are just inflation. You really shouldn't have to pay taxes on inflation. But two, it encourages investment. I think there's a good reason to have a lower long-term capital gains tax than income tax rate. That is not changing either.

Changes to Income Tax Brackets

Let's talk about what is changing if the bill were to pass in its current form. Probably the biggest is the ordinary income tax brackets would rise, primarily the top one. Proponents of the bill say it is basically just going back to what it was before the Trump tax cuts three years ago. We would be going back from 37% to 39.6%.However, the current top tax bracket, if you're married, doesn't start until $628,000. Under this bill, the top tax bracket will start at $450,000. It is not just people going from 37% to 39.6%. There are going to be a lot of people going from 35% to 39.6%. They are changing where that bracket starts.

An entirely new bracket will also be created for $5 million annual income earners. Granted, this bracket is not going to affect most of the people listening to this podcast, but nevertheless, it's a new tax bracket. But they're not calling it that. They are calling it a 3% surtax, but it functions like a tax bracket. So, in reality, the top tax bracket is going from 37% to 42.6%. And yes, in addition to that, you've still got the 0.9% Obamacare tax as well as the 2.9% Medicare tax on top of that. And of course, you've got state taxes, which in my state is about 5%. In California, the top bracket is 13.3%. That all still applies.

In fact, if somebody is making millions of dollars a year in California, they are going to be looking at a marginal income tax rate of about 60%. That's right. So, three-fifths of every additional dollar they make is going to the government.

Another big change is increased capital gains tax brackets. Instead of the top tax bracket being 20%, it's now going to be 25% and it will start if you're single at $400,000 and if you're married at $450,000. When you tack on that 3.8% NIIT tax onto your 25% bracket, in reality, it's 28.8% on your long-term capital gains.

QBI and 199A Deductions

Another change that's happening is the QBI deduction or the 199A deduction. This is the pass-through business deduction. People have had a really hard time wrapping their heads around it. I've had several posts on the blog about it, but the bottom line is as long as you're not in a specified service business like medicine, 20% of your ordinary business income is a tax deduction right now.

That is a huge tax deduction for a lot of business owners. The idea behind it was to equalize for S Corporations the lowered tax rates that C Corporations were getting. It was put in place to make a fair playing field so you didn't have to change your business structure just based on tax law. They are not getting rid of it in this bill, but they are capping it. If you are filing single, the biggest deduction you can get is $400,000. If you're married, it's $500,000.

They're talking about increasing the corporate tax rate too, so maybe they're still accomplishing the same thing where it's a level playing field between C Corps and S Corps. But it's pretty much bad for any of us that have big 199A deductions.

Another thing that is bad for S Corps owners is the NIIT tax change. The whole point of forming an S Corp is so you don't have to pay payroll taxes on the portion of your income that you call a distribution rather than salary. If you're making $600,000, you might call $300,000 salary and $300,000 distribution, and you would save your Medicare tax of 2.9% on that distribution. You would also save that 0.9% Obamacare tax. So that was awesome, right? That's why you formed the S Corp as a doctor. It was to avoid paying those taxes. That might be $10,000 a year in taxes if you're calling for a $300,000 distribution instead of salary.

Now they are viewing that as a loophole that should be closed, and it's going to be gone. Basically, there is no point to be in an S Corp if this goes through. That's a pretty significant change for a lot of White Coat Investors that have formed S Corps for precisely that reason.

Backdoor Roth IRA and Mega Backdoor Roth IRA Will Be Gone If Legislation Passes

This is another change that will affect a whole lot of people who make less than $400,000 or $450,000 a year. Under the proposed changes, the Backdoor Roth IRA and the Mega Backdoor Roth IRA are gone after this year. If this bill passes in its current form, they're gone. Basically, you're not going to be allowed to do a Roth conversion of after-tax money in retirement accounts. You can't do it in your IRAs. You can't do it in your 401(k)s. That basically means that step 2 of the Backdoor Roth IRA process is gone. And step 2 of the Mega Backdoor Roth IRA process is gone. This is your last year to do it.

If you want to make any of those conversions, it might be a good idea to do that before the end of the year, rather than waiting until 2022, because you're not even going to be able to do it for your 2021 contribution if you make it after the first of the year.

