Originally Aired: September 30, 2015
Topic: The White Coat Investor: Investing for Physicians with guest Dr. Jim Dahle
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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- Guest Introduction: Dr. Jim Dahle
- Pitfalls for Physicians
- Picking the Right Specialty
- Index Funds
- Live Like a Resident
- Learning on the Job
- The Source of Dr. Dahle’s Drive
- Insurance as Part of Smart Saving
- Health Savings Accounts
- The ‘Back Door Roth’
- Keeping Insurance Separate from Investing
Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.
1. Guest Introduction: Dr. Jim Dahle
Dan Weinberg: And welcome to The Lange Money Hour. I’m Dan Weinberg along with CPA and attorney Jim Lange, and this week, we’re tackling the subject of investing for doctors, and joining us for that discussion is one of the foremost experts in that area, Dr. Jim Dahle, a Utah-based physician. In 2011, Dr. Dahle started a website called The White Coat Investor, which now has over 350,000 page views per month, and last year, Dr. Dahle published his first book, titledThe White Coat Investor: A Doctor’s Guide to Personal Finance and Investing. Since its publication, the book has remained number one or number two in its Amazon categories. Now, during the next hour or so, Dr. Dahle will be sharing his personal story and his advice for doctors, including things like how to get out from under medical school loans, how best to structure your practice, how to buy the right type of insurance and choosing the right financial advisors. And with that, let’s say hello to Jim Lange and welcome, Dr. Jim Dahle.
Jim Lange: Welcome, Jim.
Jim Dahle: Thank you. It’s good to be here.
Jim Lange: Well, I’ll tell you, you wrote a heck of a book. I was reading it both last night and today, and you have some great information. I’d say it is great information for everybody, but particularly doctors. By the way, if you’re a physician, don’t even think about it. Just go to Amazon, go to The White Coat Investor by Jim Dahle, and just buy the book. And the other thing that I would recommend is to go to his website, which is whitecoatinvestor.com. He has all types of great information on the website, again, oriented towards physicians, but a lot of us can benefit, and I learned some stuff from reading the book.
So, notwithstanding that it could be for everybody, early on, you say that physicians have some character flaws that make them bad investors. Can you tell us what some of the character flaws of physicians might be that might make them bad investors?
Jim Dahle: Well, there’s a few things that make physicians particularly bad at investing. The first is probably that they tend to be overconfident. Physicians are, in general, people that are pretty smart and work hard. But they make this mistake that they assume that because they know a lot about one thing, they know a lot about everything. And so, they assume that they can also outsmart the market, which turns out not to be a very smart idea when you really look into the data. Other problems physicians have is it’s a bit of an intellectual failure. They’ll read all kinds of peer-reviewed literature in their field, whether that’s cardiology or general surgery or whatever they do, but they don’t realize that there’s an academic literature within personal finance and investing as well, and they have no idea what that says. And so that’s a bit of an intellectual failure that can be overcome with some time spent reading and studying about it, or with the help of a quality advisor. One other issue that physicians often have is they tend to be very trusting. They assume that every professional in the world works by the Hippocratic Oath like they do, and usually it takes getting burned two or three times for a doctor to realize that there are many professions in this world that not only don’t spend a decade in training, but also don’t necessarily always have a fiduciary duty to the physician, meaning they would do the right thing for them no matter what.
Jim Lange: Well, we should pick up on the concept of fiduciary duty. The only thing that I wanted to mention is the issue of overconfidence, and an intellectual failure to take all information into account is not just unique to physicians. I’m thinking engineers, and the engineers think because they’re very bright in one area, that that necessarily translates to another. The other thing that you bring up, the fiduciary duty, that’s very important because I know you are not a big fan of different financial products that are “investment” products, such as annuities or cash value life insurance, and there is a difference between a fiduciary advisor that not only has the moral, but the legal, obligation to sell or encourage clients to buy what they think is appropriate for the client, not what is good for them. So, I think that your idea of going to a fiduciary advisor is very good advice.
Jim Dahle: Absolutely. The biggest issue, I think, in the financial advisory business today is there are far too many people who are basically salesmen rather than advisors. Whether they’re selling annuities or whether they’re selling cash value life insurance or whether they’re selling high fee loaded mutual funds, basically their training is all in sales rather than personal finance and investing and advising, as you might see from somebody with a CFP or a CFA or a CHFC certification. And it really becomes difficult because you actually have to know something about investing before you can actually pick out a good advisor, and far too many people just go looking for the first money guy they run into and kind of blindly trust him, and often end up with a bunch of products they really don’t want.
