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Understanding Required Minimum Distributions – Podcast #205

Podcast #205 Show Notes: Understanding Required Minimum Distributions

A lot of people have this fear of required minimum distributions. Understanding how RMDs work is important but you don’t need to fear the future taxes. One listener was concerned that they would end up losing money in retirement because not enough time and effort was spent in planning strategically for RMDs. In this episode, we dive into everything you need to know about required minimum distributions: how they are calculated, what the minimum is, tax implications, and tax mitigation strategies. If you have any fears about RMDs, this episode will help alleviate them.

For those of you who are not laying awake at night worrying about RMDs, we also answer listener questions about what to do with old retirement accounts, backdoor Roth IRAs, naming beneficiaries for 529 accounts, bond tents, how risky hobbies will affect your insurance, and indexed universal life insurance.

Sponsor

Brought to you by the Laurel Road Student Loan Cashback℠ credit card. Laurel Road is committed to serving the financial needs of doctors. You take care of us. It’s time someone took care of you. With the new Laurel Road Student Loan Cashback℠ credit card, you can earn 2.0% in Cashback Rewards towards eligible student loans for each $1 spent on eligible purchases, or 1.0% in Cashback Rewards as a statement credit. Subject to credit approval. For terms and conditions, please visit www.LaurelRoad.com/WCI. Laurel Road is a brand of KeyBank N.A. Member FDIC and Equal Housing Lender. NMLS # 399797

 

Quote of the Day

This one comes from J. Maarten Troost, who said,

“There is a reason there are oodles of young Aussies, Germans, Japanese, and even Chinese backpackers traipsing around the world. They are unencumbered by debilitating student loans. No such luck for the American theater arts major with $120,000 in loans.”

Isn’t that the truth? You wonder how much our method of paying for college is affecting our lives, the lives of our young people, how we live in our 20s and 30s. You really wonder when you look at the way some of these other countries are doing it, are we really doing it right or not?

YouTube

If you haven’t checked out our YouTube channel, you should. We just surpassed 10,000 subscribers. Almost every time we record a podcast episode, we also record video and put it up on YouTube. Most of the interviews we do are also recorded on videos. So, you can see the guests there as well. We do this for the WCI podcast episodes and the Milestones to Millionaire episodes.

There are also informational deep dive videos where we discuss one particular topic in depth, like how to fill out IRS form 8606 for your backdoor Roth IRA or how to create a portfolio rebalancing spreadsheet. There is also a series of shorter videos that we call YQA – Your Questions Answered – where I answer questions that you, the listeners have asked. So, go check that out and subscribe.

First Year Medical Students

Those of you who are first year medical and dental students in the United States, if no one in your class is signed up to be the WCI champion, please do so. Go to whitecoatinvestor.com/champion. There is very little time and no money involved. All you have to do is agree to pass out free White Coat Investor guide for Students’ books to your classmates.

If you do that, we’ll send you a t-shirt. If you send us a picture of you doing it, we’ll send you a cool WCI tumbler as well. But we need time to get it out before the end of the year. If your class misses out on this, you’re going to be MS2s next year, and we’re not going to give you free books. We’re going to have moved on to the new first years at that point.

Student Loan Advice

If you didn’t see our announcement on Monday about student loan advice, there is a serious need out there for high-quality student loan advice, so we have arranged for white coat investors to be able to meet with a trained student loan planner for a quick advice session at a fair price early in their career. This is a White Coat Investor company, and we had the co-founder of StudentLoanAdvice.com, Andrew Paulson, on this episode so you can get to know him, better understand this service, and decide if it is right for you.

Milestones to Millionaire Episode

This doctor paid off $450K in student loans in 2.5 years by prioritizing being debt free above all else. Impressive amount of discipline. That amount of debt was incredibly intimidating for Daniel but it feels every bit as good as he thought it would to be free of these student loans. It is possible with commitment, budgeting, and delaying gratification. Getting rid of your student loans is a trial run for your future goal of being financially independent. Find the tools you need to manage your student loans.

Sponsored by Bob Bhayani at drdisabilityquotes.com

 

Understanding Required Minimum Distributions

Let’s talk about RMDs. A lot of people have this bizarre fear of required minimum distributions. Under current law, starting at age 72, you must start taking money out of your IRA and tax deferred accounts. The government lets you defer those taxes for a long time, but they eventually want you to pay them. That is what a required minimum distribution is. There is no law that you must spend the money, but you must take it out of the account and pay taxes on it. You don’t have to do that on a Roth IRA. Interestingly enough, though, you do have to do it on a Roth 401(k). So, if you don’t want to be taking RMDs on a Roth 401(k), make sure you roll it into a Roth IRA before you turn 72.

But there are lots of cool things you can do with RMDs. For example, this is the best way to give to charity after age 72. They’re called qualified charitable distributions. Any money you take out of that IRA and give directly to a charity counts toward your RMD. It is a great way to give it, especially if you’re now taking the standard deduction because you don’t make as much money. It’s a great way to still basically be able to use pre-tax money to do your charitable contributions.

But for the most part, RMDs are just something that you have to do each year. Typically it’s usually best to wait until late in the year to take them out, especially if you don’t need the money. Then that money benefits from that tax protected growth and asset protection throughout the whole year. Just make sure you don’t forget, because the penalty for not taking out a required minimum distribution is huge. It’s 50% of the amount you should have taken out. You definitely want to get your RMDs out of the account when you were required to take them out.

So, how much is an RMD? Well, here is the good news. It’s usually about as much as you should be taking out to spend. You’ve heard of the 4% rule. 4% a year adjusted upward for inflation each year is how much you can take out of your retirement portfolio and probably have it last throughout a 30-year retirement. So, what do RMDs start at? Well, at about age 72, they start at about 3.6%. So, it’s about how much you should be taking out anyway. No big deal. That’s what you should be spending from your retirement account.

It’s okay to take it out and spend that money. That’s what it’s for. You paid taxes on it. You saved it your whole life for retirement. Now it’s time to spend it on retirement. If you don’t need it because you’re so wealthy, maybe you should give it away. Maybe you should give it to charity. Maybe you should give it to family members who can use it.

But you can just take the money out of your retirement account and reinvest it in a taxable account. That’s completely permitted. So, let’s say your RMD was $40,000. You take $40,000 out. Maybe you’re in the 25% tax bracket. Maybe you have them withhold $10,000 for your taxes, and you reinvest the $30,000 in a taxable account. You have met your obligation. You have taken your RMD. You didn’t have to spend any of that money. You basically just have to move it out of the retirement account. Roth conversions don’t count toward that. You can’t just convert it to a Roth IRA and call that a RMD. That doesn’t work.

Yes, there is a minimum. Basically the balance of that account at the end of the prior year, December 31, 2020 is when your 2021 calculation is done and it is multiplied by that percentage. The percentage goes up as you get older. It’s about 4% in your early 70s. By the time you’re 90, it’s like 11%. So, 11% of what that balance was the year before.

Is that a huge deal? Not really. I mean, imagine you have $2 million in tax deferred assets and you have to take 5% of that out. You take a hundred thousand dollars out and pay taxes on it. If that’s your only source of taxable income, although you’d probably have social security at that point, you’re not going to pay that much in taxes on it. You’re going to pay a whole lot less than you probably saved putting it in as an attending physician.

