Today on the podcast, we are answering your questions covering an array of topics. We spend some time on where the best place to save your money is when you need to access it sooner than later. We cover when it is appropriate to carry underinsured motorist coverage, we break down the different kinds of CDs out there, and we even discuss some changes made to Venmo and whether or not that might affect your taxes.
In This Show:
Listen to Episode #302 here.
Venmo Changes and Your Taxes
“There was a lot of chatter in December about Venmo, Zelle, etc., and changes in how these are taxed. I'm having trouble finding reliable resources. Some say anything under $600 Venmo transactions is fine. Others say it's a gift, so anything under $16,000 is fine. Could you please shed light on these digital transfer services? I think a lot of listeners, especially the millennials, use these tools on a regular basis.”
I think people have read some press releases and gotten a little bit confused about what's going on here. Nothing has actually changed from a tax perspective here. All that has changed is what Venmo or Zelle or whoever reports to the IRS. If you weren't cheating on your taxes before, you're not cheating on your taxes now. When we get paid via Venmo or PayPal, etc., for earned income or work we do, we have to pay taxes on it. Whether it's $600 or more or whether it's less than $600, that's taxable income. Just because Venmo doesn't tell the IRS about it doesn't mean you're not supposed to tell the IRS about it. On the other hand, if you get a gift via Venmo, you don't pay taxes on that. It's not taxable. It's a gift. That wouldn't change if Venmo mistakenly sent me a 1099 or something saying it was a transaction. It's not a transaction. I didn't sell my time. I didn't sell a product for that money. It's not earned income. It's not taxable income. It's a gift.
I use Venmo all the time to transfer money. For example, I now have some of my nieces and nephews and my daughter in college, and we're starting to spend down some 529s. Well, what do I do? When they have an expense, they send me a receipt. I Venmo them the money out of my checking account, and then I take the money out of the 529 into my checking account. None of that is taxable. It wasn't taxable before. It's not taxable now. On the other hand, if I was having somebody pay me on Venmo for their advertising at WCI, that's taxable. There was a time many years ago where we used PayPal for that. We have different vendors now. But that was all taxable. We reported that to the IRS, which was part of the income of WCI. All that changed is that, basically, the threshold for Venmo to have to report this sort of income to the IRS came down. But if you weren't paying on that income before, you're a tax cheat, and I hope you get caught, quite honestly.
What does Venmo say about this? They clarify that it's $600 in payments for goods and services. You don't need to worry if you're just gifting money back and forth with the nurses because you pooled your money together to get lunch today.What is the change? Venmo has a nice FAQ page on its site, and it's basically said that the IRS has delayed implementation of the $600 reporting threshold for payment transactions for goods and services for one year. For the year 2022, the IRS will use a $20,000 and 200 transaction limit. That doesn't mean it's not taxable if you have fewer than 200 transactions or if you have less than $20,000. It just means they're not going to tell the IRS about it. Of course, some states do have lower reporting thresholds.
For 2023, the requirement only pertains to payments received for sales of goods and services and does not apply to friends and family payments. But if you collect $600 or more for the sales of goods and services through a payment services company without first providing your tax info, that payment services company, i.e. Venmo, is required to withhold 24% of those payments and send it to the IRS for backup withholding. That's required by the IRS; it helps to make sure that the applicable taxes due on those payments are paid. You can avoid backup withholding, of course, if you provide your tax ID in the Venmo app. The question is, are you doing business on Venmo? If you are, you need to do business on Venmo in the right way.
Their second FAQ talks about if you have sold lots of stuff in the past. Why haven't you had to do this before? The IRS has always required payment settlement entities to report earnings and issue 1099-Ks. But until 2023, the threshold was much higher: $20,000 or 200 transactions. It didn't affect nearly as many people. I hope that's clear. If you're doing business using Venmo, using PayPal, you need to pay taxes on it, and you're more likely to get caught now than you used to be.
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When Is Whole Life Insurance a Good Idea?
This one comes in via email. So many of the questions I get by email I can actually just respond to with a link to a blog post that I've written in the past. That is the case with this question.
“There's been plenty of material on the blog and podcast about why permanent whole life insurance policies are bad investment options for 99% of your readers. However, I was wondering if you could give an example of the 1% of scenarios in which it would make sense to purchase a permanent or whole life plan.”
