This week, I am talking about building wealth and intelligent ways to save. I talk about some technical and financial topics while giving you some ideas to think about when creating a plan. Reminder: everything discussed is only financial advice and you should work with a personal financial advisor, tax expert, or CPA to answer specific questions.
What’s up everybody. Welcome to episode 72 B of APM Success. You’re probably wondering why there’s a B in there.
This is what happens when you have a content calendar that’s so jam packed and then you’ve got something you want to slot in, in between two episodes instead of episode 73, which is going next week. This week, you have 72 B today. I want to talk about a few things as it relates to building wealth and an intelligent way to save. But before I do that, I want to briefly address a couple of things. First of all, regarding last week’s episode, I talked about student loans talked about what should you do between now and 2021 with, you know, Joe Biden, presumably coming into office here shortly. How does that impact the student loan landscape? One thing that warrants repeating is anybody with private student loans. Nothing that I shared last week is likely going to impact your loans with SoFi credible Ernest LendKey Wells Fargo or any of their friends.
So if you have private loans and you’re thinking, what does this mean for me? I have private student loans. How should I act? Well, if you want to refi refi, if you want to pay them off, pay them off, basically carry on as normal. Definitely try to reduce the interest rate as possible if possible, try to pay them off if possible, nothing on the private loan landscape changes and regarding today’s content. I want to make a brief disclaimer regarding what I just said. And I am about to say today’s discussion is going to talk about some technical and financial topics. I’m going to give some ideas, some concepts, some things to think about nothing that follows or nothing that preceded it should be considered financial advice, please, in your personal situation, work with a personal financial advisor tax expert, a CPA, et cetera, to answer specific questions, having to do with your specific life.
But actually, before I dive into that, I want to just mention next week, really excited. I’m going to be talking to Larry Keller. Larry is someone with whom I’ve worked for a while. He’s a disability insurance expert, and he is one of these people that can just very quickly rip apart a policy and put it back together. He understands all the deals, all the angles, all the writers, everything you need to know. So very much looking forward to talking about disability insurance in the context of anesthesiology and pain management, another episode coming up, which I’m still working on. It’s a little bit technical, but it’s so interesting and so important. I mentioned in the past having to do with private equity ownership in anesthesia, what it means, which companies are private equity owned, what’s happening to them right now, how COVID is impacting them, what it means for employees of those companies, et cetera, private equity it’s no secret has had growing market share with physicians broadly and especially anesthesia anesthesiologists and anesthesia practices with the sort of consolidation trends of the last handful of years.
This 2020 has been a total paradigm shift. And I can’t wait to talk about this. Got a really great guest lined up, but it takes a little bit more research just because of how technical it is. So stay tuned for that one, with regards to the topic at hand, I want to talk about an optimal savings hierarchy with regards to taxes, with regards to building wealth for new attendings specifically, like if you’ve got a bunch of money that you’re making now, you went from making 70, as a fellow to three 50, three 75 on an annualized basis as an attending, we’ve got a lot of money. We have a lot of different priorities, different things that we want, different values and ways that we want to use that money to sort of form our life into what we want it to be. One of the questions then that an anesthesiologist or pain management doc, who is newly finding this money is what the heck do I do?
Where do I begin? How do I start to understand what is the proper sequence to think about what to do with this money? So I want to tackle that topic today and explain sort of the rationale for each of the different steps or the, you could envision like a, one of those fountains where there’s like a little dish at the top and then a bigger one below that. And then a bigger one below that. And each level needs to overflow before the water flows down to the next level, thinking about savings hierarchy, especially tax optimized, savings hierarchy for building wealth is a lot like one of those fountains. So what I’m going to do today is sort of describe the different levels, different thresholds in tears and what it means and the implications of each different threshold.
For starters, you know, you’re, you’re getting all this money and you, you have a lot of sort of clamoring priorities. The first thing that I generally recommend is say, where is the highest interest debt? If there is any, maybe you’ve moved across the country to take a job. You swipe the credit card for $12,000 to a moving company to pack up your house and move it to another house coast to coast. That can be, you know, a financial obligation that a lot of new attendings are dealing with. There’s a great company out there. Let me actually just remark dock to dock lending. I’ve talked about, and with them in the past doctors, while they Marshall, one of the founders has been a guest of this podcast. I really like this company and their mission and what they’re doing. It’s physician founded specifically anesthesia and pain management, boarded physician founded.