So, you really have to have a very large IRA to truly have a required minimum distribution problem. By problem, I mean, you’re paying a higher tax rate on it than you saved when you put the money in. You have to be a real supersaver. We’re talking about high seven figure, eight figure tax deferred accounts. Most doctors aren’t getting there with all their assets, much less just their tax deferred accounts.

If you’re one of them, then what you ought to be thinking about is more Roth contributions and more Roth conversions, both during your working years and, particularly, between the time you retire and when you have to start taking RMDs. Those are prime years. When you start taking social security, too, if you delay that to age 70, those are prime years to do Roth conversions in relatively low brackets to minimize that RMD problem.

But what are the tax implications of RMDs? It’s ordinary income. You pay taxes on it. You don’t have to pay social security or Medicare taxes on it. You paid that on the money before it went in, but you have to pay ordinary income tax rates on it. They’re not capital gains or qualified dividend rates or anything.

There is no maximum. The larger your account, the more you have to take out of it. So those are things to be thinking about with RMDs. A lot of people really make you fear them. Like it’s this huge tax bomb you’re going to have down the road. Well, it’s only a huge tax bomb if you did really, really well during your life. And if that’s the case, you can usually see it coming enough that you can do some pretty significant Roth conversions to minimize the effects of that.

For most people, it’s income you’re going to spend, you might as well pay taxes on it and take it out. Isn’t it wonderful that the government let you put that off for 30 or 40 years and have it in this great asset protected account in the meantime? So, don’t have a lot of fear of RMDs. Certainly, if you’re a typical doc, you should not.

If you have some crazy, awesome situation where you are super wealthy, maybe you do have an RMD problem. But honestly, the solution to that is not to avoid retirement accounts in the first place or to take money out of them prematurely. It’s to do Roth conversions.

Recommended Reading

Don’t Fear the Reaper

 

Reader and Listener Q&As

What to Do with Old Retirement Accounts

“My employer recently reorganized in such a way that our retirement plan provider has changed. And so, I’m trying to figure out what to do with the old retirement accounts. And what I’ve got is a 401(k) with both Roth and pre-tax dollars, the Roth dollars total of $193,000 and the pre-tax totals just under $29,000. There is also a 457, which is all pre-tax dollars, $159,000. And so, I have a solo 401(k) with Vanguard and also a traditional IRA with a balance of zero and a Roth IRA at Vanguard. And I was planning to roll the Roth dollars into the Roth IRA and the pre-tax dollars from both the 401(k) and the 457 into the solo 401(k). However, I recently learned that Vanguard does not allow that. They might within the next few months, but there’s no guarantee there. And so, I’m wondering if I should just leave the pre-tax dollars where they are for now, or if I should get a new solo 401(k) somewhere else or what you might recommend doing in this situation.”

The good news is that Vanguard’s solo 401(k) product now takes IRA rollovers. They didn’t for years. You can now just do the simple thing, roll all that into your solo 401(k).

Even before though, they accepted 401(k) rollovers to 401(k) rollovers. They just weren’t taking IRA rollovers into the 401(k), but they do that now. So, it sounds like your plan is working great. This will help you minimize taxation and help you get the asset protection available from your retirement accounts.

529 Account Beneficiaries

Can I open a 529 as the account owner and named my fiancé as the beneficiary? My intent is to save money in the 529 before we have our first child so it can grow in time to use for private school tuition for K1 through 12. After the child is born and has a social security number, I would transfer it to the child as the beneficiary. I plan to do this in Utah My529 as we live in Texas and don’t have an income tax. Can I do this? Can I use this 529 money for my fiancé who is attending graduate school? Any tax implications of doing this once we’re married?”

Good news. You can do that. That’s a reasonable thing to do. You can also make yourself the beneficiary if you’d like. A lot of people don’t realize that, but you can be the beneficiary of your own 529. Now, when you start renaming beneficiaries that are multiple generations below you, you start running into some gift tax issues.

Honestly, a lot of this is kind of overkill for people that are trying to do this before the baby’s born, because you can put a lot of money into a 529 when the baby is born. You put $15,000 for each parent, times five years into a 529. So, the day you get the social security number for your kid, you can put $150,000 into a 529.

It is not like you have to creep a little bit in there in the year or two before they’re born to try to make up for that. I mean, if you really want to truly maximize the benefit of this sort of thing, you can do that, but it just seems like a lot of work and hassle when you can turn around the day they’re born or the day you get the social security number, open the account and put $150,000 into there.

In fact, there is no law that keeps you from doing that in multiple states. You can open a 529 in one state and you can go to another state and open a 529 for your kid as well. And put another $150,000 in there. You can really put a ton of money into 529s but you have to ask yourself, “how much do I really want in there? How quickly do I need to get it in?” because you could have all of your money in 529 spread across the entire nation if you really wanted to.

Certainly, we would have you be the owner if you’re going to name the beneficiary as a fiancé, because we don’t really think you should be mixing your finances until you’re married. But since you still control the 529 as the owner, and you can change the beneficiary at any time, that’s fine because you still totally control it. So, if you want to name your fiancé as a beneficiary, that is fine.

Bond Tents

“I’ve recently heard talk about bond tents to protect against sequence of return risk right before and after retirement. I’m having a little trouble getting my head around bond tents and equally even sequence of returns risk. It seems simple, but maybe it’s not.”

Sequence of returns risk is the risk of running out of money in retirement despite having average returns that were adequate to sustain your withdrawal rate because the crummy returns showed up first and the good returns showed up later.

So, what you’re trying to avoid is the combination of withdrawals and bad returns early on, because that can cause you to run out of money. That’s what sequence of returns risk is. So, what is a bond tent? Well, the idea behind the bond tent is that your percentage of bonds goes up as you approach retirement and as you’re in your first few years of retirement and then goes back down.

That came from these research papers that came out in the last few years, that suggested actually increasing your percentage of equity in retirement can reduce the risk of running out of money in retirement. Because the big risk there is inflation. Inflation destroying your savings. If you get all your money in bonds, there’s not much fluctuation there, not much volatility, but it’s at risk to inflation. That research showed that if you actually increase the percentage of money in equities throughout retirement, that risk is lower. And that’s true, using past data.

For three to seven years after you retire and two to three years before you retire, that’s your highest risk time for a big nasty bear market affecting your retirement spending.

The idea is that during that period of time, you have more bonds than you would otherwise have the rest of your life, during the accumulation phase and even later during the decumulation phase. That is your bond tent. Maybe you were 65% stocks and 35% bonds. And you went to 50/50 for that period of 5 to 10 years. And then you went back to maybe 60/40 or something like that. That’s the idea behind a bond tent. It’s no more complicated than that.

Now, there are still lots of people out there that think you ought to just gradually decrease the aggressiveness of your asset allocation throughout retirement. So, this is definitely a controversial area. Maybe you ought to just decrease how risky your asset allocation is two or three years before you retire and keep right on decreasing that. That wouldn’t be a bond tent. With a bond tent the idea is that you later increase your equity allocation.

Backdoor Roth IRA

“My wife and I recently started the process of a backdoor Roth IRA. In order to do this, we needed to take a sizable traditional IRA that my wife had and reverse rollover it to a solo 401(k). We were hoping to do this before December 31th 2020 but were unable to get through the whole process before the end of the calendar year. My question is regarding taxes. I read that one can perform a backdoor Roth IRA prior to filing taxes and claim it for the prior year. However, considering we did not reverse roll over the traditional IRA to the 401(k) until 2021, can we do that in this case for filing taxes this year? If we can, what do we need to do to comply in filing the tax forms correctly?”