I've got a blog post originally published in 2015 called “Appropriate Uses of Permanent Life Insurance.” I certainly am in agreement that we're talking about 1% of docs, maybe, for whom this is a good idea. Most people do not need permanent life insurance. Permanent means it's going to pay out whenever you die. This is whole life insurance or its cousins, index universal life, other types of universal life, variable life, variable universal life, all these variations on a lifelong insurance policy combined with some sort of savings or investment component where you can use the cash value during your life if you wish to.
What are some scenarios where this makes sense? If you want to reduce your estate tax but you don't want heirs to be able to access the money until you die, life insurance can work for that. This is for someone with an estate tax problem. What's an estate tax problem? If you're single and you have an estate of at least $13 million, double that if you're married, then you might want to think about something like this. Keep in mind, some states also have a lower exemption amount. But basically, the way that you avoid that is you give money away before you die. You give to charity; you give it to your heirs. You're allowed to gift a certain amount each year, but there's a limit to how much you can give each year. I think it's $17,000 for 2023.
Maybe they're not mature enough to use it right now. You don't want to give it to them now for whatever reason. What do you do? You start an irrevocable trust and put the money in there. An irrevocable trust can invest in anything. They can invest in stocks and bonds and mutual funds and real estate or whatever, small businesses, etc. But they can also invest in life insurance. Since life insurance generally grows in a tax-protected way—the cash value on it—there's no tax due as it grows, which is good because trust tax rates tend to be relatively high. You get to the top tax bracket pretty quickly with trust income.
The idea here is that you have this trust, this irrevocable trust, and you buy a permanent life insurance policy. You're paying premiums on it. Maybe they're $17,000-a-year premiums, and then when you die, all of the benefit, the death benefit, is in this trust. It's not part of your estate. You've taken that money out of your estate, and the heirs get it when you die. That's one reasonable use of whole life insurance that can help you to reduce your estate tax due at your death. Another nice thing about the death benefit from a life insurance policy, it takes you a week or two to get it or whatever. You have to send them a death certificate, but when it comes, it's liquid. They're not sending you shares of a mutual fund. They're not giving you a family farm. They're not giving you a really illiquid small business. You're not getting a bunch of syndications that you can't sell for five years. You're getting liquid money.
If there is a need for liquidity at death, life insurance can really provide that. Let me give you an example. Maybe the main asset being passed on is a family farm. Say this family farm is worth $15 million. There are three heirs, and only one of them wants the family farm. The idea is to try to give this family farm to one of the heirs, but you want to be able to buy out the other heirs. You need some liquid cash to do that, and life insurance can provide that. If you need liquidity at death for whatever reason, that can be helpful. Sometimes there are some business uses that are related to that as well. Maybe to be able to buy out the heirs of your business partner, you can see a use for a permanent life insurance policy for that. Obviously, if you're not going to be in business when you're old, you can use a term policy for that, as well, but it does work if you're going to be owning this business until late in life.
Here's another example. Providing for a disabled heir when you're never going to be financially independent. If you're financially independent and you can live off your nest egg for the rest of your life, your heir probably can, too, if you leave it to them when you die. But if you're never going to be financially independent—if all you're living on is Social Security, for instance—and you want to be able to provide for that disabled heir once you're gone and that Social Security won't be going to the disabled heir, well, a life insurance benefit can provide for that. Obviously, if you die when you're 90, you're probably going to want to use a whole life insurance for that benefit rather than a term life insurance.
I mentioned a business use: key man insurance, key person insurance, somebody really important to the business, late in life. The company wants to be able to find somebody else like that or needs to be able to recover from the business hit they're going to take from this key person dying off. You can replace at least their financial value with life insurance.
Here's another example. Some people want to take an annuity. Whether it's from their pension or whether it's an annuity they buy from an insurance company, they want to just have it be a single life annuity, so it pays out the maximum amount. The problem is, what's your spouse going to live on if you die? That annuity stops paying out when you die. If you also have a permanent life insurance policy that pays off when you die, then your remaining spouse can take that pool of money and buy another annuity with it. They have something for them to live on for a while. That could be a reasonable use if you don't want to do a dual life annuity; you could buy a single life annuity and combine it with a life insurance policy.