Jim Lange: Well, interestingly enough, I got your name from John Bogle, who is, of course, the founder of Vanguard, and he is a big believer in all advisors having a fiduciary duty. Now, that’s not the way it is, but I asked him if he was czar, what would he do? And he said, “I would make all advisors be fiduciary advisors,” meaning they have to look out for the good of the client, and, in addition, he would have them all reveal to the nickel how much money they make on any given transaction or even just managed money. And by the way, I agree with him completely on that, and that also seems to be consistent with the advice in your book.
Jim Dahle: That’s correct. In fact, I even take it one step further. I’m a huge fan of John Bogle and started reading his books some time ago. But even on my website, every year I have a state of the blog post, where I actually reveal where all the income on my blog comes from. And so, a lot of people find that a little bit reassuring, just because they know exactly what I’m making money from, and they can see how that could bias my opinions. And I wish every advisor would do that, and it’s a little bit easier when you’re a fee-only advisor, obviously, then when you’re a commission-based advisor. But I think a lot of people, doctors in particular, would think twice before purchasing a cash value life insurance policy if they had any idea how big the commission on that policy was.
Jim Lange: And I think the same might be said of certain annuity products that might pay a ten percent commission, or other financial products. I mean, I actually am a big believer that clients should know how much the fees are, and I also prefer the model where it is basically a fee for service rather than a commission on a sales product.
Jim Dahle: Absolutely. I’m a big fan of fee-only. In fact, that’s probably the first place…if people can just get that much right in choosing a financial advisor, they’re about seventy-five percent of the way there.
Jim Lange: Well, that might be a lot. I actually think there’s a big difference in the quality of advisors, even fee advisors, but we’re on the same wavelength about fees. The other thing that you talk about concerning physicians is you call it the ‘big squeeze,’ and you talk about tuition and interest rates and starting salaries. Could you tell our listeners a little bit about…you know, we all think that doctors are going to be just stinkin’ rich and they have it so easy. Then you read your book. It sounds like they’re basically paupers for the first ten years of their professional life.
Jim Dahle: Boy, I wish it only lasted ten years!
Jim Lange: Sorry about that!
Jim Dahle: It’s really disturbing, even for older docs, to realize how things have changed now, but it’s now getting to the point where tuition has climbed so high, and the terms on student loans have gotten so bad, that medical students are now routinely coming out with $300,000, $400,000, $450,000 (my record is $680,000) in student loans, and those are at six and eight percent interest. It’s just unbelievable how quickly that can spiral upward in residency when you’re not making enough money to even pay the interest on the loans. But to start your professional life with, basically, the mortgage on a huge house, but no huge house, can really handicap you quite a bit. So, you’re getting the squeeze from the education side, and then, of course, like with many professions, medicine has seen a trending down in salaries, particularly with the move into how a lot of docs are now employed rather than owners of their own practice. And so, with increasing costs to become a doctor and decreasing salary as a doctor, and then with the increase in expenses to comply with all the new compliance issues in medicine, it’s really become difficult for a lot of docs to actually get ahead. It certainly is not a guarantee of wealth like perhaps it was twenty or thirty or forty years ago. Still, if doctors will manage their income well, they can still climb out of the hole they start their career in, but far too many grow into their income way too fast to do that.
3. Picking the Right Specialty
Jim Lange: Well, the other thing that you pointed out, which was, to me, a pretty shocking statistic, is that physicians’ salaries are down twenty-eight percent after adjusting for inflation. And as you mentioned, more and more are actually taking jobs because of government interference, the high cost of insurance, etc.
Jim Dahle: Correct. It’s really become difficult in some fields. In fact, there are a lot of medical schools in this country whose graduates cannot afford to be pediatricians. They literally cannot pay back their loans on a pediatrician’s salary.
Jim Lange: Yeah, and I was going to ask about that later on, but now that we’re on that topic, you actually said that the decision of which field of medicine doctors should enter is, other than choosing their wife, the most important decision there is. Could you expand on that? Because I thought that was pretty interesting!