Here is the truth about the pro rata issue. It’s important to understand that the backdoor Roth IRA is not an account that you fund. It’s a process, and the process has two steps. You put money into a traditional IRA and you convert that money from the traditional IRA into the Roth IRA. Now you can do the contribution any time up until Tax Day of the next year. So, you can make a contribution for 2020 any time until April 15th, 2021.

But there is no time limit on the conversion. You can do the time conversion now, you can do it next year, you can do it in 20 years. There’s no time limit on it. It’s not a conversion for 2020. It’s a conversion you did in 2021. The pro rata calculation, which comes from line 6 of form 8606, says that you need to have a balance of $0 in a SEP IRA, traditional IRA, simple IRA, or rollover IRA on December 31th of the year that you do the conversion step. You can still make a contribution for 2020. If you don’t do the conversion until 2021 for that contribution, you have until December 31st, 2021 to get rid of that traditional IRA.

That sounds like what you’re describing for your wife’s account. So, no harm done yet as long as you didn’t do a backdoor Roth IRA for her last year, like you’re doing this year. That is fine to go ahead and make your 2020 contribution now. You have to the end of the year to get rid of that traditional IRA so that your conversion done in calendar year 2021 doesn’t get prorated.

This question comes in from email. “When doing my taxes online, reporting the backdoor Roth information I’m always a little flustered by the question about my IRA basis. Is it wrong or unadvisable to just check zero for this every year? If so, could you explain what this basis is and a simple way to calculate this for tax purposes?”

As a general rule, basis is post-tax money. So, if you’re buying in a taxable account, if you buy a stock, put $100,000 into a stock, and then it appreciates to $200,000 and you sell it your basis, what you paid for, it’s $100,000. The hardest question on form 8606, where you report your backdoor Roth IRA is line two, where it asks about your basis. And even the instructions for that say, “If this is your first year of filling out form 8606, you should probably put zero on this line”. That is what goes on our form 8606 line two every year. The reason why is because we didn’t have any basis in our traditional IRAs the year before, because they were all zeroed out.

We don’t want to say this is the correct way to do a backdoor Roth IRA, because there are obviously different ways you can do it, but this is by far the simplest way to do the paperwork for backdoor Roth IRA. Make the contribution during the calendar year and do the conversion for that contribution right afterward. It keeps your paperwork very simple. And if you’re doing that every year, line two should be zero. Your basis is zero.

But, for example, let’s say you make a late backdoor Roth IRA contribution, meaning you make a 2020 contribution in the first three and a half months of 2021. Then when you put in your 2020 form 8606, all you are documenting is the contribution. But when you go to do your 2021 form 8606, it’s going to ask you about your basis. And your basis at that point is your 2020 contribution. Your 2020 contribution, that money you put in the year before this, doesn’t get taxed again. So, if you put $6,000 in for 2020, in the first few months of 2021, you put $6,000 on line two of your 8606 for 2021 – that’s your basis. So, you don’t have to pay taxes on it twice.

The idea behind basis is you only pay taxes on money one time. If you think it through that way, then it should make sense to you.

Recommended Reading

Backdoor Roth IRA Ultimate Guide and Tutorial

Risky Hobby Affecting Insurance

“I’m currently working on life insurance and disability insurance, but had a question. I had a “risky” hobby prior to residency, which I have not had the time to engage in over the last three years. But I am wondering if I get insurance now and re-engage in that hobby, say after residency in a couple of years, does this mean that my premiums will go up then, or will they not be covered?”

Definitely something to discuss with the independent agent from whom you are buying disability and term life insurance. You didn’t mention what your risky hobby is, but generally it’s jumping out of airplanes,  scuba diving, rock climbing, or flying planes. Whatever it might be, you haven’t done it in three years. If you haven’t been rock climbing in three years, you’re not a rock climber.  So put that on your application that you don’t climb rocks. It’s okay. It’s been three years.

The way this typically works is they have a look back period. If you haven’t done it in 6 months or 12 months, and you don’t have any plans to do it in the next 3 months or 6 months or something like that, then you can honestly answer that question “No”.

On the other hand, if you went climbing last week and you’re planning a trip to Red Rock in two weeks, you pretty much have to answer that question “Yes”. The goal is not to lie about it.

Now, if there’s a claim, will the insurance company go back? Sure. But they don’t go back so far as to see if you ever went scuba diving 15 years ago. If you go in another 15 years, they’re not going to nail you for going scuba diving, because you didn’t say you’d been scuba diving. That’s not what they’re asking. They’re not asking whether you ever did something. They’re asking whether this is something you do frequently. And objectively what that comes down to is have you done it in the last few months? Do you have plans to do it in the next few months? But don’t hide this from your agent. Talk to your agent about it, ask them what the guidelines are and report it accurately.

If you tell them you rock climb or you scuba dive and you’re doing it regularly, you’re either not going to get insurance, it is going to be excluded, which is what usually happens on disability insurance, or you’re going to pay dramatically more for your policy, which is what usually happens with life insurance. So be aware of that.

Indexed Universal Life Insurance

A listener asked for our opinion on indexed universal life insurance.

The bottom line is IUL is generally a product designed to be sold, not bought. The problem with it is you end up with poorer returns than you get with a VUL, fewer guarantees than you get with a guaranteed universal life policy or a whole life policy, and more commissions than either. So, it’s like the worst of all worlds and really something that agents push because it pays the highest commissions of any of the permanent life insurance policies.

They try to sell it as you get to participate in the market with no downside. But the truth is you give up so much of the upside that it’s too much for the guarantees you’re given.

The type of returns we would expect out of an IUL are about what you would get in the long run out of a whole life policy or a more typical universal life policy. One of the parts about universal life that we don’t like over whole life is that the cost of insurance goes up later in life. So, your premiums either have to get bigger, or you have to shrink your death benefit, or it starts eating up the cash value of the policy.  So these, more so than whole life, have to be managed late in life. The management usually consists of reducing the death benefit, which isn’t something people really do with whole life insurance. Keep that in mind that you really are buying something that’s significantly different from whole life and, in most ways, significantly worse. A product to be avoided in our opinion.

 

Full Transcription

Intro:
This is the White Coat Investor podcast where we help those who wear the white coat get a fair shake on Wall Street. We’ve been helping doctors and other high-income professionals stop doing dumb things with their money since 2011. Here’s your host, Dr. Jim Dahle.
Dr. Jim Dahle:

This is White Coat Investor podcast number 205 – Understanding required minimum distributions.
Dr. Jim Dahle:
Thanks to our sponsor Laurel Road. This episode is brought to you by the Laurel Road student loan cash back credit card. Laurel Road is committed to serving the financial needs of doctors. You take care of us, it’s time someone took care of you.
Dr. Jim Dahle:
With the new Laurel Road student loan cash back credit card, you can earn 2.0% in cash back rewards towards eligible student loans for each $1 spent on eligible purchases or 1.0% in cash back rewards as a statement credit.
Dr. Jim Dahle:
Subject credit approval. For terms and conditions, please visit www.laurelroad.com/wci. That’s www.laurelroad.com/wci. Laurel Road is brand of KeyBank, N.A and member at the FDIC, an equal housing lender. NMLS number 399797.
Dr. Jim Dahle:
Let’s do our quote of the day. This one comes from J. Maarten Troost, who said, “There is a reason there are oodles of young Aussies, Germans, Japanese, and even Chinese backpackers traipsing around the world. They are unencumbered by debilitating student loans. No such luck for the American theater arts major with $120,000 in loans”.
Dr. Jim Dahle:
Isn’t that the truth? You wonder how much of an effect is our method of paying for college, affecting our lives, the lives of our young people, how we live in our 20s and 30s. You really wonder when you look at the way some of these other countries are doing it, if we’re really doing it right or not.