Another example is you can combine it with a charitable trust. If you have an estate tax problem, you're planning to give some money to charity, you've got some highly appreciated shares of an investment you'd like to sell, and you still want to maximize how much your heirs get, you may be able to combine a permanent life insurance policy with the charitable trust. You could take the highly appreciated shares and put them in a charitable remainder annuity trust. You'd avoid capital gains taxes on the asset. You'd get an income tax deduction this year for the remainder portion. You'd avoid estate taxes on the money since it's now out of your estate. Then you use the annuity payments from the trust to buy a life insurance policy in an irrevocable trust for your heirs to replace the money you gave to charity. The devil is in the details here, but it's possible that this complicated process can enable you to help your favorite charity and still pass more money to your heirs than you could have if you had not given anything to charity. The free lunch there comes from the taxes avoided. It's a fairly complicated setup, but there are obviously some estate planning uses to a permanent life insurance policy.
The next one, there are a lot of people that are into banking on themselves. Bank on Yourself is a brand name, Infinite Banking is another brand name, sometimes it's called LEAP. The idea here is that you overfund or maximally fund a life insurance policy. The point here isn't the death benefit. The point here isn't the investment return, necessarily, on it. The idea is to get to break even very quickly. Instead of breaking even in 10 or 15 years, like on a typical policy, you might break even in four, five, or six years. At that point, your cash sits in the whole life policy, maybe making 4, 5, 6% instead of whatever you're getting in the bank. These days, I'm getting 4%+ in the bank just out of a money market fund. This doesn't look nearly as good as it might when interest rates were 1%. But people were really excited to be making money long term on their cash at 4% or 5% instead of 0.2% in their bank.
There are some downsides. You have to qualify for life insurance if you do that. You have to go through the negative return years, which are the first few years, and you have the hassle of dealing with it. But it's a way, long-term, to earn a little bit more on your cash. Instead of keeping a bunch of money in the bank, you keep it in your insurance policy. The insurance policy needs to be designed to do this. That usually means getting wash loans, having non-direct recognition, using the maximum number of paid-up additions, so that the policy is designed to do this. But this isn't unreasonable. You just have to decide whether the tradeoff is worth it to you. The tradeoff of having to get an insurance policy, the tradeoff of having a few negative return years in exchange for a little bit higher rate on your cash long term.
Another example is asset protection. Some people really value asset protection. In many states, maybe close to half of them, life insurance cash value is very much a protected asset. If you, heaven forbid, were in an extremely rare situation that you had to declare bankruptcy due to an above policy limits judgment that wasn't reduced on appeal, you'd get to keep everything in your retirement accounts, usually, and sometimes some of your home. And in some states, the money—the cash value—in a life insurance policy. Some people who really value the asset protection more than a better return on their money might choose to buy a whole life insurance policy for that reason. Those are all some reasonable uses of a whole life insurance policy. Notice that none of them are, “You're a doctor.” You don't need one of these just because you're a doctor.
I still think it's probably 1% of doctors that need this. Most doctors don't even have an estate tax problem. Only 10% of doctors have more than $5 million. You can even have $10 million. If you're married, you could have $20 million, and you still don't have an estate tax problem. All these niche business uses, niche estate planning uses, they just don't apply to most docs. Don't believe the salesman that comes in and tells you, “You're a doctor now; you need a whole life insurance policy” and meanwhile, you're paying 7% on your student loans. It doesn't make any sense whatsoever. I hope that answers your question.
More information here:
Appropriate Uses of Permanent Life Insurance
Where to Keep Your Money
“When my mother died, I inherited her brokerage account with Merrill Lynch. I decided to sell some of the stock and was floored to learn that one transaction would cost me $800 in fees. This was 10 years ago when Fidelity cost $8 per trade, now zero. So, the decision was easy. I transferred all of our holdings to my Fidelity account. Recently, the kind folks at Wells Fargo sent me an email announcing that because I was such a valued customer, they were changing my free checking account, which needed a balance of about $30,000, to a higher level, which would now demand a daily balance of $250,000 or else I would be hit with a monthly fee. I sent them a nasty email, and they reverted my account.
Last week, I received a renewal email for renter's insurance. We sold our house and are waiting for the market to soften in the DC area. The fee was very small, $14.50 a month. But when I inquired about why it was billed monthly, I learned that a $5 fee was being applied. That was more than a 50% increase. Not a lot of money, but nothing irks me more than being nickeled and dimed. As you can guess, I would never be a Fisher Investments client paying 1% or 1.5% win or lose. I would love to see a spreadsheet of a $1 million account over 10 years. Did someone make in excess of $100,000-$150,000 with Fisher? Who is the best deal for storing your money? Does Fidelity have better brokerage CD rates than Schwab? By paying hidden fees when I buy tax-free bonds within my account, am I losing out by being too cheap to invest with the likes of Fisher?”