It gets worse, though. You can't even do Roth conversions of pretax money starting in 2032. There is a big delay, another 10-year delay, before you can do that if you're higher. So, if your taxable income is $400,000 single, $450,000 married, you're not going to be able to do Roth conversions at all. That's basically going back to the way the law was before 2010.

Recommended Reading:

How to Do a Backdoor Roth IRA [Ultimate Guide and Tutorial]

The Mega Backdoor Roth IRA

Required Minimum Distribution (RMD) Rules

Another change will be to a couple of RMD rules. You remember the story of Peter Thiel? Peter Thiel is the guy who somehow managed to buy this startup company that did really, really well inside a Roth IRA. He ended up with this $20 million Roth IRA, and it made the news and was covered in Forbes. People thought what he did was not fair. This part of the bill should basically be called “The Peter Thiel rule”.

They don't want you to have big retirement accounts anymore. And when I say big, they're talking about $10 million-plus retirement accounts. If you have more money than $10 million there, and you have an income of more than $400,000 single, $450,000 married, you are going to have an RMD, even if you're not 72 yet. The distribution is going to be 50% of the amount over $10 million. If you have a $16 million IRA, you're going to have to take out $3 million. And the next year, you're going to have to take out $1.5 million-plus dollars. And very rapidly it's going to get very close to $10 million again.

There is an additional rule for Roth accounts. If you have more than $20 million in retirement accounts, before you even apply the other required minimum distribution, you're going to have to take out the lesser of either everything that's Roth or everything over $20 million. So, the RMD is 100% of everything over $20 million and 50% of everything over 10 million.

The good news is, you're not going to have to pay the early withdrawal penalty. That 59.5-year-old rule, that's not going to apply. But you're still going to have to take that money out. And so, the bottom line for people who were able to get rid of the really large retirement accounts, you're not going to be able to do that anymore.

Defective Grantor Trust

One change that is going to affect fewer people is the idea of a defective grantor trust. The defective grantor trust is going away. People do that using an irrevocable life insurance trust as an estate planning tool. The new law will make it so this is no longer a useful estate planning tool. Maybe people buy fewer whole life insurance policies to put inside their irrevocable trust because of this. But they're viewing it as a loophole that needs to be closed.

Estate Tax and Estate Planning

Here's another big thing—the estate tax. Right now, the estate tax exemption is basically $10 million per member of the couple. So, if you're married, it's $10 million for you, $10 million for your spouse. But that number was indexed to inflation so that the total is now almost $12 million each. So, $24 million in total.

That was scheduled to be halved in 2026. They are basically accelerating that, so it will be halved in 2022. Instead of having this estate tax exemption of $24 million for a married couple next year, you're going to have an estate tax exemption of $12 million. If you're single, it's only going to be $6 million.

The bottom line is a whole lot more people are going to need estate planning attorneys starting next year. That's just accelerating something that was going to happen in four years anyway. But it's definitely a change that is going to affect estate planning pretty significantly.

Family-limited partnerships are also becoming less useful. Previously people could pass assets onto their children at a discount by putting it in the family limited partnership. The heirs couldn't get the assets for a number of years, and that made it less valuable to them. And so it costs the estate less of the estate tax exemption to pass it to the kids via a family-limited partnership.

Now they are saying those rules and discounts only apply to real businesses, real family businesses. It doesn't apply to a bunch of stocks and real estate or whatever non-business assets you are trying to pass to your kids using that same method. So, it's going to be a lot less useful for estate planning.

Child Tax Credit and Wash Sale Rules

The child tax credit is becoming more generous. Many doctors are still going to be phased out of this, but it could be as high as $3,600 per kid under 6, per year. Likely, it’s going to be more generous.

The wash sale rules are going to change as well. This is another loophole that is being closed. Wash sale rules don't count for cryptocurrency, commodities, foreign currencies, etc. Wash sale rules apply to stocks and mutual funds, and you have to wait 30 days before you can buy back anything you sell. As the law is right now, you don't have to do that for Bitcoin. You can sell your Bitcoin, take the loss, buy Bitcoin back an hour later, and it's not a wash sale. I expect this part of the bill will go through, given that the IRS now looks at cryptocurrency as an investment and not a currency.