Dr. Jim Dahle:
At any rate, today is March 22nd. This is going to go live on April 8th. It’s been quite a spring. Hope things are going well for you. They are certainly going well for us. Our coronavirus counts keep trending down and I am going multiple shifts now without seeing a positive COVID patient. So, I hope you are having the same experience and looking forward to the day when most of us are vaccinated and none of us are wearing masks. I suspect I’ll be wearing one at work for a good chunk of the rest of the year. But looking forward to maybe not wearing it everywhere else.
Dr. Jim Dahle:
If you haven’t checked out our YouTube channel, you should. Our YouTube channel just surpassed 10,000 subscribers. In case you didn’t know, you can watch us record the podcast on YouTube. I’m actually sitting in front of a camera right now. And almost every time we record a podcast episode, we also record video and put it up on YouTube. Most of the interviews we do are also recorded on videos. So, you can see the guests there as well. We do this for the WCI podcast episodes, as well as the Milestones to Millionaire episodes.
Dr. Jim Dahle:
There are also informational deep dive videos where I discuss one particular topic in depth, like how to fill out IRS form 8606 for your backdoor Roth IRA, or how to create a portfolio rebalancing spreadsheet. There is also a series of shorter videos that we call YQA – Your Questions Answered. Where I answer questions that you, the listeners have asked. So, go check that out. Just go to YouTube and search for “White Coat Investor” and make sure you subscribe to stay up to date on everything we’re doing over there.
Dr. Jim Dahle:
Those of you who are first year medical and dental students in the United States, if nobody in your class is signed up to be the WCI champion, please do so. Go to whitecoatinvestor.com/champion. There’s very little time and no money involved. All you got to do is agree to pass out free White Coat Investor guide for students’ books to your classmates.
Dr. Jim Dahle:
If you do that, we’ll send you a t-shirt. If you send us a picture of you doing it, we’ll send you a cool WCI tumbler as well. But we need time to get it out before the end of the year. If your class misses out on this, you’re going to be MS2s next year, and we’re not going to give you free books. You got to buy them. We’re going to have moved on to the new first years at that point, most likely.

Dr. Jim Dahle:
All right, let’s take a few questions off the Speak Pipe. This first one comes in from an anonymous listener who’s wondering what to do about retirement plans. Let’s take a listen.
Speaker:
Hey Jim, thanks for everything you do for folks like me who are just learning to manage our own finances. My employer recently reorganized in such a way that our retirement plan provider has changed. And so, I’m trying to figure out what to do with the old retirement accounts. And what I’ve got is a 401(k) with both Roth and pre-tax dollars, the Roth dollars total of $193,000 and the pre-tax totals just under $29,000. There is also a 457, which is all pre-tax dollars, $159,000.
Speaker:
And so, I have a solo 401(k) with Vanguard and also a traditional IRA with a balance of zero and a Roth IRA at Vanguard. And I was planning to roll the Roth dollars into the Roth IRA and the pre-tax dollars from both the 401(k) and the 457 into the solo 401(k).
Speaker:
However, I recently learned that Vanguard does not allow that. They might within the next few months, but there’s no guarantee there. And so, I’m wondering if I should just leave the pre-tax dollars where they are for now, or if I should get a new solo 401(k) somewhere else or what you might recommend doing in this situation. Thanks very much for your help.

Dr. Jim Dahle:
All right. So, it looks like I got good news for you. Vanguard’s solo 401(k) product now it takes IRA rollovers. They didn’t for years. And so, I’ve been including that information in blog posts and podcast questions and so forth, but now they do. So, good news to you. You can now just do the simple thing, roll all that in your 457. It sounds like it’s a governmental one, because you can roll it into another plan and your 401(k) from your old plan, I guess your new one’s not as good. That’s fine. Just roll it into your solo 401(k). Vanguard now accepts all that.
Dr. Jim Dahle:
Even before though, they accepted 401(k) rollovers to 401(k) rollovers. They just weren’t taking IRA rollovers into the 401(k), but they do that now. So, it sounds like your plan is working great. This will help you minimize taxation, help you get the asset protection available from your retirement accounts.
Dr. Jim Dahle:
All right, let’s take our next question. This one comes from Dina.
Dina:
Hey Jim. It’s Dina from Michigan. Can I open a 529 as the account owner and named my fiancé as the beneficiary? My intent is to save money in the 529 before we have our first child so it can grow in time to use for private school tuition for K1 through 12. After the child is born and has a social security number, I would transfer it to the child as the beneficiary. I plan to do this in Utah my 529 as we live in Texas and don’t have an income tax. Can I do this? Can I use this 529 money for my fiancé who is attending graduate school? Any tax implications of doing this once we’re married? Thanks for all that you do. I appreciate you.
Dr. Jim Dahle:
Good news. You can do that. That’s a reasonable thing to do. You can also make yourself the beneficiary if you’d like. A lot of people don’t realize that, but you can be the beneficiary of your own 529. Now, when you start renaming beneficiaries that are multiple generations below you, you start running into some gift tax issue, kind of things.
Dr. Jim Dahle:
And honestly, I think a lot of this is kind of overkill for people that are trying to do this before the baby’s born, because you can put a lot of money into a 529 when the baby is born. You put $15,000 for each parent, times five years into a 529. So, the day you get the social security number for your kid, you can put $150,000 into a 529.
Dr. Jim Dahle:
So, it’s not like you got to creep a little bit in there in the year or two before they’re born to try to make up for that. I mean, if you really want to truly maximize the benefit of this sort of thing, you can do that, but it just seems like a lot of work and hassle when you can turn around the day they’re born or the day you get the social security number. So, you can use it to open the account and put $150,000 into there.
Dr. Jim Dahle:
In fact, there is no law that keeps you from doing that in multiple states. You can open a 529 in one state and you can go to another state and open a 529 for your kid as well. And put another $150,000 in there. You can really put a ton of money into 529s but you’ve got to ask yourself, “Well, how much do I really want in there? How quickly do I need to get it in?” et cetera, because you could have all of your money in 529 spread across the entire nation if you really wanted to. So, I think it’s overkill, but yeah, you can do that if you want to.
Dr. Jim Dahle:
And certainly, I would have you be the owner if you’re going to name the beneficiary as a fiancé, because I don’t really think you should be mixing your finances until you’re married. But since you still control the 529 as the owner, and you can change the beneficiary at any time, that’s fine because you still totally control it. So, if you want to name your fiancé as a beneficiary, I think that’s fine.
Dr. Jim Dahle:
All right. Our next question comes in via email. It asks, “I’ve recently been seen talk about bond tents to protect against sequence of return risk right before and after retirement. I’m having a little trouble getting my head around bond tents and equally even sequence of returns risk. It seems simple, but maybe it’s not. I was wondering if you’d be up for a blog post about it. Bond tends to come up on firesides quite a bit. As an EM doc, I started med school at 30. I’m not in the FIRE crowd, but I’d like to retire in about 10 years. So, I’m starting to think about that phase of my savings”.
Dr. Jim Dahle:
Well, shoot, if you’re thinking about retiring in 10 years, you’re probably a FIRE kind of person. Just because you don’t retire at 32, it doesn’t mean you’re not a FIRE person. I mean, early retirement, 62 used to be considered early retirement. So, if you’re still talking about retiring in your 40s, 50s, early 60s, I think the principles of FIRE certainly still apply to you even if you’re not the classic tech row that retired at 28, right?
Dr. Jim Dahle:
All right, sequence of returns risk is the risk of running out of money in retirement despite having average returns that were adequate to sustain your withdrawal rate because the crummy returns showed up first and the good returns showed up later.
Dr. Jim Dahle:
So, what you’re trying to avoid is the combination of withdrawals and bad returns early on, because that can cause you to run out of money. That’s what sequence of returns risk is. So, what is a bond tent? Well, the idea behind the bond tent is that your percentage of bonds goes up as you approach retirement and as you’re in your first few years of retirement and then goes back down.
Dr. Jim Dahle:
And that came from these research papers that came out in the last few years, that suggested actually increasing your percentage of equity in retirement can reduce the risk of running out of money in retirement. Because the big risk there is inflation, right? Inflation destroying your savings. If you get all your money in bonds, there’s not much fluctuation there, not much volatility, but it’s at risk to inflation. And so, that research showed that if you actually increase the percentage of money in equities throughout retirement, that risk is lower. And that’s true, using past debt.
Dr. Jim Dahle:
The problem with that is sequence of returns risk. That period of time right around when you retire. And your biggest risk year is the year after you retire. And then the year after that and the year after that and the year after that, and then you go back to the year before you retire and the year before that.
Dr. Jim Dahle:
But basically, for three to seven years after you retire and two to three years before you retire, that’s your highest risk time for a big nasty bear market affecting your retirement spending.
Dr. Jim Dahle:
And so, the idea is that during that period of time, you have more bonds than you would otherwise have the rest of your life, during the accumulation phase and even later during the decumulation phase. And so, that’s your bond tent is maybe you were 65% stocks and 35% bonds. And you went to 50/50 for that period of 5 to 10 years. And then you went back to maybe 60/40 or something like that. That’s the idea behind a bond tent. I hope that’s helpful. It’s no more complicated than that. But that’s the idea behind it.
Dr. Jim Dahle:
Now, there are still lots of people out there that think you ought to just gradually decrease the aggressiveness of your asset allocation throughout retirement. So, this is definitely a controversial area. Maybe you ought to just decrease how risky your asset allocation is two or three years before you retire and keep right on decreasing that. That wouldn’t be a bond tent. With a bond tent the idea is that you later increase your equity allocation. Hope that makes sense.
Dr. Jim Dahle:
All right, we’re going to bring a special guest onto the podcast with some really exciting stuff I’ve been wanting to announce to you all year. Well, now’s the time.
Dr. Jim Dahle:
Our special guest today on the White Coat Investor podcast is Andrew Paulson. Andrew, welcome to the podcast.
Andrew Paulson:
Thanks for having me, Jim. It’s great to be here.
Dr. Jim Dahle:
Now, you’re a new father and a new member of the WCI team. Tell us a little bit about your background.