There are a lot of questions in that particular email. I don't know that I'm going to answer all these questions, but let's go through a few of them. First, where do I keep my money right now? This varies. You ask me again in a month, it might be somewhere else. But for the most part, my money, at least my cash, moves between three different places. Right now, it's sitting in the Vanguard Municipal Money Market Fund. It's making, I don't know, 3.6%, 3.7% federal tax-free. That's an equivalent due to being in the high tax bracket of a taxable yield of something like 4.5%. That's where it is a lot of the time. There are some times, though, where it actually makes sense for it to be sitting in the Vanguard Federal Money Market Fund, which is just their sweep account. Right now, that's paying like 4.3%. There are times, actually, where those yields vary between the municipal account and the regular taxable federal account where it actually makes sense for me to be in the federal and just pay the taxes. Sometimes I transfer them back and forth there.
There are other times, particularly in the last few years when money market yields have been pretty low due to the Fed keeping interest rates low, that it actually made sense to just keep it in a high-yield savings account. I've had that at Ally for many years. I would transfer money back and forth there. I just have the accounts even though there's no money sitting in my Ally account right now. But if it were paying 4.8%, I'd transfer the money over to Ally. I might look at that every 2-3 months and if it makes sense, transfer money back and forth between those. But those are my usual choices.
What you don't want to do is have it sitting in the savings account at your credit union paying 0.2% or to have hundreds of thousands of dollars sitting in your checking account earning nothing. For the most part, any of those reasonable high-yield options are OK. You don't need to be checking every other day to make sure you're in the very highest account. You don't want to be opening 20 accounts every year to do this. But if you have a high-yield savings account at a bank and you've got an investing account at Vanguard, Fidelity, Schwab, or whatever, you may want to have both of those open and occasionally transfer money between the two and you'll be fine.
Now, does Fidelity have better brokerage CD rates than Schwab? I doubt it. I have no idea. I haven't looked into the brokerage CD rates. These days with a money market fund paying over 4%, I don't see a lot of point in messing around with the CD anyway. It doesn't seem like the CDs I've seen pay much more than that anyway. “Am I paying hidden fees when I buy tax-free bonds within my account?” I don't know. You would have to check. I don't actually buy individual municipal or tax-free bonds. I just use the excellent municipal bond funds at Vanguard. They're very low cost. It's almost free to have a diversified investment there. I don't see any reason to try to build your own bond fund.
As far as Fisher Investments, let's just say they wouldn't be approved to be on the WCI recommended financial advisors list. If you're wondering who is on that list, just go to the website, go to the recommended tab, scroll down to Financial Advisors and you'll see who's on the list. They're all fee-only advisors. Some just do second opinion kind of things for people who are mostly do-it-yourselfers. Other people want to manage your money. It just depends on how full of a service you're looking for, which advisor you want to pick there. But Fisher is definitely not on that list. At least the Fisher that sends you all these notices in your mail, and you're not going to see people on there charging you 1.5% of assets under management. Obviously, for people who have a multimillion-dollar account, like many white coat investors, that can get to be an outrageous price pretty darn quickly. I hope I answered all of those questions.
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Brokered CDs, Bank CDs, and Laddered CDs
“Hello, Dr. Dahle. It's Trish from Arizona. I was wondering if you can do a segment on CDs—the difference between a brokered CD and a bank CD and also CDs and Laddered CDs. I was looking at Fidelity's website and it's a little bit too much information, but the yields are pretty good. Some of the new-issue CDs are going up as high as 4.9% on a three-year CD. And then when you ladder it, it's coding up to 4.72% on a laddered CD for two years. So, maybe a little bit more information. I'm confused. I mean, if this is a good investment, then why aren't many people talking about it?”
Let's talk about CDs. A CD or a certificate of deposit is an investment product or a savings product depending on how you want to look at it, offered by a bank. Basically, you give them money, they hold onto it for the term of the CD—one year, two years, three years, five years, seven years. Those are pretty typical terms. Then, they give you the money back. In the meantime, they pay you interest, periodically, I don't know, quarterly, maybe, on the CD. Maybe they pay it monthly, whatever. It's a very low-risk way to invest. As a general rule, you'll get paid a little bit more with a CD than you will with a money market fund or a savings account. The reason why is because your money is tied up. You've agreed to be less than liquid. Typically, you will lose something if you break that CD before the term is up. There's usually some sort of penalty. It might be three months of interest; it might be a year of interest, whatever.