Jim Dahle: Well, I think it really is, because not only will it affect your lifestyle for the next twenty or thirty or forty years, but it will also affect your income. The issue isn’t that I want doctors to choose their salary based on how much it pays and what kind of a lifestyle it leads. The issue is that medical students, almost as a rule, don’t consider those two issues at all in medical school. You are never more optimistic about life and never more idealistic than when you are in medical school. And so, for most doctors, they choose a specialty based on what they find interesting in a four-week rotation, or what system of the body they find most interesting to study. And while I do think that it’s very important that you love the work you’re going to be doing for hours and hours on end, it’s also important to inject a little bit of realism into the formula as well, and realize that ten years out of residency, how much you make and how much call you’re taking and how many nights you spend up in the hospital are going to matter to you much, much more than they matter during medical school. But that’s the only message I’m trying to get across to medical students, so they at least consider those factors. I’ve just run into too many people going into primary care with $400,000 in debt and they literally may not be out of debt until after their kids are through college.
Jim Lange: And you actually went through that personal choice yourself, which I thought was pretty interesting, and the two areas that you were considering (OB/GYN & emergency medicine) just seem so significantly different. Can you tell us how you made a choice when you were considering those alternatives?
Jim Dahle: Well, they certainly are different. Certainly, going back, I’m glad I chose emergency medicine. I think if I went back to do it again, my second choice probably would’ve been anesthesiology. I’m not sure why I didn’t look at it more closely in medical school, but I found that a lot more interesting throughout residency and my career than OB/GYN. But I guess what I really liked about OB was you had all these wonderful moments where babies are coming into the world. It’s just so much more rewarding, I think, than working with a lot of people who are on death’s doorstep. Almost every family you deal with is wonderfully happy with the outcome. And so, I found that very rewarding in medical school, and so I considered it very seriously, but, in retrospect, I’m definitely glad I did emergency medicine as it fits me much better.
Jim Lange: All right. Getting back to the money part, you also talk about a lot of physicians trying to outguess (not just physicians, everybody) the market, and then you go back to index funds. Is that what you think basically most investors and most physicians and, actually, all of our listeners should be doing?
Jim Dahle: Pretty much. I mean, if you look at all the real experts in investing and look at what they say about index funds, they all recommend it, whether it’s Warren Buffett or Jack Bogle or Peter Lynch or whoever you might read. When you really pin them down, they say, “Yeah, most people should be using index funds.” But it takes a little bit of humility to say, “Yes, I am most people,” and to realize that if you can just get the market return at the lowest possible cost, those returns are adequate to fund your retirement, and when you realize that, in reality, nobody knows anything about the future…
Jim Lange: Well put!
Jim Dahle: …it’s very freeing. All of a sudden, you don’t have to spend all this time trying to beat the market. All you have to do is just buy the index fund and then you can go spend your time doing whatever you enjoy with your life.
Jim Lange: Well, the other thing that’s interesting is that the two people that you quoted as being big fans of index funds, Warren Buffett and Peter Lynch, are probably two of the most successful active traders certainly alive today, and it’s very interesting that both of them now say that index funds are the way to go for most investors.
Jim Dahle: Right, and I think even if you look at Buffett’s mentor Benjamin Graham, who basically wrote the book on picking stocks, toward the end of his career, he realized that the task was much harder than it was early in his career just because of the competition. It isn’t that active fund managers are dumb, it’s that they’re all so good, that it’s very difficult for them to beat each other.
Jim Lange: Yeah. The other thing that I was struck by is…and it seemed to be a theme throughout the book, which is to really reduce your cost as an intern, as a resident, and even a young physician, and you talk a little bit…in fact, one of the great quotes you have is, “If you are willing to live like no one else while early in life, then you can live like no one else can later in life.” And you talk about not putting a lot of money in cars and not putting a lot of money in houses. Could you expand on the idea that these poor residents who have been poor for so long and then, finally, they’re making $40,000-$45,000 and they want to spend some money, and you’re saying, “No, put away some money, even when you’re not making a lot of money.”
Jim Dahle: Yeah. Clearly, it’s interesting. You run into doctors in their sixties and you see one of two things: either they’ve done very well and they have plenty of money, and they never will need to worry about it again, or they basically have nothing, and it’s amazing how many docs in their sixties I run into in that situation, and the difference really comes down to when they got started with their saving and investing program. And so, the solution to the big squeeze we talked about earlier that doctors run into is basically four words: live like a resident. Now, a typical medical student graduates from medical school with all this debt. About $200,000 is the average right now of people that came out in the last year. And then, for three to five years as a resident, they’re making $40,000 to $55,000 a year. And what I tell them to do is when they finish residency, for two to five more years, keep living on that same resident salary, spending $40,000, $50,000, $60,000 a year. Maybe give yourself a little bit of a raise. But if you come out of residency where you were making $50,000, and now you’re making $200,000 or $250,000 a year. If you can just keep your lifestyle the same for a few more years, you can take the difference between those salaries, pay off all your student loans, jump start your retirement savings, save up a down payment for that big doctor house you want, and all of a sudden, your finances are on easy street just five to ten years out of residency, whereas far too many doctors just grow straight into their income. Sometimes even before they graduate, they’ve already got a home bought based on their contract, they’ve already got two cars bought on credit. You know, they’ve just felt like they’ve been deferring gratification for so long that now they’ve really got to let loose. If I can just get them to defer it for a couple more years, it makes all the difference in the world over the course of their career.