Andrew Paulson:
Yeah, sure. I’m excited to be here. I’m excited to be part of the WCI team. So, growing up, I didn’t always want to be in the business world. I thought for a time that I was going to be a professional golfer. And once I got to the collegiate ranks, I realized I was mediocre. I wasn’t good enough to really be making a paycheck playing golf. And so, I love that I was able to be doing something passionate in college, but realized that I needed to start kind of shifting and getting into a career.
Andrew Paulson:
Naturally, I was always interested in businesses, how they ran, working with people and entrepreneurism. And so, I started going down that path and studied business, finance and accounting in school to learn the language of business. Often my friends would ask me for investing financial markets advice and how to retire. And I kind of really liked doing that for them.
Andrew Paulson:
So, thereafter, I started to try to get jobs and try to get a job at the best company out there and get a broad range of experience. And mentors had told me to go work at a large firm and then see if I liked it. If I didn’t like that, I could always go down to smaller firms. It was fortunate to land a job at Goldman Sachs while I was in school. And there we worked on private equity and hedge funds and really that piqued my interest in asset management and investing.
Andrew Paulson:
And then from there while I was in school, I met and married my sweetheart. She was in nursing. And while we were in school, we both worked full or part-time to try to be out of debt and not have to deal with student loans, but we still came out with some student loans. When she finished nursing school, we had to figure out what to do with those loans, whether we pay them off as soon as possible, or we use every trick in the book and try to pay as little as possible and receive loan forgiveness. But that gave us a flavor of the complexity that exists with student loans.
Andrew Paulson:
Then after that we graduated school and we moved to the East coast, moved to Boston, and I got a job at Royal Bank of Canada in an asset management group there. And my roles encompass product management strategy, relationship management and marketing our long-term institutional investment asset classes to clients. And there, I learned how to work with people, how to solve complex problems and really gained a passion for the markets. And then just recently as of March this year, I moved back to Utah to our home and started my journey with studentloanadvice.com.

Dr. Jim Dahle:
All right, studentloanadvice.com. This is the new White Coat Investor service that we have developed for you. We’ve seen a huge need for this. It’s perhaps not everybody out there, but a significant enough percentage of the White Coat Investor community is looking for a service like this. They don’t necessarily want to go to a financial advisor and get a full financial plan or pay somebody an AUM fee to manage their assets. They’re looking for a quick hit kind of a transactional situation where they get some advice on their student loans.
Dr. Jim Dahle:
Because the problem we’ve seen is if people don’t manage their student loans properly, it often cost them tens of thousands, maybe hundreds of thousands of dollars in lost opportunities. They might be in the wrong IDR program. They might have a refinance when they should have gone for forgiveness. Maybe they’re just not sure how to file their taxes or which retirement accounts to use while they’re going for public service loan forgiveness.
Dr. Jim Dahle:
But they really usually just have two or three or four questions, but they need somebody to do a deep dive into their student loan situation to find answers to those questions. And so over the years, as student loans have become more and more complex with more and more IDR programs, more and more situations like we’ve had the last year or so where student loan payments went to 0% for a while, it’s just become much more complex for people to manage.
Dr. Jim Dahle:
So, we’ve seen this need, we’re trying to fill this need for those of you who need it. And that’s where studentloanadvice.com comes in and where Andrew comes in. So how did you get involved with studentloanadvice.com?

Andrew Paulson:
Yeah, as I was talking about earlier that I always wanted to be an entrepreneur, run my own business, and WCI approached me with an opportunity to run a sister company, this studentloanadvice.com idea that would help student loan borrowers manage their student loans. And my background in finance investing and understanding of loans was a great fit for this opportunity.
Dr. Jim Dahle:
Awesome. So how did you learn so much about student loans?

Andrew Paulson:
Yeah. Firsthand, the experience that we have with my wife’s loans from nursing school. That led me on this journey to where we are now with studentloanadvice.com and frankly my number of years in finance and investing.