And the, the goal of this company is to allow doctors in this situation to refinance high interest debt and they do so in a really intelligent way. They say, I know that a graduating fellow or graduating resident, isn’t actually a high credit risk. I know they have a signed job offer. They’re going to make a lot of money. It’s okay to bet on them. It’s okay to lend them money as much as they need within reason to be able to fund their short term transition, because we know that they’re going to make good money and pay it back. So dr. Doc lending has been able to really insert themselves in this part of the market for doctors who may be incur high interest credit card debt during a time of transition and say, Hey, we’re going to let you refinance this. We’ll give you a personal loan at a lower rate of interest.
And I just think they’re doing really important work. So I want to point that out. But you know, at the end of the day here, what we’re talking about is where should your free dollars go that you’re earning so high interest credit card debt 10, 12, 15, 19, 29%. In some cases, this is the first place that this money should go, essentially what’s happening is you’re paying off, you know, this very, very expensive type of debt. It’s in a different category from other debt, from car loans, from your mortgage, et cetera. You want to hit that credit card debt really as quickly and as hard as you can. The one potential exception being, if you have any 0% credit cards, maybe during this transition, when you’re moving across the country, you said I know I’m going to be spending a bunch of money that I don’t yet have.
And so I’m going to get a new credit card where I have 0% interest for 12 or 18 months. And I’m going to put all my moving expenses on that credit card. And then you’ve got a year to pay it off if that’s the case, okay, maybe I can live with it for a little while. If you said, I’m going to, I’m going to pay this off eventually, but I want to ride the 0% interest rate for awhile. That’s, that’s fine. But that’s the only exception. That’s generally the first place that new money should go for an attending. The second place I’m thinking about this in terms of tax optimization. So as we’re thinking about this fountain with all these like overflowing levels and tiers, one thing to be aware of is you’re now in a different tax bracket than you’ve ever been before. And there’s a potential for new tax policy coming down the pike in 2021, it’s only going to be more and more important to be intelligently saving from a tax standpoint.
So credit cards obviously have no tax benefit, but it’s just like bleeding out financially. If you’re paying a bunch of interest to the credit card company. So we want to get that taken care of, but then we want to start thinking about what does it look like to save intelligently from a tax standpoint, enter the HSA, the health savings account. This is what some would call the stealth IRA or a triple tax benefit savings account. It’s not something that everyone can access. So only if you’re participating in a high deductible health plan for your medical insurance, through your employer, will you be able to save money in an HSA? Now an HSA health savings account is an account into which you can defer money from your paycheck and you can use it for, you know, medical expenses as they are incurred for an individual it’s about 3,500 bucks for a family it’s 7,100 that you can save in any given calendar year.
Now, the reason that this is special, the reason this comes first on the list is you can take it out. First of all, you know, if you’re 35, you put a bunch of money into this account. You can it out in that year for qualifying health expenses. If you need to with no tax implications, however, the highest and best use of an HSA is to save that money. Pre-Tax meaning you get a tax deduction for this contribution. If you have a family and you have $350,000 of adjusted gross income, and you make that max $7,100 contribution, your taxable income goes down in the amount of your contribution and your taxes go down commensurately. And then you can invest that money. Most HSEs will allow for investment. Once you reach a balance above a certain amount, and that balance then grows and his attitude and grows and grows and grows tax deferred until retirement.
And then once you reach age 65, you can use that money. You can withdraw it for medical expenses in retirement, which most of us are going to have those to in some meaningful amount and you take the money out tax-free. So it’s literally never taxed. It’s what, again, some call it triple tax benefit account. So funding the HSA first and treating it in this manner can be really valuable. Now note, I’m not talking about an FSA, a flex spending account, which I don’t like nearly as much. The FSA is the same as the HSA, except every year your balance goes down to zero. If you don’t use it, it’s a user lose that account, which I don’t. I never liked the pressure of having to use that. So unless you have very regular predictable expenses from a healthcare standpoint, FSA not remotely the same, that’s not what I’m talking about, but HSA is good priority.