Jim Lange: And Jim Dahle is the author of a book that I would recommend for all physicians. Again, I wouldn’t even think about it. I would just go out and buy it. It’s called The White Coat Investor: A Doctor’s Guide to Personal Finance and Investing. It has a lot of great information. I’m really going to recommend this to all the physicians, and actually, it’s a good book for most people. Again, that’s The White Coat Investor: A Doctor’s Guide to Personal Finance and Investing, and Jim has a terrific website with a good e-mail newsletter and a blog, and I would recommend going to that also, and that can be found at www.whitecoatinvestor.com.
Jim, one of the things that kind of stuck out as a non-physician reading your material is that you are not necessarily a big fan of going to the most expensive private medical school, and then you wrote that ninety percent (and this isn’t really a financial issue, but I guess maybe it is somewhat) of what you’ll need to know as a physician is learned in your residency, not your medical school. I don’t know if that surprised me or scared me. Can you comment on that? Now, this is a, I guess, more of a medical issue, but you think that you spent all those years in medical school, you’d learn something that’s useful.
Jim Dahle: Well, don’t get me wrong. It’s useful, but it’s almost like it’s preliminary. It’s like you spend four years learning the language of medicine. But what you will actually do in your day-to-day practice is really learned during your residency training. It’s a common joke among doctors that the scariest time to be in a hospital is the first week of July, because that’s the week all the new interns and all the new residents start their training, whereas the last week of June, they’re all very experienced because they’re about to graduate or move on to the next year. But that’s just kind of the nature of medical training, if you will. You certainly learn a lot in medical school, but what you will really do in your day-to-day practice, you really learn that in your residency.
Jim Lange: The other thing that really struck me is…and I think that I really wanted to have you talk about this for a minute, and again, it&rsrsquo;s not on the financial side, but you said that most doctors go to medical school to help people, not to make money. And I think not necessarily everybody has that opinion. In fact, I’m even getting a little bit of a sly look around the station, like “What are you talking about?!?” Can you expand on that thought? Because you certainly know a lot of physicians. You’ve been working with them your whole life, and I think you probably have a better insight as to what makes them tick, but could you expand on the thought that most doctors go to medical school to help people, not to make money?
Jim Dahle: Well, I think probably the best way I can demonstrate this is talking a little bit about my day-to-day work in the emergency department. About one out of five patients that comes in does not have insurance, and those patients are called ‘self-pay’ patients. But in reality, all of us in medicine know they’re really ‘no-pay’ patients, and we’re basically working for free. So, in essence, I have a job where every Friday, I go to work for free. But what I am amazed with is when I call a consultant, a specialist whose help I need to take care of one of these patients, at 3:00 in the morning, I’m dragging him out of his bed to come in and see a patient and take him to the operating room, or admit him to the hospital, and not once do they ever ask me, “Does the patient have insurance?,” “Am I going to get paid for this?,” etc. etc. They get themselves out of bed and they come into the hospital, and I’m always amazed by that.
Doctors are some of the greatest people I’ve ever met, and that’s probably what fuels my passion to help them with their finances, because they’re such great people and so terrible with their money that they’re so quick to be taken advantage of, and that really galls me that people that would dedicate so much of their lives to healing the sick and injured would be taken advantage of so much. Now, are they kindergarten teachers or paramedics or nurses, you know, if we’re going to talk about people that really want to help people, you know, doctors probably aren’t Mother Theresa, but compared to the typical professions out there, certainly docs are some of the most idealistic as far as trying to save the world, especially early in their careers in medical school and residency. So, I’ve always been really impressed by that. I spent about a year on an admissions committee at my medical school. I was a fourth-year medical student. And I was so impressed with the caliber of the people who were applying to the school that I felt like I should give up my spot to them, and we routinely had people come in that had done amazing things: started orphanages in Mexico, and really made huge differences all before they ever even started medical school. And I’m not going to say there are no doctors out there who are not interested in making a good salary and that’s not a big motivation for them, particularly as they progress throughout their career. But I think compared to most groups of people, physicians are really top notch.