Dr. Jim Dahle:
Awesome. And what does studentloanadvice.com actually do? How’s it works?
Andrew Paulson:
Yeah. So, we do a one hour consult with those of you who have student loans. So just frankly, help you manage your student loans. And paying off your loans isn’t as simple as mortgage debt or dealing with credit cards. There is a variety of different things you have to think about. There’s income driven repayment, refinancing, federal loans, private loans, tax filing status, loan forgiveness programs. And frankly, it just touches many parts of your finances.
Andrew Paulson:
And so, we sit down, create a customized plan for you that’s going to help you save money and whether that’s paying them off as soon as possible, or it is utilizing loan forgiveness, paying as little as possible over time, our goal is to have you pay the least amount of money and have the least amount of stress dealing with your loans. And we often can find a number of high yield strategies out there that you’re just not taught while you’re in school and thereafter we also provide six months of email follow-up and we can usually save tens of thousands of dollars in savings for our client.

Dr. Jim Dahle:
Yeah. So, they get the one-hour consultation, then they can email you any follow-up questions for six months.
Andrew Paulson:
Yes.
Dr. Jim Dahle:
And the typical questions people have when they come to a firm like studentloanadvice.com is what IDR should I be in? Should I go for PSLF? If you’re married, how should we be filing our taxes, married filing jointly, married filing separately? Should I refinance? When should I refinance?
Dr. Jim Dahle:
If you have these sorts of questions, this is what studentloanadvice.com is for. They’re not going to help you draft up an investment plan, right? They’re not going to help you with an asset allocation. They’re going to help you with your student loan questions and make sure that you’re not screwing that up like unfortunately, many White Coat Investors have done in the past. But it’s not just White Coat Investors you work with. Who will you work with at studentloanadvice.com?

Andrew Paulson:
Yeah, that’s right. We certainly work with doctors, other healthcare professionals, but we’ll work with anybody who needs help managing their student loans.
Dr. Jim Dahle:
Awesome. And what are some of the common pitfalls you’ve seen for your clients?
Andrew Paulson:
Yeah, you kind of touched on a couple of them earlier, but mandatory forbearance for a lot of our resident and fellowship clients where this is usually the worst thing you can do because they tell you that you can’t make that payment. So, they say, “Okay, we’ll put you in this forbearance period and you can pay them off later”. But that’s almost to the point where it’s as bad as defaulting on your loans. But the reasons being is that your subsidized and unsubsidized loans will continue to grow. And then at the end of your forbearance will capitalize and then your loans will grow at a higher amount every year thereafter.
Andrew Paulson:
And then secondly, when you’re in an income driven repayment plan, you can make small payments because it’s based off your lower income when you’re a resident or you’re a fellow. And those payments can then count towards some type of loan forgiveness program. And if you’re not enrolled in an income driven repayment and you’re forbearing, you’re not going to get the payment count during that time.
Andrew Paulson:
And then lastly, there’s government subsidies that exist when you’re in income driven repayment plans that often our clients aren’t aware of that can save them a lot of money. So, this has led me to why is this happening? And it’s because the loan servicers and the student loan financial aid offices at your schools just are unaware and they don’t understand the complexity that exists in student loans. And those are just different ways that we can save you tens of thousands of dollars yearly and over the term of your loans.

Dr. Jim Dahle:
Yeah, it’s interesting. All those people mean well, but they don’t necessarily know all the connections between your taxes and your student loans and so on and so forth. And so, they try to do their best. I don’t think they’re doing it maliciously. But the lack of education that students are getting, the ignorance of the people who pick up the phone when you call your loan servicing company, and of the people who’ve given advice in your student loan financial aid office at school, it does affect you. It costs you money, tens of thousands, potentially hundreds of thousands of dollars in certain situations. So how about current conditions? How are current conditions affecting student loans?
Andrew Paulson:
Yeah, we are currently in this payment hold and interest rate freeze as of March of last year due to COVID.
Dr. Jim Dahle:
For federal loans.
Andrew Paulson:
For federal loans. Yes. So those of you who have private student loans, make sure you look into your master promissory note because probably you should be paying those right now, but this is going until the end of September currently as it is.
Andrew Paulson:
And so, really you have two situations right now. If you’re going for public service loan forgiveness, or loan forgiveness, make sure you’re enrolled in an income driven repayment plan to have those payments counting towards receiving forgiveness in the future, because you don’t even have to make payments right now and they’re counting. And the interest isn’t growing.
Andrew Paulson:
And for those of you that are not going for loan forgiveness, you can be paying those loans off right now and finding a great rate to refinance your loans, whatever that is at and to pay them down as soon as possible and to be out of debt sooner.