That is the review of what is going on in Congress. So, what do you do with all of this information? You ought to pay attention to this bill and you probably ought to write to your congressperson. But for the most part, what can you do? Well, if you're planning on doing a Backdoor Roth IRA for 2021, get it done before the end of the calendar year. If you're planning on doing a Mega Backdoor Roth IRA before 2021, get it done before the end of the calendar year. If you're planning on any other Roth conversions of after-tax money, do that before the end of the calendar year. If you want a defective grantor trust or an irrevocable life insurance trust, get it done before the end of the year. It sounds like any of those that are already established are going to be grandfathered in. Any non-business assets that you want to pass to your kids through your family-limited partnership, get them in there before the end of the year.

Don't bother tax-gain harvesting, though. The long-term capital gains rate change is going to be retroactive to Sept. 14. Selling your stuff and buying it back to avoid paying 25% so you can only pay 20% on it is not going to work. It is too late for that already. And then of course, remember this is just the tax bill and the final law is probably going to be significantly different.

Public Service Loan Forgiveness During COVID

“I'm calling because I have a question about public service loan forgiveness, and some of the COVID changes that have happened with the federal loans. Basically, I'm a second-year resident now. I've been making $0 payments for the last year since I decided to skip my forbearance and go into repayment right away so that I could have 12 of those 120 payments be $0. I just reapplied to re-certify my income as I was supposed to, but they told me that they had put my application to re-certify my income on hold until March of 2023, because COVID had basically extended that re-certification anniversary deadline.

So, what this means is that I will continue to make $0 payments for the next two years until 2023. And I won't be able to, and don't have to re-certify my income, even though it's gone up, until then.

They also said that those $0 payments will count toward my PSLF 120 payments. So, this just seemed very interesting to me. I'm wondering if you can confirm that this is something you've heard other people experiencing. I kind of feel like this is a great deal for me, that 25% of this 10-year period will now be $0 payments. And if this is true, should I be telling all of my friends to also skip their forbearance and go into repayment? Or are they too late now? Because I guess they'll be based on their 2021 tax returns or 2020 tax returns during which they've made money.”

Well, that's weird. You're the first person that's mentioned this to me. To all the readers out there: if you have also gotten this answer on the phone from any of the loan servicing companies, send me an email at [emailprotected]. I'd like to hear about it.

Now, if this is really the way it is and you're going for PSLF, this is all good for you. Instead of making $100 or $200 or $300 payments during residency, you're making $0 payments. It's just going to be more money forgiven and better cash flow for the next few years.

But I would not say that this is how the program is designed. I don't think this is their policy. And in fact, I'm skeptical that if you called back and talked to a different representative on the phone that you would even get the same answer. But so long as they are accepting your income being nothing for calculating your PSLF or your IDR payments toward PSLF, you might as well take advantage of it.

It might be worth the second call though, just to double-check. But you're right. If you skip that six-month forbearance period by consolidating your federal loans as you come out of medical school, you get six more months of payments toward 120. That's not a new thing. That has been going on for a long time. I definitely encourage every MS-4 to file a tax return if they're planning on going into an IDR program and especially if they're going for PSLF, and then to consolidate and skip that forbearance period. You don't want to be in forbearance if you're going for any sort of forgiveness program. That is the worst possible option. That's even worse than refinancing in a lot of ways.

But you sound like you're doing everything right. You may get a little additional blessing there. I would not count on it. If it happens, great for you, it might be that you are just a bug in the system and somehow slipped through it. That's kind of what it sounds like to me, more likely you just got bad information from someone who doesn't know what they're talking about on the phone.

In the meantime, I would continue to fill out the paperwork you need to fill out and keep records of every $0 payment that you're making. I hope that's helpful.

Defined Benefit Plans

Our next question is from Andy regarding defined benefit plans.

“Hi, this is Andy in the Midwest. Thanks for all you do, Jim. I'm in private practice in a surgical subspecialty. And our office has a defined benefit plan. The defined benefit plan has been open for quite some time. And after review, we have decided to close the plan and reopen a new one as you have talked about in the past.

I am currently planning on rolling my defined benefit plan into our 401(k), which has pretty good options. However, I am a little concerned about the fees involved. Would it be wiser or an option to consider opening a self-directed 401(k) at a different institution and roll my defined benefit plan into there? I feel like I would be able to control the investments and maybe have lower fees involved. What do you do with your defined benefit plan? Thanks.”