Number one, for me, savings account standpoint, if you have access to one second place that often makes sense for someone in a high bracket is whatever your employer plan is. Your you’re the main employer plan. So 401k four Oh three B are the two most common. What this will allow you to do is make these pre-tax contributions up to 19,500. So in the same way that the HSA up to 7,100 reduces your AGI contributions up to 19,500 in a 401k tax advantage reduces your taxes. If you make these on a pretax basis, and this is again, in terms of tax optimization, something that’s going to be very important for a single earner, making that in that 350 K range, this is definitely worth taking advantage of on a pretax basis. For a, if it’s a dual income household, you know, maybe we’ve got a physician and another professional, maybe it’s two physicians.
If your household income is over half a million bucks, this is even more important in both spouses to try to take advantage of this, if possible. So maxing out that 401k can make a lot of sense. Once you reach age 50, you can start adding another 6,000 6,500 on top of that 19 five to get you up to currently 25 K a year. So that 401k probably makes sense to be your next go-to. And then there’s some institutions often more in academic medicine or with the government that have a four 57 option. The four seven has many different flavors and varieties, depending on how the plan is set up. But the bottom line is it’s another tax deferral pre-tax contribution type of account. So if your AGI is reduced with the HSA, meaning your taxes go down on a, you know, some percentage basis, but 401k pre-tax contributions, your taxes go down on a percentage basis.
So again, to use round numbers here, 20 K in the 401k, maybe I get a 25% tax benefit. My taxes might go down $5,000 in the 401k. Four 57 has that same limit. It’s the 19,500 threshold. So maybe I’m getting again, depending on my effective tax rates, somewhere between a five and $7,000 tax deferral benefit. Now some four 50 sevens are gonna force you to kick out that income in a few years. So it might not be as beneficial, but if we’re thinking about savings in terms of tax preferenced hierarchy, the four 57 is usually going to come next. So we’ve got HSA, we’ve got 401k slash four with three B, we’ve got four 57. The next one, the next little tear on this fountain would be a Roth IRA or potentially up a dependent care FSA. So a FSA flex spending account.
We talked about these before, in terms of health care, it can be disadvantageous if you don’t use it, you lose it for the dependent care FSA. It’s still use it or lose it. But often childcare expenses are much more predictable. Like if I have a kid, if I go to daycare, I’m going to be paying daycare and I can count on it. And the FSA limits, you know, I think it’s $5,000 in the year 2020. It’s usually, you know, especially if you’re in a dual earning household, it’s not hard to tell if I’m going to spend $5,000 for my kids in a calendar year for childcare. Cause maybe I have a nanny or we’re doing daycare and we’re going to spend many times that amount. So it dependent care. FSA can be another good mechanism, good low-hanging fruit, that’s a pre-tax deduction. But once we kind of get through that FSA, then we get into sort of a different class of tax benefit.
So HSA 401k for three B four 57 independent care FSA, those are all going to be pre tax deductions. Those are in that reducing taxable income to get a percentage taxable benefit category. So that’s sort of the best category to have. Now we’re getting down to the second tier where we’re in the backdoor Roth, IRA five 29 tier. And now we’re getting into some tax benefit, but not as much tax benefit as the others for an attending physician. You know, looking at something like a Roth IRA, often you can’t do a Roth IRA. If you have a full year of earnings because you make too much money, depending on if you’re single or married, it phases out somewhere in the mid a hundred thousands to 200,000 range of modified, adjusted, gross income. And what that means is if you make more than say a married, I make more than 200 K of modified AGI.
I can’t just put money straight into a Roth. So there’s this thing called the backdoor Roth IRA, where you put the money in a traditional Roth IRA, and then you convert it in a non taxable conversion. And you it’s basically a two-step method to get money into an IRA, a Roth IRA. I should say. The reason this has beneficial obviously is a Roth. IRA is an after tax savings account that can be invested that does grow, and that will never be taxed. Again, at least as the law currently reads. What that means is if you put, you know, 6,000 a year, which is the contribution limit for anyone under the age of 56,000 a year in that Roth IRA every year, doing six thousand six thousand six thousand, eventually that’s going to grow to some multiple, you know, so you put in 120,000 total, over 10 years jointly as a, as two spouses or 20 years as a single person, you know, that a hundred and 20th contributions could grow to 200, 300 K or more, and that can then be taken out tax free whenever you need to.