7. The Source of Dr. Dahle’s Drive
Jim Lange: Well, actually, interesting that you said that that was one of the things that motivated you to write this book, write your blog. Obviously, you’re spending a lot of time, and personally, as an author and somebody who writes blogs myself, my guess is if you’re making ten or twenty bucks an hour, you’re probably doing pretty well. What was the motivation, and why have you spent so much time educating physicians? And the fact that you are a physician has caused a lot more excitement about your book than if, let’s just say, a financial guy had written it.
Jim Dahle: Well, I think there’s two reasons why doctors kind of flock to my website. The first is that they trust me, and I take that very seriously, especially when it comes to disclosing my sources of income on the website. But the other reason is that I can speak their language. I’ve been through what they’ve been through. You know, I’ve worked these eighty or a hundred hour weeks. I’ve been on-call every other night or every third night. I know what it’s like to work thirty-six hours straight in a hospital taking care of patients, and I know what it’s like to be taken advantage of by financial professionals, and that’s what really got me interested in learning about this stuff on my own is I just got sick of being taken advantage of, and so I decided never again. After a few years of learning this stuff and talking about it in online forums or blogs or whatever, I realized that there weren’t any other doctors out there that knew any more about this than I did. So, I ended up spending most of my time helping others and sharing, and maybe not learning quite as much as I was initially in the beginning.
Jim Lange: Well, I think you’ve done a great service for doctors, and again, for any physicians who are listening who have not yet done it, I would urge you to buy The White Coat Investor by James Dahle. Again, that’s The White Coat Investor by James Dahle. He also has an excellent website and blog that can be found at www.whitecoatinvestor.com.
Jim, even though you seem to be pretty much of a…I don’t know if it’s fair to call you a cheapskate, but you want people to rent and not buy early on. You don’t want them to have big cars. You don’t want them to live a lavish lifestyle. But on the other hand, you are a fan of buying insurance, and you mentioned life insurance, disability insurance and liability insurance as an important part of what physicians should be doing. Could you expand on that idea?
8. Insurance as Part of Smart Saving
Jim Dahle: Well, a couple of topics there you gave me. Let’s start with the insurance. My thoughts on insurance are that you ought to spend your money on the insurance you really need and not buy the insurance you don’t need. The things you need to insure against are really the financial catastrophes you face in life, and the biggest financial catastrophe for a doctor is if he dies and leaves his family without any means. Obviously, early in your career, you don’t have much of a nest egg, so it’s really a financial tragedy if you die for anybody who depends on your income. So, life insurance is a must. Other financial catastrophes include acquiring a disability and losing the ability to earn that high income that you spent ten or fifteen years learning how to do. Medical malpractice liability is obviously a huge financial catastrophe. Some of the awards for medical malpractice are shocking sometimes for people to hear about them. But personal liability insurance, basically an umbrella policy on top of your homeowners and auto policy, is also something I recommend to all doctors. Oftentimes, whether you have deep pockets or not, people who know you’re a doctor are going to assume you have them, and so it’s best to have some liability insurance to cover that. Health insurance is another area that’s really a financial catastrophe. It’s amazing how quickly I can spend $10,000 or $20,000 in the emergency department ordering tests and doing treatments. Healthcare is just so expensive. You can’t afford not to insure against something bad happening to you.
Jim Lange: Well, by the way, I happen to agree with just about every concept in the book. One thing in there that I will throw out an idea about that will appeal to cheapskates for life insurance is a lot of people, and even if you are convinced that term insurance is the best way to go, which is what I basically believe in, particularly for young professionals, physician or otherwise, is rather than getting, let’s say, a thirty-year policy, is splitting it up. And if you think about it, when you get a thirty-year policy, you’re effectively overpaying in the early years and you are underpaying in the later years. But the idea is that you are going to be insured no matter what happens between the day that you get it and, let’s say, thirty years down the road. One of the things that I have done to keep the term insurance policy premiums to a minimum is I might actually separate that into three different policies, depending on the age of your children, their education needs, etc. So, rather than getting, I think you mentioned two to five million dollars of term, but let’s just oversimplify and say three million dollars is the appropriate need, I might get a million dollars of ten-year, a million dollars of twenty-year and a million dollars of thirty-year on the theory that in the later parts of your career, you will hopefully have built up some money in your 401(k) plan that you won’t need as much insurance. So, I just thought I would just add that little bit because it seems to be consistent with your idea of not overpaying for some of these things.