Remember, anytime you close a defined benefit cash balance plan, there has got to be a legit reason for doing so. Usually, it's a business structure change or something like that. If it's been five-plus years, it's probably not as big a deal to close it. But if you're closing it after it's only been open a year or two, you better have a very good reason because the IRS is going to ask about it.

The other downside is there are costs to closing it, including accounting and actuarial costs. Make sure it is the right move for the business first. In this case, it sounds like you've already decided that this plan is going to be closed, and you're going to roll the assets over. Most people just roll it into their 401(k). If you're in charge of this business and you've got a good 401(k) in it and you've got a good defined benefit plan in it, why wouldn't you want to just use your own 401(k)? It sounds like maybe you don't like your 401(k). If it's a crummy 401(k), then it's worth looking at other options. If you have an individual 401(k) from a business you own—self-employed income is a requirement for an individual 401(k)—then you can roll it there.

In the past we've had two closure events and both times I've rolled the money into the federal TSP that I've kept open since I was in the military. My main one for a long time was the TSP G fund. And so, by rolling money back into the TSP, I've been able to put more money into the G fund than I would have otherwise been able to just from my military service. Basically, you pick the best 401(k) available to you and roll it in there.

Now, as I mentioned at the top of this podcast, the Roth IRA and the Backdoor Roth IRA may be going away based on these changes in Congress. That's the main reason why we stopped rolling things like this into traditional IRAs, which could also be a self-directed traditional IRA. And if that is truly gone, we're not going to be able to do Backdoor Roth IRAs anymore. Bear in mind that a self-directed individual 401(k) does have a few advantages over a self-directed IRA, particularly if you're putting equity real estate in there, and there's a tax you can avoid if you use a 401(k) instead of an IRA for that.

In general, I think equity real estate goes in the tax bill anyway. And so, I don't think that's a big deal, but that might be an option for you. It’s just to go into an IRA. Now, if you do it before the end of this year, it'll screw up your Backdoor Roth IRA for 2021. But if you're not doing this until 2022 maybe it doesn't matter anymore. Maybe you can just go straight into a traditional IRA.

IRA Catch-Up Contribution

The next question is from email.

“If I turn 50 in February 2022, can I make an IRA catch-up contribution in 2022? Or do I have to be 50 for a full year?”

See Also

How to Open a Roth IRA: A Step-by-Step Guide - NerdWalletQuanto Aumenta la Pensione se Continuo a Lavorare? - MoneyfarmShould You Use Your Roth IRA to Buy a Home? - NerdWalletFinancial Plans 101: What Are They and How Can You Make One? - Investadisor

Nope. If you turn 50 on Dec. 31 of 2022, you can make your catch-up contribution on Jan. 2, 2022. You just have to turn 50 at some time during that year. You don't have to be 50 for a full year. You just have to turn 50 in the same year that you make the catch-up contribution.

Solo 401(k) for a Side Business

Our next question from Mark is regarding clarification about a solo 401(k) for a side business.

“Hello, Dr. Dahle. This is Mark, a physician in New Jersey. I have a follow-up question to a recent Speak Pipe question when a physician asked if he was an owner of a business with employees, if he would be able to open up a solo 401(k) for his side gig business. Of course, your answer was no, that is not allowable. However, you did note if the private practice was not in full ownership by that physician, that it might then be possible.

So, I wanted to clarify, if I put my solo practice business as 50% ownership by myself and 50% ownership for my wife, would I then be able to open up a solo 401(k) for a side gig business? Thank you very much. Thank you for all that you do.”

I don't think your workaround is going to work. The relevant number here is 80% control. If the same group of people control 80% of both businesses, they're considered related. And you only have one 401(k) for all of the businesses and you have to consider the employees of all of the businesses when you do it.

The issue here with just giving it to your spouse—50% to your spouse and 50% to you, the IRS considers what your spouse owns as being owned by you. So, if it was 50% your friend and 50% you, that would get you around it. Now you could go open an individual 401(k) for this other business that is owned completely by you, but not your spouse. It's not going to work with your spouse. I'm sorry. A good idea but it’s not going to work.