Now there’s other benefits to potentially leaving that to errors or other strategies that are beyond the scope of this discussion. But the point is Roth. IRA is sort of that second tier. There is some tax benefit. It doesn’t help you in the current tax year. It’s not going to reduce my taxes in 2020 if I do a backdoor Roth IRA, but it will give me another tax bucket from which to draw in the future. And if you fast forward think, okay, I’m a 60 year old, a physician I’m retired, I’ve got a couple different buckets of money from which to draw. I’ve got a bunch of cash saved up, which I can pick out whenever I want. I’ve got some Roth IRAs that have been plowing money into for 30 years. And then I’ve got some, you know, 401k four Oh three B that kind of thing that is pre-tax money, the 401k money.
So to take money from that, it’s going to be taxed in the year that I take it. Whereas the Roth IRA perhaps can be, you know, money that I access to get me perhaps to social security age. So I’m doing a little more active tax planning. Then I take my 401k money out at age 70 when I’m you know, pulling social security. And there’s, there’s more a benefit to perhaps taking it a little bit later. Again, Roth IRA, some tax benefit. Also in this tier, the five 29 five 29, obviously an education savings account. This is an account where you can save for your kids’ education anywhere from K to 12 tuition up to vocational schools, technical schools, and obviously college and university. These are all fair game, as far as usage now, whether or not there’s going to be a tax benefit, it kind of depends.
And, and the extent to which there is a tax benefit, depends. So in my state of Pennsylvania, there is a state income tax deduction at the state level only. So uncle Sam still wants his peace, but in Pennsylvania, I can deduct the contributions into a five 29 from my Pennsylvania state income taxes. Now NPA 3.07% is the state income tax. So if I put 10 grand into a five 29 with my kid’s name on it, the benefit to me is going to be $307 in terms of a, a tax benefit at the state level only. So whether or not that is going to mean anything to anybody else it’s going to depend on state rules. Now, the nice thing about the state of Pennsylvania is PA has reciprocity with any other state. So I could open, you know, a New York five 29, which I like New York, five, 20 nines.
They’re very low costs. They have access to DFA funds and it’s a great long-term savings option. If I’m using the New York five 29 for my myself, I’m a PA resident. I have a kid, my kid might go to school anywhere. It doesn’t matter if I’m in Pennsylvania, I can use any plan in any state in every state administer is thrown five 29, and I’ll be able to get that same tax benefit, that same 3.07% deduction of my contribution. Other States don’t treat this the same way. In some States, you need to use that state’s plan in order to get the tax benefit. And some States they don’t give you any tax benefit, no matter where you’re at. So New Jersey is one such state where it doesn’t matter if you use the New Jersey plan. It doesn’t matter if he use any other plan, Jersey doesn’t care Jersey wants their money, and they’re going to tax you at the state level, no matter what.
So five 29, again, it’s sort of that middle ground. There’s no federal deduction. Sometimes there’s a state deduction. The money does grow tax free. As long as you use the money for a qualified educational expense. So as long as little Johnny or Susie goes to, you know, some school where I’m paying tuition, whether a K to 12 or college or whatever, then I’m taking that money out without paying any taxes on it. If I’m using it for whatever else, then there are tax implications and penalties that may be assessed, but backdoor Roth, five 29, you can think of those as sort of the second tier. So again, on the first tier we’ve got the HSA 401k 43, B four 57 dependent care FSA. Those are all going to reduce our taxable income. Second tier backdoor, Roth IRA, and the five 29 there’s some tax benefit kind of depends. It depends on how you look at, it depends on what state you live in, but not nearly as much and not in the current year. In most cases with the exception of the five 29, depending on the state
Speaker 3 (20:23):
Now, after we’ve filled up sort of that first bucket,
The fountain. And then we got down to the second bucket. We filled that up. And by the way, you know, filling up the Roth IRA, that’s 6,000 for each spouse. So if there’s two that’s 12 grand and five 20 nines don’t have contribution limits per se, there is like a very high ceiling. But, but there’s a lot of flexibility there. I mean, there’s gifting limits 15,000 per person per year, but again, lots of flexibility there, but once you’re doing more than, you know, the 401k Oh three B and the Roth IRA and the five 29, now we’re getting into the I’m saving more than 50 or $60,000 per year range. And we’re saying, what do I want to do with this money? We fill up all the other buckets. So now we’re getting into the territory where the financial planning questions, while they’re always important are going to get even more important because there’s going to be more options.