Dr. Jim Dahle:
Yeah. For those federal loans, the rate is great right now, 0%. So, every dollar you’re putting toward them is going to principal, but obviously a big refinance day for those who need to refinance come October 1st. So, keep that on your calendar for sure. That’s when your federal student loans start accumulating interest, again, at least under current law.
Dr. Jim Dahle:
So, if you’re one of these people that has a super straightforward situation, you’re single, you know you’re not going for any sort of forgiveness, you’re going to refinance as soon as you get out of residency, you just need to enroll in repay while you’re in residency, you might not need student loan advice. It might not be worth paying a few hundred dollars to get student loan advice.
Dr. Jim Dahle:
But if you’re in any sort of a complex situation, you’re married, you’re not sure exactly how to file your taxes. You’re not sure which IDR program is right for you. You’re not sure how to maximize how much you get for public service loan forgiveness. This is well worth a few hundred dollars in an hour of your time. So, check that out at studentloanadvice.com. Andrew, thanks for taking the time to be on the White Coat Investor podcast today.
Andrew Paulson:
Thanks for having me on.
Dr. Jim Dahle:
All right. Our next question comes from email. It says, “Please do a blog and podcast focusing specifically in required minimum distributions. I saw an article on Doximity today on people not taking the burden of taxes on RMDs into considerations. How do RMDs actually work? How is it calculated for any particular person? What’s the minimum and maximum? Is there even a maximum? I know there’s definitely a minimum. What are the tax implications? What are some of the tax mitigation strategies in retirement? Sometimes we do things to save efficiently and might end up with a much larger nest egg than an expected”.
Dr. Jim Dahle:
Oh, heaven forbid, you have a larger nest egg than expected. What will you ever do?
Dr. Jim Dahle:
“I might end up losing a lot of money in retirement because not enough time and effort was spent in planning strategically. Your research and blog post, as well as podcast on this issue specifically will help people like me plan RMDs well ahead of time”.
Dr. Jim Dahle:
All right, well, let’s talk about RMDs. I have done blog posts about RMDs. There is one called “Don’t fear the Reaper” on the blog. I wrote it in 2018. A lot of people have this bizarre fear of required minimum distributions.
Dr. Jim Dahle:
Under current law, starting at age 72, you must start taking money out of your IRA and tax deferred accounts. The government lets you defer those taxes for a long time, but they eventually want you to pay them. And so that’s what a required minimum distribution is. There is no law that you must spend the money, but you must take it out of the account and pay taxes on it. And so, you don’t have to do that on a Roth IRA. Interestingly enough, though, you do have to do it on a Roth 401(k). So, if you don’t want to be taking RMDs on a Roth 401(k), make sure you rolled it into a Roth IRA before you turn 72.
Dr. Jim Dahle:
But there’s lots of cool things you can do with RMDs. For example, this is the best way to give to charity after age 72. They’re called qualified charitable distributions. And any money you take out of that IRA and give directly to a charity counts toward your RMD. So, it’s a great way to give it, especially if you’re now taking the standard deduction because you don’t make as much money. It’s a great way to still basically be able to use pre-tax money to do your charitable contributions. And so, that’s a really cool thing you can do with RMDs.
Dr. Jim Dahle:
But for the most part, RMDs are just something that you have to do each year. And so, typically it’s usually best to wait until late in the year to take them out, especially if you don’t want the money. And then that money benefits from that tax protected growth and that asset protection throughout the whole year. Just make sure you don’t forget because the penalty for not taking out a required minimum distribution is huge. It’s 50% of the amount you should have taken out. And so, you do not want to miss this one. You definitely want to get your RMDs out of the account when you were required to take them out.
Dr. Jim Dahle:
So, how much is an RMD? Well, here’s the good news. It’s usually about as much as you should be taking out to spend. You’ve heard of the 4% rule. 4% a year adjusted upward for inflation each year is how much you can take out of your retirement portfolio and probably have it lasts throughout a 30-year retirement. So, what RMDs start at? Well, at about age 72, they started about 3.6%. And so, it’s about how much you should be taken out anyway. No big deal, right? That’s what you should be spending from your retirement account.
Dr. Jim Dahle:
So, it’s okay to take them out and spend that money. That’s what it’s for. You paid taxes on it. You save it your whole life for retirement. Now it’s time to spend it on retirement. If you don’t need it because you’re so wealthy, maybe you should give it away. Maybe you should give it to charity. Maybe should give it to family members who can use it.
Dr. Jim Dahle:
But you can just take the money out of their retirement account and reinvest it in a taxable account. That’s completely permitted. So, let’s say your RMD was $40,000. You take $40,000 out. Maybe you’re in the 25% tax bracket. Maybe you have them withhold $10,000 for your taxes, and you reinvest the $30,000 in a taxable account. You have met your obligation. You have taken your RMD. You didn’t have to spend any of that money. You basically just have to move it out of the retirement account. Roth conversions don’t count toward that. You can’t just convert it to a Roth IRA and call that a RND. That doesn’t work.
Dr. Jim Dahle:
So, is there a minimum? Yeah, there’s a minimum. They’d take basically the balance of that account at the end of the prior year, December 30, first of 2020 is when your 2021 calculation is done and they multiply it by that percentage. And the percentage goes up as you get older, right? It’s about 4% around in your early 70s. By the time you’re 90, it’s like 11%. So, 11% of what that balance was the year before and everywhere in between, it gradually gets larger and larger.
Dr. Jim Dahle:
Is that a huge deal? Not really. I mean, imagine you have a $2 million. $2 million in tax deferred assets and you got to take heaven forbid you got to take 5% of that out. You got to take a hundred thousand dollars out and pay taxes on it. If that’s your only source of taxable income, although you’d probably have social security at that point, you’re not going to pay that much in taxes on it. You’re going to pay a whole lot less than you probably save putting it in as an attending physician.
Dr. Jim Dahle:
So, you really have to have a very large IRA to truly have a required minimum distribution problem. And by problem, I mean, you’re paying a higher tax rate on it then you saved when you put the money in. You’ve got to be a real, super saver. We’re talking about high seven figure, eight figure tax deferred accounts. And most doctors aren’t getting there with all their assets, much less just their tax deferred accounts.
Dr. Jim Dahle:
If you’re one of them, then what you ought to be thinking about is more Roth contributions, more Roth conversions. Both during your working years and particularly between the time you retire and when you have to start taking RMDs. Those are prime years. And when you start taking social security too, if you delay that to age 70, those are prime years to do Roth conversions in relatively low brackets to minimize that RMD problem.
Dr. Jim Dahle:
But what are the tax implications of RMDs? It’s ordinary income. You pay taxes on it. You don’t have to pay social security or Medicare taxes on it. You paid that on the money before it went in, but you have to pay ordinary income tax rates on it. They’re not capital gains or qualified dividend rates or anything.

Dr. Jim Dahle:
Is there a maximum? No, there’s no maximum. The larger your account, the more you have to take out of it. So those are things to be thinking about with RMDs. A lot of people really make you fear them. Like it’s this huge tax bomb you’re going to have down the road. Well, it’s only a huge tax bomb if you did really, really well during your life. And if that’s the case, you can usually see it coming enough that you can do some pretty significant Roth conversions to minimize the effects of that.
Dr. Jim Dahle:
For most people, it’s income you’re going to spend, you might as well pay taxes on it and take it out. Isn’t it wonderful that the government let you put that off for 30 or 40 years and have it in this great asset protected account in the meantime? So, don’t have a lot of fear of RMDs. Certainly, if you’re a typical doc, you should not.
Dr. Jim Dahle:
If you’ve got some crazy, awesome situation where you are super wealthy, maybe you do have an RMD problem. But honestly, the solution to that is not to avoid retirement accounts in the first place or to take money out of them prematurely. It’s to do Roth conversions. All right. I think I beat that horse to death at this point, but those are the main things you need to understand about RMDs.

Dr. Jim Dahle:
All right. Let’s take a question about who knew? A backdoor Roth IRA question. I’m not kidding you this year. I swear I’ve answered five backdoor Roth IRA questions a day for the first three months of the year. It’s been really impressive how many questions people can come up with. And I keep trying to rewrite the posts on the blog, like the backdoor Roth IRA tutorial, and put information in there so that I’ve answered every possible question people can come up with. But people still come up with questions and every now and then they’re even new questions. But let’s take a listen to this one from John.
John:
Hey Jim, my name is John and I am attending sports medicine doctor who is finally figuring this finance stuff out. My wife and I recently started the process of a backdoor Roth IRA. In order to do this, we needed to take a sizable traditional IRA that my wife had and reverse rollover it to a solo 401(k). We were hoping to do this before December 31th 2020, but we’re unable to get through the whole process before the end of the calendar year.
John:
My question is regarding taxes. I read that one can perform a backdoor Roth IRA prior to filing taxes and claim it for the prior year. However, considering we did not reverse roll over the traditional IRA to the 401(k) until 2021, can we do that in this case for filing taxes this year? If we can, what do we need to do to comply in filing the tax forms correctly? Thanks.