Refinancing Student Loans on 1099 Income

Our next question is about refinancing student loans on 1099 income. Let's take a listen.

“Hi, Dr. Dahle. I'm a practicing physician about a year out of fellowship looking to refinance federal student loans with the forbearance ending in the next few months. And my question is which loan refinance companies will refinance to a physician who has less than two years of 1099 income?

At a brief glance, it looks like refinancing might be a bit of a struggle until next year when I have two years of 1099 income. Thank you for all that you do, and thank you for answering my question.”

For the most part, this is not an issue like it is with getting a mortgage. It takes a little bit more paperwork, etc., but for the most part, you can still do it. CommonBond’s latest deal is the 0% deal they have until the forbearance period ends. They're not letting you do that with 1099 income. But all of the other lenders on our list don't seem to have a problem with it. So, I would go through the usual process of applying to two or three or four or five of those and taking the lowest rate they give you. Now, if one of them tells you “We're not going to do you just because you're 1099,” fine, you should still have multiple other options.

I would also be interested in hearing from you after you go through that process, if there's a bunch of them telling you that they won't do your loans just because you have 1099 income. We're really not getting that feedback from anybody. If you are having a big issue, I'd like to hear about it. And maybe we can do a blog post on this question if there really are a bunch of people turning you down. Because to our understanding, that is not a reason people are getting turned down for refinancing. So, let us know, stay in touch, and we'll update the podcast too, if we hear that I just gave terrible advice.

Life Insurance and Estate Planning

All right, our next one comes from email.

“I'm writing to you today because I have a question that might be applicable to many of your listeners. I am six months pregnant with my first born. I'm the breadwinner in my family. More so now that my husband is out of a job due to COVID. We follow all your financial pearls and I read persistently about finance. One thing that I just started doing in light of the upcoming addition to the family is in regards to all the things I should be preparing financially for the upcoming birth of my child, other than opening a 529 account. My husband is not very interested in finances. And I've been managing all for the most part. I already have disability, term-life, and umbrella policies and actually I have increased the payouts for my disability and term-life recently.

Some of my concerns and questions are that birth can be traumatic and at times deadly to the mothers. I worry that if I die during my delivery and my child survives, my husband and child may not receive all of my assets. They might even lose the house since my paycheck pays for the majority of the mortgage. My husband is the beneficiary of my accounts and life insurance in the event of my death, but is this enough? I live in Philadelphia if that matters.”

Well, this is the purpose of life insurance. The idea with life insurance is that it replaces your portfolio at financial independence. So, if you need $5 million so that you and your husband never have to work again, then the total of your portfolio, plus your life insurance, should be $5 million. As your portfolio grows closer to that number, you can decrease the amount of insurance you have until you become financially independent and you can drop your term life insurance. If the amount of life insurance you have is not enough to pay off the mortgage and to provide for your husband and child to be able to stay in that home and to live more or less the same life they're living now, then you need more insurance. That's probably going to be a little bit difficult. I think you said you're six months pregnant. It's going to be tough to get life insurance at this point.

But after you deliver, and it's been a few months and everything went well—and it does most of the time and hopefully will this time—it's time to increase your life insurance. You don't have enough. It sounds like you just increased it, though, so you're better off than you would have been. But basically, that's how you cover this particular risk.

“Number two, I was contemplating estate planning, but wouldn't it make more sense to do it after the baby is here?”

Putting a will in place is kind of the bare minimum for estate planning, especially once you have a kid. That will should dictate not only who's going to take care of that kid in the event you and your spouse die, but also who's going to manage the money in the event that you and your spouse die. It is important to get that in place. You will need to update the will as life changes happen, such as more children, marriages, or divorces. I like your idea of at least doing some minimal estate planning at this point.

“Last question, are there books and articles that talk about financial preparations and strategies and setting up secure financial plans for children, including how to slowly transfer wealth and the pros and cons for each? For example, opening a 529 account when the child is such and such age for this amount, ways your children can start earning so they can start a Roth IRA early, different types of trusts, etc.”