There's going to be some sort of penalty if you don't wait the full term. That's why you're getting paid more is because you're willing to not have the money back for five years. Whereas with a money market fund or a savings account, you can request it all back tomorrow to do whatever you want with it. That's what a CD is. A bank CD is issued by a bank. A brokered CD, you buy through a CD broker. At the end of the day, it's usually still a bank in the back that is the one that has your money. These generally do have FDIC, Federal Deposit Insurance Corporation, insurance. That's up to $250,000. If you got you and your spouse on it, it might be twice that. You get some FDIC insurance with it that you might not have with a money market fund or with a short-term bond or something like that.
A CD ladder, like a bond ladder, is you are simply just buying a bunch of different CDs of different durations. If you had a one-year CD and you had a two-year CD and you had a three-year CD and you had a five-year CD and you had a seven-year CD, that's a CD ladder. Why would somebody ladder these investments? The reason you would ladder them is because you can get a higher yield on the longer-term ones than you can on the shorter-term ones most of the time. As I'm recording this, I think the yield curve is probably inverted. That's not necessarily true, but most of the time you can. The idea is, let's say you're getting 5% out of a seven-year CD and you're only getting 4.8% out of a five-year CD and you're only getting 4.5% out of a two-year CD. If you owned all seven-year CDs, you'd be making 5% out of all of them, but you'd buy them all a year apart. Maybe if you wanted to set up a ladder, you'd buy a seven and a six and a five and a four and a three and a two and a one. Now, you've got a seven-year CD ladder. Then, every year you take the money that came out of the one that just matured and you buy a new seven-year one.
That's an approach a lot of bond investors and CD investors use with their CDs to try to earn a little bit higher yields in the long run but to still have some money coming out every year. That's the point of a ladder. Are these awesome investments? No, these are safe investments. If you want to earn a safe return for tying your money up for this period of time, this is a reasonable thing to do. Sometimes CDs are better than bonds; sometimes they are not. You can do the same thing with a bond. You can go buy a Treasury bond, you can ladder them just like you can a CD. Sometimes bonds pay more; sometimes CDs pay more. It just depends. You have to look if this is the sort of investment you're looking for.
On the other hand, if you just want something a little more liquid, you're willing to earn a little bit less on them, you can make something like 4.3% right now out of a money market fund. You can get it all back tomorrow if you want. The way I look at it is my longer-term money, I tend to invest more aggressively and not necessarily have it in a bunch of bonds and CDs and cash and that sort of stuff. I don't invest in CDs myself, but they're not a bad investment. You just have to understand what you're buying. If that's what you want for part of your portfolio, then buy it. It's OK to invest in CDs. You probably shouldn't have all your money in them. You need an investing plan. You need to follow your investing plan. If your investing plan says build a CD ladder with 20% of your portfolio, then do that. It's a totally reasonable way to invest.
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Short-Term Investments
Safer Investments
“Hello, Dr. Dahle. This is Stella. I would like to get your opinion on money market mutual funds, please. Would you kindly describe what they are, what kinds of MMFs are available, and whether or not they're a good option for temporary cash holding, such as for our emergency funds? With the Fed raising interest in earnest, are money market funds back in the game?”
Near and dear to my heart. I like money market funds. I have a lot of money sitting in money market funds right now. I use them all the time. I think money market and mutual funds are great. I'm particularly fond of the ones at Vanguard. I think they do an excellent job with their money market funds. Always have. These are safe investments. They're very short-term, liquid, low-risk investments. I'm not saying they're back in the game because interest rates are up now. I was using them when interest rates were 1% or 0.5% or whatever they were, because it was still the best thing you could get on safe, liquid money. Sometimes a high-yield savings account is a little bit better. But most of the time they're pretty similar—high-yield savings accounts and money market mutual funds.