Jim Dahle: Absolutely. I think that’s a great way to approach it. Another way I’ve seen people do it, especially people who expect to be financially independent relatively early in life, is to actually use annually renewable term. That’s the term insurance, of course, that goes up every year, but it starts out very inexpensive, and if you think you’re going to be financially independent after just fifteen or twenty years of working, you’ll end up spending a lot less money on insurance than somebody who bought a thirty-year level term policy and then cancelled it after twenty years.
Jim Lange: All right. The other area that I thought was terrific is you’re really trying to give people some good advice, and I’ll tell you the thing that I learned about, and I’ll be a little bit honest with you, I was embarrassed that I didn’t understand health savings accounts until I actually read your description, and when I did, I ran over to the CPA in our office and I said, “Am I maxing out my health savings account?” And he said, “No.” And I said, “We have to change that immediately!” And then, I said, “Are we spending money from it?” And he said, “Yes.” And I said, “That’s the second thing that we have to change immediately.” So, what I would love to do after the break is to talk about health savings accounts, and this, by the way, is going to apply to anybody, physician or not, as long as your company offers them, and tell you that I just think it is a great thing.
Dan Weinberg: And we are talking smart money with Jim Lange and Dr. Jim Dahle, an expert on helping doctors be better with their money.
Jim Lange: And Jim is the author of The White Coat Investor, which, if I were a physician, I wouldn’t even think about it, I’d just go onto Amazon and I would buy it, and the other thing that I would do is I would go to Jim’s website and blog which can be found at www.whitecoatinvestor.com. There’s a wealth of information there. He has a newsletter. He has a blog. I would sign up for all of them.
Right before the break, I brought up the topic of health savings accounts, and Jim is both an expert in medical care and in finance. So, Jim, if you could tell our audience a little bit about health savings accounts, I think that we would all get a lot of great information.
Jim Dahle: Sure. What I really like about a health savings account is that it really functions as a bit of a stealth IRA. I’m frequently contacted by doctors and other high-income professionals who are looking for an additional tax-protected retirement account that they can use, and a lot of the time, they don’t even realize that perhaps their best account is their health savings account. The reason for that is because the health savings account is really the only tax advantaged account out there that is triple tax-free. You get a tax deduction when you put the money in, it grows in a tax-protected manner, and then when you take it out, as long as you spend it on healthcare, it comes out completely tax-free. So, it’s triple tax-free, and so that’s a huge advantage. If you compare that to a traditional IRA or a Roth IRA, you’ll notice quickly that it’s even better than both of those, as long as you spend it on healthcare. But one thing a lot of people don’t realize is even if you don’t spend it on healthcare, you can pull that money out after age sixty-five and spend it on anything you like without paying any penalties. You will have to pay taxes on those withdrawals, but that’s no different from any other tax-deferred retirement account. So, in essence, it’s like an extra retirement account. One thing a lot of people don’t realize about the health savings account too is that you don’t actually have to take the money out of the account in the same year you pay for the healthcare expense. As the law is currently written, you can hold on to your receipts for years and years and years, and then when you pull the money out after twenty or thirty years of tax-protected growth, the money still comes out tax-free, an amount equal to the amount you spent on healthcare. I wouldn’t be surprised to see Congress close that loophole in future years, but as of right now, it’s a great strategy to be able to get that money out tax-free even if, at that point, you’re actually spending it on something else and you just paid for your healthcare with taxable money.
Jim Lange: Yeah. I want to emphasize what you already said, and listeners should understand this. You get a tax deduction when you put the money in, just like a regular IRA. The money grows tax-free, not tax-deferred, but tax-free, while the money’s invested. And then, when you do finally withdraw it, it’s income tax-free, assuming you’re taking it out for a medical purpose. So, it’s better than a traditional IRA, it’s better than a Roth IRA, and the lesson that I took from that is assuming that you can afford it, you should max out what you’re allowed to put into that, and then, unlike what I have been doing up until I read your book, is I was actually using that account to pay for my medical expenses. Then, it occurred to me, this thing is growing income tax-free. My other money is not. What I should be doing is just letting that money continue to accumulate. As you said, a married couple, even retiring in 2013, is going to have $220,000 of medical expenses. So, it’s very unlikely that money won’t ever be spent. So, my new plan is to max out every year and then, when I do have medical expenses, rather than drawing on that account, I’m going to pay for it out of my pocket. And then there’s a few other plans that probably we don’t have time to get into, and then let that money continue to grow tax-free, and, to me, it’s even better than a Roth IRA because I get a tax deduction when I put the money in.