I've written about a lot of this stuff over the years on the blog. We’ve talked about it on the podcast. If you're looking for a book, I think the best one on that particular subject is called Make Your Kid a Millionaire. It goes through and explains 529s, Roth IRAs, UTMAs, trusts, etc. I think it even goes through some variable annuities as well, as options to make your kid a millionaire. The truth is if you've got 60 years of compound interest to work on that money, you don't have to put that much money into it in the very beginning for them to become a millionaire.

But I'll tell you the approach I used with my kids' 529s. First, we didn't have any money when they were all born. So, their 529s were very small until recently. And now we put in the max amount each year. We now have sizable 529s for each of them with the idea that that money pays for as much college, plus any graduate or professional school, as possible. They're probably still going to have contributions of their own from scholarships and jobs. And if they go to professional school, probably a few loans, too, I suspect. I suggest waiting three months, until after your child is born and you have the social security number, and then go ahead and open a 529 for your kid then.

Second, we have UTMA accounts—Uniform Transfer to Minor Accounts. These are taxable accounts for your kid. The tax play here is that the first $1,100 or $1,200 of income in that account is not taxed. And the next, again, I can't remember if it's $1,100 or $1,200, the amount is taxed at their income tax rate. So basically 10%. And after that, any income above and beyond that is taxed at your income tax rate. This is known as the kiddy tax. The bottom line is if you invested tax-efficiently in some index funds, you can basically get about $100,000 in there before you have to start paying taxes at your income tax rate on that money. The one downside is that it's the kids' money. In most states when they turn 21, it's their money. If they want to blow it on hookers and cocaine, there is nothing you can do about it.

The third thing is Roth IRAs. For any earned money, it can go on the Roth IRA. You can give them an equal amount of money out of your earnings for them to spend if you want. But the total amount that they earn can go into a Roth IRA up to the contribution limit for the year, currently $6,000 per year. Basically, whatever they earn, I put in a Roth IRA for them. And the idea being that if they don't touch that till 60, it'll have 40 or 50 years of compounding.

So, how do they earn money? Well, once they're 10 or 12, they can start babysitting and doing lawn mowing, stuff around the neighborhood. Remember, doing chores for you doesn't count. It has to be for somebody else. As they get older, they may have more of a standard type of teenager job. And now all of that money can go into a Roth IRA. If you want to do it really young, you're going to have to be creative. If you have read the blog, you know there are a lot of pictures of my kids. We decided to pay them to be models for the blog. And that's legitimate. We pay them a fair rate, keep a timesheet and have contracts. They had to fill out the paperwork that proves they're U.S. citizens, as well as W-2s and W-3s every year to make it legitimate.

The reader provides a few more comments that I thought were worth sharing. You might have noticed this paper that came out a few weeks ago, about how surgeons miscarry at twice the rate of non-physicians. And I suspect if we look at other specialties, it's probably going to be increased, as well. And the impressive thing about that paper is that that happens even when you're controlling for age, work hours, and the use of IVF.

An additional part of planning worth considering is cutting back on work in the third trimester. And in a family where you're the sole breadwinner, that's a big deal. You add that for roughly three months of working halftime and add that to a three-month maternity leave. That's a lot of cash you need just to get through this period. And so, saving up a big fat cash buffer is very prudent in this sort of a situation.

I think as soon as you become pregnant, that's the time to go crazy building up a huge pile of cash. Maybe even stop your retirement account contributions, stop any 529 contributions, maybe cancel a vacation or two, put off buying that Tesla, and pile up cash, cash, cash, cash, cash, to get you through that six-month period, to have that cash in the event something goes wrong. You might have some complication that keeps you out of the workforce for even longer.

Other people have looked at some of these other policies like Aflac, and found that to be a pretty good deal. It's a short-term disability policy. Look into any short-term disability policy you have at work. It may cover not only complications of pregnancy, but it might cover just being pregnant and just delivering a baby as well. So, read what's actually covered in those policies. They can also help bridge that cashflow gap that you have. I hope that's helpful to you.

Tithing

All right. Let's take another question on paying tithing.

“Hi, Dr. Dahle. Thanks for everything you do. My question concerns tithing from UTMA accounts for children. With some help from their grandparents, we've been saving for college fairly aggressively the past couple of years and have reached the point where we think our children's 529 accounts are close to fully funded, assuming average future market returns. Our next goal is to fund a UTMA account for help with post-college expenses. We're fortunate enough that the grandparents on both sides would like to contribute a combined total of approximately $20,000 per child per year to these accounts. Unlike when they wrote a check to help us fund the 529 accounts, they would like to make the UTMA contributions primarily in the form of a low basis stock transferred directly to the UTMA accounts.