More people are going to go in different directions at this juncture. So maybe you’re saving for a house. Maybe you’re saving for a car or some other big purchase practice buy in something like that. And you want to build up cash savings. There’s no tax advantage to doing this, but it could be just a practical need of yours where you want to be positioning yourself, to be able to meet that future need without going into more debt. So saving cash is perfectly reasonable, legitimate, doing it in some kind of way where you’re going to earn a little bit of interest is a good idea. So high yield savings right now. Unfortunately they’re paying somewhere in the mid zeros. So like 0.5% 0.6%. I really like ally bank. I like Amex American express. Marcus has a good one. There’s a few others. You can just Google best high yield savings accounts and see what’s out there.
Unfortunately, even the best are going to pay you somewhere South of 1%, which to give you an idea on 10 grand, you know, 50 basis points or 0.5% is $50 per year. So not life-changing money, but yeah, you know, if I was walking down the street and I saw Ulysses S grant looking up at me on the sidewalk, I’d probably bend over and pick them up. If you’re going to pick any savings account, might want to pick one of these guys. And you can obviously fund that to the extent needed for whatever purchase you’re considering. But now we’re also getting into this, you know, on this third tier, this non-tax advantaged tier to ask the question, does it make sense for me to consider debt pay down instead of, you know, building up cash or buying a CD or high yield savings or something?
And the answer is, well, definitely like if I have private student loans, if I have a low interest rate car loan, if I have family loans, you know, your mom and dad’s spot you a couple of bucks to move across the country to go take that job. We’re definitely in the territory where it makes sense to start settling some of those other debts, no tax advantage to doing so, but we’ve sort of maxed out all of our tax advantage higher up on the fountain. And we’re now in a place where crushing the debt can make a lot of sense, especially, you know, depending on where you’re at and how you’re wired. There are some people for whom you know, being in debt makes them physically lose sleep. And if you’re one of those, you could even make a case. You know what, instead of doing the backdoor Roth this year, I want to pay back my brother who let me borrow some money because I just hate family debt.
And Thanksgiving has been weird. And now I want to be able to settle that before I get into the other savings opportunities. And that’s perfectly legitimate, but definitely, you know, once you’ve done all the other tax advantage stuff, we’re in the space where paying back these debts makes sense. And then the final piece on this third tier, this non tax advantaged tier is what I would call taxable investments. This is just a broad term to mean money that you save, that you invest, that doesn’t have any inherent tax advantage. Now there’s still tax implications and there can be a broad dispersion of if I do it really well, versus if I do it really tax inefficiently, there’s a tax cost that needs to be accounted for. But what this represents is, you know, mutual funds, stocks, ETFs, rental, real estate say buying into businesses into a medical practice, into a surgery center.
Any of these things, any gains on these assets are going to be taxable in different ways and understanding the taxability of those things means, well, we want to make sure that we, in, in many cases, we want to do this stuff higher up on the tax hierarchy first, but this is absolutely an important, you know, even though it’s lower down on the fountain, there’s no limit to the amount of money you can put in any of these. You can open a taxable investment account at Vanguard or Charles Schwab or wherever, and you can put a million dollars a year into it. There’s no limit now gains are going to be taxable when they are realized. So if I buy a hundred thousand dollars worth of a mutual fund, the next year, it goes up to 150, as long as I don’t sell it, I don’t pay taxes on those gains except for small taxes based on the activity of the fund itself.
But, you know, if it goes from a hundred to 150 to 200, I keep buying more and investing in investing only when I sell, if it goes up to 200 and I sell, and there’s a hundred thousand of gains only in the year that I sell will taxes happen. So again, there’s no tax advantage. I’m not saving in taxes in the year that I make these investments. Conversely, I am going to pay taxes in the, that I sell, but as long as I’m being smart, as long as I have what we call a low turnover strategy, meaning I’m not buying and selling, I’m not day trading, I’m not getting in and out of Tesla and Apple based on quarterly earnings reports or, you know, doing your Robin hood account or whatever. I’m just buying and holding. That is a very efficient tax strategy in general, as long as the thing that you’re buying is you know, you’re not buying a manager, that’s also buying and selling with their own high turnover strategy, but this taxable investment bucket, this is where you can have a lot of creativity, a lot of room to, you know, I want to buy, I want to invest in a house and I want to, you know, own rental properties or a duplex or something like that.