Dr. Jim Dahle:
Great question, John. And thanks for what you do. So, here’s the truth about the pro rata issue. It’s important to understand that the backdoor Roth IRA is not an account that you fund. It’s a process and the process has two steps. You put money into a traditional IRA and you convert that money from the traditional IRA into the Roth IRA. Now you can do the contribution anytime up until Tax Day of the next year. So, you can make a contribution for 2020, anytime until April 15th, 2021.
Dr. Jim Dahle:
But there is no time limit on the conversion. You can do the time conversion now, you can do it next year, you can do it in 20 years. There’s no time limit on it. It’s not a conversion for 2020. It’s a conversion you did in 2021. The pro rata calculation, which comes from line 6 of form 8606, says that you need to have a balance of $0 in a SEP IRA, traditional IRA, simple IRA, or rollover IRA on December 31th of the year that you do the conversion step. You can still make a contribution for 2020. If you don’t do the conversion until 2021 for that contribution, you have until December 31st, 2021 to get rid of that traditional IRA.
Dr. Jim Dahle:
And that sounds like what you’re describing for your wife’s account. So, no harm done yet as long as you didn’t do a backdoor Roth IRA for her last year, like you’re doing it this year. And that’s fine to go ahead and make your 2020 contribution now. You have to the end of the year to get rid of that traditional IRA so that your conversion done in calendar year 2021 doesn’t get prorated. I hope that’s helpful.
Dr. Jim Dahle:
All right, this question comes in from email. “When doing my taxes online, reporting the backdoor Roth information I’m always a little flustered by the question about my IRA basis. Is it wrong or unadvisable to just check zero for this every year? If so, could you explain what this basis is and a simple way to calculate this for tax purposes?”
Dr. Jim Dahle:
As a general basis is post-tax money. So, if you’re buying in a taxable account, if you buy a stock, put $100,000 into a stock, and then it appreciates to $200,000 and you sell it your basis, what you paid for, it’s $100,000. The hardest question on form 8606, where you report your backdoor Roth IRA is line two, where it asks about your basis. And even the instructions for that say, “If this is your first year of filling out form 8606, you should probably put zero on this line”. And that’s what goes on my form 8606 line two every year is zero. And the reason why is because I didn’t have any basis in my traditional IRAs the year before, because they were all zeroed out.
Dr. Jim Dahle:
So, I don’t want to say this is the correct way to do a backdoor Roth IRA, because there’s obviously different ways you can do it, but this is by far the simplest way to do the paperwork for backdoor Roth IRA. It’s to make the contribution during the calendar year and do the conversion for that contribution right afterward. It keeps your paperwork very simple. And if you’re doing that every year, line two should be zero. Your basis is zero.
Dr. Jim Dahle:
But for example, let’s say you make a late backdoor Roth IRA contribution, meaning you make a 2020 contribution in the first three and a half months of 2021. Then when you put in your 2020, 8606, all you are documenting is the contribution. But when you go to do your 2021, 8606, it’s going to ask you about your basis. And your basis at that point is your 2020 contribution, right? Your 2020 contribution that money you put in the year before this doesn’t get taxed again. So, if you put $6,000 in for 2020, in the first few months of 2021, you put $6,000 on line two of your 8606 for 2021 – That’s your basis. So, you don’t have to pay taxes on it twice.
Dr. Jim Dahle:
The idea behind basis is you only pay taxes on money one time. And if you think of it through it that way, then it should make sense to you. I hope that helps. But by far that’s the hardest part of form 8606.
Dr. Jim Dahle:
All right. Let’s take a question from Daniel about risky hobbies and insurance.
Daniel:
Hi, Dr. Dahle. I am a general surgery resident on the West coast who recently found your podcast and website. Thank you so much for all this great material. I say it is helping me get my financial ducks in a row. I’m currently working on life insurance and disability insurance, but had a question. I have a “risky” hobby prior to residency, which I have not had the time to engage in over the last three years. But I am wondering if I get insurance now and re-engage in those say after residency and a couple of years, does this mean that my premiums will go up then, or will they not be covered? Any advice that you can give me on this subject would be really helpful.
Dr. Jim Dahle:
Good question Daniel. One I’ve dealt with myself and definitely something to discuss with the independent agent from whom you are buying disability and term life insurance. You didn’t mention what your risky hobby is, but generally it’s jumping out of airplanes or scuba diving or rock climbing or fly in planes. It’s one of those usually. So, whatever it might be, you haven’t done it in three years. If you haven’t been rock climbing in three years, you’re not a rock climber. I’m sorry. So put that on your application that you don’t climb rocks. It’s okay. It’s been three years.
Dr. Jim Dahle:
I was a resident and I climbed even during residency. It wasn’t until the military moved me to the East coast where I basically had no ready access to rock climbing that I wasn’t rock climbing. And after I hadn’t done it for a while, well then, I could honestly answer that question that I hadn’t been climbing rocks.
Dr. Jim Dahle:
The way this typically works is they have a look back period. If you haven’t done it in 6 months or 12 months, and you don’t have any plans to do it in the next 3 months or 6 months or something like that, then you can honestly answer that question “No”.
Dr. Jim Dahle:
On the other hand, if you went climbing last week and you’re planning a trip to Red Rock in two weeks, you pretty much have to answer that question “Yes”. The goal is not to lie about it.
Dr. Jim Dahle:
Now, if there’s a claim, will the insurance company go back? Sure. But they don’t go back so far as to see if you ever went scuba diving 15 years ago. If you go in another 15 years, they’re not going to nail for you for going scuba diving, because you didn’t say you’d been scuba diving, right? That’s not what they’re asking. They’re not asking whether you ever did something. They’re asking whether this is something you do frequently. And objectively what that comes down to is have you done it in the last few months? Do you have plans to do it in the next few months? So that’s the way I would address that question, but don’t hide this from your agent. Talk to your agent about it, ask them what the guidelines are and reported accurately.
Dr. Jim Dahle:
But I can tell you this. If you tell them you rock climb or you scuba dive and you’re doing it regularly, you’re either not going to get insurance. It’s going to be excluded, which is what usually happens on disability insurance, or you’re going to pay dramatically more for your policy, which is what usually happens with life insurance. So be aware of that.
Dr. Jim Dahle:
All right, next question comes in from Fernando.

Fernando:
Good morning. Thank you for your insight in whole life insurance. Could you please shed some light on index universal life insurance and your opinion on it?
Dr. Jim Dahle:
Great question, Fernando. A short Speak Pipe, a long answer, if I was going to answer this one fully. The bottom line is IUL is generally a product designed to be sold, not bought. I really don’t think is something you ought to buy. The problem with it is you end up with poor returns than you get with a VUL, less guarantees than you get with a guaranteed universal life policy or a whole life policy and more commissions than either.
So, it’s like the worst of all worlds and really something that agents push because it pays the highest commissions of any of the permanent life insurance policies.
Dr. Jim Dahle:
The way they sell it is they try to sell it as you get to participate in the market with no downside. But the truth is you give up so much of the upside that it’s too much for the guarantees you’re given.
Dr. Jim Dahle:
The type of returns I would expect out of an IUL are about what you would get in the long run out of a whole life policy or a more typical universal life policy. One of the parts about universal life that I don’t like over whole life is that the cost of insurance goes up later in life. And so, your premiums either have to get bigger, or you have to shrink your death benefit, or it starts eating up the cash value of the policy. And so, these have much more so than whole life. These have to be managed late in life. And the management usually consists of reducing the death benefit, which isn’t something people really do with whole life insurance.
Dr. Jim Dahle:
And so, keep that in mind that you really are buying something that’s significantly different from whole life and in most ways, significantly worse. So, product to be avoided in my opinion.
Dr. Jim Dahle:
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Dr. Jim Dahle:
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Dr. Jim Dahle:
All right, so you heard about studentloanadvice.com today. Be sure to check that out. That’s new this week. You can learn all about Andrew as well as studentloanadvice.com and get some information there. So be sure to check that out.
Dr. Jim Dahle:
Thanks for those of you who have left us a five-star review and told your friends about the podcast. Our most recent one comes from Dave the Director, who said, “Amazing! WCI saved me over $4500 in taxes! TurboTax had my taxes high, but when I reviewed the forms, I knew the Form 8606 for our Back Door Roth’s didn’t look correct because of your podcast and forum content. Even the TurboTax live couldn’t figure it out. But I kept digging and found the error – I needed to add the traditional IRA contributions. Boom! Thanks for all you do”. Thanks for that nice review.
Dr. Jim Dahle:
Head up, shoulders back. You’ve got this and we can help. We’ll see you next time on the White Coat Investor podcast.

Disclaimer:
My dad, your host, Dr. Dahle, is a practicing emergency physician, blogger, author, and podcaster. He’s not a licensed accountant, attorney or financial advisor. So, this podcast is for your entertainment and information only and should not be considered official personalized financial advice.

The post Understanding Required Minimum Distributions – Podcast #205 appeared first on The White Coat Investor – Investing & Personal Finance for Doctors.

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