As people of faith, we believe that tithing is important and would want our children to continue to tithe on these gifts. Well, this was relatively simple when the gifts were in the form of a check, eventually going into a 529 account. We know that our ability to take money out of a UTMA account on behalf of our minor children is much more limited. Would it be legal for our kids to pay their tithe on these gifts by withdrawing funds from the UTMA account? The language on what is permissible with UTMA funds seems fairly general in nature to us, and we're not sure if this would be allowable or not. Thanks in advance.”

Here is the bottom line with tithing. What you do with it is between you and God. That's the bottom line. Do what you feel is best after thoughtful pondering and prayer.

But let me give you a few guidelines. I think in general with most types of accounts, like retirement accounts, HSAs, etc., it's easier to not pay tithing on what went in there, on what grew in there over the years, and to pay it when you take the money out of the account. That's the way I treat retirement accounts. That's the way I treat HSAs, etc. And I think that's probably the easiest and the right way to do it.

Can you do that with the UTMA as well? As long as you're reinvesting all those dividends, it's really easy to do it that way. And then you're simply paying tithing when you make withdrawals. Remember, the idea behind a UTMA account is that they're going to be taking the money out in their 20s. When they're going to college or whatever. And so, at that point, you can basically take the money out and use it however you like. It's just a taxable account and you can give it to anybody. You can give it to charity. You can give it to the homeless guy on the street. You can spend it on whatever, there are no rules. It's just a taxable account.

As far as the IRS rules on this, the money just has to be spent for the benefit of the child. I think that's a justification you can make. If the child pays tithing, they're spending it for that particular purpose. Now it might be a bad idea if you try to claim that on your taxes, as a charitable deduction. That might look like it's for your benefit. But as long as that's not being claimed, I think it is perfectly fine to take it out, to pay tithing on that.

But honestly, what I'd do is I'd wait until they start making withdrawals from the account and pay tithing on that. I hope that's helpful. That's not the way I treat my taxable account as an adult, but I think it's a pretty reasonable way to treat my kids' taxable accounts, which is what UTMAs are. And in fact, that is how I treat my kids UTMAs from a tithing perspective. None of that money has been tithed going in, none of that money has been tithed as it grows. And it'll be up to them to pay tithing on it as they make withdrawals down the road.

I hope that's helpful to you. If you have more questions about that, feel free to send me an email. I don't think I've ever done a big blog post about tithing. I'm not sure that it's a subject of enough general interest for the entire WCI community, but maybe I ought to get around to doing that sometime. It's just interesting because a lot of faith tithings just basically means an offering. They don't look at it as any sort of a strict 10% of income or 10% increase kind of rule. But for those religions that do, questions like these matter.

When you go down that rabbit hole, you'll find all kinds of questions that matter. What to do with an HSA? Because you can only take the money out and use it for healthcare expenses. You can't take the money out for tithing and healthcare expenses. So, you got to pay the tithing from some other fund of money. Same way when you draw 529 money, for instance.

Other questions that come up are if most of a long-term capital gain is inflation, should you use it to really increase? Is that really income? Should you really be paying tithing on the entire thing or should you adjust it for inflation? What about if you do tax-loss harvesting? How should that be treated from a tithing perspective? So, if you really want to get in the weeds, there are a lot of things to think about with tithing. And in the end, you'll likely arrive at the same conclusion I have—which is, it’s between you and God.

401(a) Accounts

The next question is about 401(a) accounts.

“Dr. Dahle, first, I want to thank you for the work you've put in both the blog and the podcast. They've been a great introduction, a great guide in the path to understanding personal finance. I'm a third-year surgical subspecialty resident with a question about how to manage your 401(a) while transitioning to fellowship and attending. I have a 10% mandated withholding for this account—just matched a little better than one-to-one by the employer. The fund is fully invested immediately and to be fully portable on separation from my institution. I had intended to roll this into an IRA then do a Roth conversion during the year, consisting of half residency and half fellowship, and had a few concerns. First, by the time of separation, I'd likely have $70,000-$85,000 in this account. Clearly the tax bill and the conversion are going to be sizeable compared to a resident or fellow salary.