Or it’s a pretty much a catch all bucket. The point is you shouldn’t be investing in rental real estate without filling up your 401k, unless you’re seeing it as a strategic business decision where I want to be a, a real estate Maven. And this is such a high priority to me that I’m willing to forego the current year tax deduction at a very high income, which yields a very high tax rate. I’m willing to forego that tax benefit in order to sort of jump down to the third tier. That’s the only case in which it would make sense. And whenever you’re jumping between tiers, without filling up the pre previous one, you always want to just count the cost and say, you know what? I can do backdoor Roth IRAs before my 401k is filled up, but there’s a cost to doing that. And I can tell you that I would never recommend doing, or at least let me put it this way.
I have never yet recommended doing a backdoor Roth IRA before the 401k is filled up. It just doesn’t make any sense because the 401k benefit is so huge. And the backdoor Roth IRA is much more muted in benefit compared to the 401k. Now I’ll tell you the backdoor Roth it’s, it’s like a sexy thing. I’ve had people reach out to me and say, Hey, Justin, you know, I’ve, I’ve got a lot of financial things going on. Here’s my questions. I know we’ve never talked before, but I just, I need help with the backdoor Roth IRA. And it gets, that has that cache, you know, they, I was listening to white coat investor podcast the other day, and it came up like two or three times in the listener questions section. This is it’s something that, you know, is part of can be part of a holistic strategy, but it’s it doesn’t in my opinion, most of the time warrant you know, the focus primary attention of somebody who’s busy and making a lot of money it’s second or third down on the hierarchy.
And as far as the actual line items of all the things you should do, it’s probably down in the twenties or thirties, as far as things are going to be drivers of wealth building, you know, it’s something that you do something that is part of the overall strategy, but it’s, it’s generally not a high priority just because there’s a lot of other things to be thinking about. So hopefully this is helpful as you think about savings hierarchy. One of the important things, you know, just behaviorally psychologically is take the emotional energy out of it. If you’ve got a system, if you can build this fountain in your brain and say, okay, I fill up my, I pay off my credit card. Then I fill out my HSA for 7,100 bucks. Then I fill up my 401k for 14,000 or for 19,500. I don’t have access to a four 57.
So then I’m doing backdoor Roths, 6,000 for each spouse, and maybe I’m doing a five 29 for 10 grand for my kids. And then all the rest I’m going to just pay off my student loans until they’re gone. And then once the student loans are gone, then I’m going to start using a taxable investment account. Something like that. That’s a very, you know, hypothetically, that’s a very reasonable approach. Now, obviously, if you have other unique needs, unique desires goals we’ve got to sort of slot those in there in a customized way. That’s going to make sense, but once you remove the question of like, huh, now I’ve got $25,000 in my checking account. And last week I had 5,000. What should I do with the extra 20 grand? It’s likely that if you’re asking that question the emotional energy required is going to be a barrier to doing something productive.
So if you can automate this, you automate the HSA, you automate the 401k, you automate the Roth IRA. You automate every step of this cycle. What you’re going to find is that as month after month after month goes by and ultimately year after year, you are building wealth in an automated fashion with little to no emotional energy required. The only thing you need to do is keep going to work, keep earning money, keep keep on being a conscientious practitioner of medicine, and then focus on all the other important things in life. And if you did nothing else like this, wouldn’t be a hundred percent optimized, but it would be pretty darn close and you would be moving in the right direction. Certainly you know, in the top core tile of earners who are less conscientious about how to focus on these things. So that’s all I’ve got for this week as always, thank you very much for tuning in very much, appreciate the time I don’t take for granted. It it’s there’s opportunity costs whenever you’re listening to somebody ramble on for a period of time, I’m pretty ruthless. I don’t listen to podcasts that don’t add value to my life. So I appreciate you listening today
And whoever he has a great week, talk to you next week. If you liked what you heard this week, head on over to APM success.com, where you can find more content and free resources to help you build a successful career in anesthesia and pain management. If you wanted to leave a review in iTunes, I’d also really appreciate it. Thanks for using some of your valuable time to join me today on APM success.