Jim Dahle: Well, it gets even better if you have an employer that’s putting the money in for you directly out of your check. If the employer’s putting it in there, as opposed to you being self-employed and putting it in, it also comes out payroll tax-free. So, it’s really a fantastic account, and it’s the first place I put my investing dollars every year. January 2nd every year, I max out my HSA before I do anything else.
Jim Lange: Yeah. I didn’t even realize the payroll tax-free, but what you’re talking about, I assume, is the Social Security taxes and unemployment taxes, etc.
Jim Dahle: That’s exactly right.
Jim Lange: All right, well, I actually think that that’s a great thing. So first, you know, you say always put in whatever an employer is willing to match, and I completely agree with that. So, people who are still working…and by the way, at the University of Pittsburgh, if you put in eight percent, they put in twelve percent. Can you imagine there are professors who are actually not matching? They’re not even putting in the eight percent. And that’s your first rule, isn’t it? To always do the employer match?
Jim Dahle: Right. I mean, that’s basically free money. It is part of your salary you’re leaving on the table if you ever don’t get an employer match.
Jim Lange: Yeah. And then, you’re a big fan of paying off high interest debt, and like you said, people are coming out with seven-eight percent debt, and that’s just killing them on high amounts. So, you’re a big fan of paying that off after the employer match. Is that right?
Jim Dahle: Absolutely, absolutely. It’s a difficult balance sometimes deciding whether to max out a retirement account or pay off moderate to high interest debt. But if doctors coming out would just continue to live like a resident, they can do both. They can max out their retirement accounts as well as get rid of that debt, within just two to five years of coming out of medical school.
Jim Lange: And that’s also a great time to be putting money into these HSAs, and if you’re in a low tax bracket, like a lot of starting out physicians during their residency, or maybe soon afterwards, Roth IRAs are great, and not only Roth IRAs, but Roth 401(k)s and Roth 403(b)s if you’re working for a non-profit, and then traditional 401(k)s might be more appropriate a little later in your career when you’re in a high income tax bracket. Is that fair?
Jim Dahle: Absolutely. Roth is for residents. When you’re in low income brackets, such as residency, or if you spend some time in the military, for instance, those years, you ought to be maxing out your Roth 401(k) and Roth IRA as much as you can. You may have some opportunities later, if you take sabbaticals or retire early, to do some Roth conversions to add to that Roth bucket, but for the most part, during your peak earnings years, this is the time to be using those tax-deferred retirement accounts.
Jim Lange: Yeah, and you also talk about something that I’ve been writing about for years, which I really like, and I think is worth listening to for everyone, both physician and non-physician, and you actually called it something that I’ve never heard before. You call it the ‘back door Roth.’ Can you tell our listeners about the back door Roth? And let’s assume, for discussion’s sake, now we’re a little bit beyond the residency period and we’re talking to people who have significant incomes, let’s say over $200,000, and the normal rules for people with incomes that high is that they do not qualify for a Roth IRA because the limitations are you can’t do a Roth IRA if your income is that high, but you have a technique that, frankly, I have been using for years and writing about for years, but maybe you could tell our listeners about the back door Roth.
Jim Dahle: Sure, absolutely, and I think those who really understand how these retirement accounts work have been talking about it for years, but it’s unbelievable still how few advisors and high income professionals don’t know about this. Basically, prior to 2010, a high income professional such as a physician with a high income, over $200,000 or $300,000, wasn’t able to convert tax deferred money into Roth money, nor were they able to contribute directly to a Roth IRA. However, in 2010, the law changed, such that while high income people still couldn’t contribute directly to a Roth IRA, they were allowed to convert from a traditional IRA to a Roth IRA. However, assuming they have some kind of a retirement plan at work, as most do, they were not allowed, and still aren’t allowed, to deduct a contribution to a traditional IRA. But they can still make it. That contribution is completely legal. It is also completely legal to then convert the contribution in this traditional IRA into a Roth IRA. So, basically, you’re taking money that would’ve been in a taxable account, or would’ve been in a non-deductible IRA, and turning it into a Roth IRA. It’s really a win-win. There’s a few caveats to it, though. The main one is that you can’t have any other traditional, simple or SEP IRAs due to the way the IRS calculates your conversion. So, what most doctors end up doing is rolling any of those into a 401(k) or, perhaps, if it’s not too big, just converting the entire traditional IRA to get rid of that. But you have to be aware of the pro-rata rule. If you’ve got a bunch of traditional IRAs on the side, this just isn’t going to work for you.