Additionally, my current program does not allow for moonlighting. We did buy a house at the start of residency and, barring some huge housing bear market, should have a decent amount of equity in it by the time we sell. Does it make sense to plan on using the funds from selling to pay for the conversion and run the risk of a downturn in the market in the interim? I'm still trying to build a decent emergency fund and pay off the last couple thousand on credit card debt from medical school. And we were looking to have a child in the next two or three years. So, I'm unsure if I'll be able to put aside enough for the taxes otherwise.

Secondly, I'm unlikely to go to fellowship with my current state of residence. How do I best arbitrage state income tax rates between my current state and wherever I do fellowship? Can I choose where to file or do I just split it and do something to both? I'd also given some thought to holding back a year’s max HSA contribution to do the once-in-a-lifetime IRA to HSA funding, to save a little on the tax bill. Does that sound reasonable?

Finally, should I just suck it up and wait to do the conversion until the year of half fellowship and half attending so the money isn't a problem, but take a hit on a higher tax bracket? Thank you again.”

I've talked about this period of time before. This is a really hard period of time. That first six months, when you're moving into the big bucks. You have all these needs for cash and the amount of cash you have is just really limited. You might have to start saving up to buy into a practice. You want to get a house, you want to do Roth conversions like you're talking about, you need to beef up your emergency fund. Maybe you've got some credit card or auto debt you need to get paid off. All of a sudden, now you have to start paying on these student loans. You have all these great uses for cash and you just don't have enough cash to go around.

And so, you have to rank them. You have to decide what's most important to you. The most important thing honestly is what percentage of that new income you've got going toward building wealth. That's what really matters. Whether it goes toward your student loans or to max out retirement accounts, that doesn't matter so much. But if you can squeeze in paying for this Roth conversion that year, that's a good thing. Especially given the talk in Congress about maybe limiting your ability to do Roth conversions later in your career. This might be the only way you're going to be able to get a sizable Roth account going. And so, I'd encourage you to do it if you can. That's certainly another reason you shouldn't wait a year. When your income is higher, you might not be allowed to do the Roth conversion, even if you have more cash to do it with. Is it a bigger priority than beefing up your emergency fund or paying off credit card debt? Probably not. Is it a bigger priority than maxing out some retirement accounts? Maybe, maybe not. It's a judgment call on your part. And so, good luck with that decision. It is a good thing to do if you can do it.

As far as the state arbitrage, I would claim that conversion in the state you're living in when you do it. If you are going from a low-income tax state to a high-income tax state, I would do the conversion your last month of fellowship or residency. Then you can claim it in that state. That's where you were when you did the conversion, that's totally fair. If you're going to a lower income tax state, maybe I'd do it in September or maybe October just in case it's enough money that requires you to pay quarterly estimated taxes. It's better to do it in October. Then you don't have to make the payment until Jan. 15. It gives you a little more time to come up with that cash.

And that's another thing to keep in mind, right? The truth is paying for this, paying the taxes for this, you really have until April to do it. You might get nailed on not staying in the safe harbor as far as not making quarterly estimated payments. But there's a little bit of leeway in doing that your first year. So, instead of having to come up with the money by September, you might not have to come up with the money until next April, which would be a lot easier for you as an attending physician. So, that's probably what I would look to do, but do consider that state arbitrage.

As far as this one-time IRA to HSA thing, that's kind of a gimmicky thing. I don't really see any big reason to do that. If you put it in an IRA, that's good. If you put it in HSA, that's good. But using the IRA to make an HSA contribution, I don't see a huge benefit to doing that. So, I wouldn't monkey around with that. If you're eligible to use both, I'd try to max out both. Those are both good things to do with your money, but again, a period of life in which the money is limited.

The other thing you can do if you wait is you don't actually have to do a Roth conversion on this money. I would say what most people do is they roll it into a 401(k). And you can roll it into the 401(k) at the fellowship. You can roll it into the 401(k) at your new job, whatever you want to do. Then you don't have to pay any taxes on it at all and you can use that cash for the other cash needs you might have. And then you can NOT do the Roth conversion. Your call though, good luck with your decision. It's not an easy one.

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