Jim Lange: Yeah, that’s right, but let’s say that you do, and let’s say that, for discussion’s sake, that your employer offers a set of low-cost index funds as a 401(k) or 403(b) option. What you said, which is that you could take your traditional IRAs, you can roll them into your 401(k) or 403(b) at work, that will mean that you’ll have no traditional IRA left, then what you can do is, you can make a non-deductible contribution, and by the way, you can do it for your spouse. So, let’s say, in 2015, it’s now March, 2015, you could put in $6,000 for yourself, or is it $6,500 if you’re fifty and over? Six thousand dollars for yourself, $6,000 for your spouse for 2015, then you could also do it for 2016. That is another $6,000 for yourself, $6,000 for your spouse. And I actually think it’s $6,500. So, you could get $26,000 into Roth IRAs in one quick day. Again, mechanically what you do is you make a contribution to a non-deductible IRA, and then you could actually make a Roth IRA conversion of it the next day. So, I am a big fan of that strategy that you recommend.
Jim Dahle: Yeah, I think those who had their ear to the ground in 2010, or prior to that when the laws were being set up for 2010, really saw this coming, and a lot of people even started making non-deductible contributions prior to 2010, anticipating that conversion coming up. But I’m still amazed that every time I present this at a conference where I speak or when I write about it on the website, it’s still new to a lot of people who just assumed that they cannot use a Roth IRA once their income is beyond the limit.
Jim Lange: And of course, you know, I’ve been working with Roth IRAs, and I actually wrote the first peer-review article on Roth IRAs. I actually wrote it in 2009, even before it became law, and I am a big fan of Roth IRAs while you are young. Maybe traditional retirement plans when you are, let’s say, in the high income years, with the exception of the back door Roth that we’re talking about, and then I’m also a big fan of Roth IRA conversions in that sweet spot number of years when you are retired. So, you don’t have your income from your job or your business. You, let’s say, are holding off on Social Security, or maybe you’re not even sixty-two yet, but I’m a big fan of holding off in general. You are not yet seventy, so you don’t have your minimum required distribution from your retirement plan. Those might be your lowest tax base years that you’re ever going to have, and doing a series of Roth IRA conversions, along with following the advice of Dr. Jim Dahle who we’re talking with, author of The White Coat Investor, he’s going to give you advice so that you could, perhaps, if you want to, retire in your fifties or sixties. That would be a great long-term strategy to do your Roth conversions after you retire, but before you hit seventy. So, again, I like the fact that you’re very cognizant of Roth IRAs and trying to take advantage of the tax laws as much as you can.
So, the other thing that you talk about is that you don’t like to mix insurance with investments, and I think that that’s a good rule for a lot of people, and I might think, well, there are certain things about second-to-die insurance, but that comes much later on, and that’s when there’s more than enough money for you and your spouse. But, in general, you’re more of a fan of low-cost term insurance and non-product type solutions, particularly for young physicians. Is that right?
11. Keeping Insurance Separate from Investing
Jim Dahle: Absolutely. I mean, there are always niches where you can find a use for a particular type of annuity or a particular type of cash value life insurance. For example, you mentioned the second-to-die insurance. Another example, in an irrevocable trust, in an effort to save on some estate taxes. It’s a great use of life insurance. But the problem I run into is I have doctors who are in residency, or just out of residency, owe $200,000 or $300,000 at seven percent, aren’t even maxing out the retirement accounts, and they’ve been sold a huge whole life insurance policy that’s totally inappropriate for them. And so, I try to get the message out that that’s certainly not an essential or required part of a financial plan, to pick up one of those policies early in life, despite all of the people trying to sell one to you. And so, I try to provide a little bit of warning there. A lot of times, too, when you find yourself mixing investing insurance and these various types of products, you end up with the worst of both worlds. You end up paying too much for the insurance, and you end up with a terrible high-cost, high fee investment. And so, by separating them out, you can actually pick the best of both worlds, and I think that’s the way most people ought to go, especially early in their careers.
Jim Lange: Well, Jim, this has been a great hour. We’ve been talking with Dr. Jim Dahle. He is the author of The White Coat Investor: A Doctor’s Guide to Personal Finance and Investing. If I was a physician, or I was working with physicians, I wouldn’t even think for a minute, I would go right to Amazon, and again, it’s The White Coat Investor: A Doctor’s Guide to Personal Finance and Investing by Jim Dahle, and I would also go to www.whitecoatinvestor.com and sign up for Jim’s blog and his newsletter.