There are a lot of different kinds. There are prime money market funds. Vanguard had one of these until a few years ago. I was kind of disappointed to see it go. They're usually the highest-yielding ones. That's because they're technically the riskiest ones. Anytime you have a fixed-income investment like this, you have to ask, “Well, who am I loaning money to?” With a prime money market fund, you were generally loaning money short-term to corporations mostly. They'd borrow money for a few days or a few weeks or a few months even. That short-term paper is what that money market fund held. Because you can charge more to a corporation than you can to a government, you tend to have the highest yields in those.
Now, they're still very safe. It was very rare for a money market fund to break the buck. This is part of why 2008 was such a big deal because there was a money market fund that broke the buck. You only got 98 cents back of your dollar. That's the kind of risk we're talking about with the money market fund. It's just very, very low risk. The next step down is something like Vanguard's current sweep account, which is their federal money market fund. This is basically money that's loaned to the US government and its agencies. There are also Treasury money market funds, which is another step down in risk where these are just loans to the US government, not to its agencies. That tends to be the lowest yield of the money market funds, but there's usually not a huge difference even between a prime and a Treasury money market fund. With Treasury money market funds (and any Treasury bonds or bills, I guess they would be in this case, since they're shorter than a year), inside that money market fund are state tax-free as well. That's the other benefit of a Treasury money market fund is it is state tax-free, the interest. Those are all taxable for the most part, though, at least on the federal level.
On the other side are municipal money market funds. These are tax-free. The reason why is because these are short-term loans to state and local government entities. The way the tax laws are written, when you loan money to state and local entities, government entities, you don't have to pay federal income tax on that income. It can be that even though you're earning a lower yield than you would on a federal or a prime or a Treasury money market fund, you actually come out ahead after tax if you're in one of the higher tax brackets. That's the case right now as I record this on January 18. You are better off if you're in the highest tax bracket being in a municipal money market fund than if you are in a taxable money market fund.
Keep in mind that there are also state-specific municipal money market funds that only do loans to government entities in California or Massachusetts or wherever. If you're a California resident or a Massachusetts resident, you invest your cash in this fund. Not only do you not pay federal income taxes on that interest, but you don't pay state income taxes on that interest.I don't know of a good one for Utah so I just use the federal one. But if you know of a good one for your state, you may choose to use that. The one downside of it is you're not quite as diversified as you would be if you used a more general municipal money market fund. But in short, these are great investments. They're great for short-term holdings, liquid holdings, very safe holdings. You don't want to be saving the majority of your retirement money in a money market fund by any means. But if this is money you're going to need to pay your taxes in two months or to buy a house in four months, or you're just using this as your savings account for a little bit of extra cash, part of your emergency fund, these are perfect. These are great. These are one of my favorite short-term safe investments out there.
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Underinsured Motorist Coverage
“This is Tim in Salt Lake City. What do you think are the most cogent reasons for a high-income professional to carry underinsured motorist coverage? When might someone decide to drop that coverage?”
Here's the truth of the matter. You're probably going to have to keep it and you're probably going to be forced to keep it by your umbrella policy. Your umbrella policy is probably going to require a minimum amount of uninsured and underinsured motorist liability coverage. I don't love this particular coverage. In some ways, there's no real point to having it if you have comprehensive and collision coverage. Technically, if your vehicle is damaged in a car accident where the other driver is at fault but they don't have insurance, that would be paid for by uninsured or underinsured motor vehicle coverage. You've already got comprehensive and collision insurance that covers that stuff. My policy is going to be paid no matter what if they crash into me, no matter who's at fault. If I can get out of it, I do try to get out of it. But you may find that your umbrella policy requires you to have it.
You can ask about dropping it. If you have comprehensive and collision, I don't think you can make a really great argument to have it. But I think you may end up still having it anyway. You'll have to ask your insurance coverage providers.If you're going to have it and they require it, it's probably going to be a big amount, like $300,000. I think that's what my umbrella policy requires me to carry in uninsured and underinsured. I think that's what I have.
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Brokerage Account Titled as a Trust or an LLC?
“Hi, Jim. Quick question. I was advised to change my brokerage account from being titled under my trust to an LLC so that my brokerage account will pay dividends and interests at the corporate rate, which is 21%, rather than my personal rate, which is 35%. And my capital gains rate is 23.8% with the NIIT add-on tax. It's very inexpensive to form the LLC and to maintain it year after year. And it seems like it would save me money. Is this, just like low fees and diversification, a free lunch for investors in a high-income tax bracket, or is this not worth the trouble? I typically get about $70,000 a year in my brokerage account as far as income interests. And I do live in a corporate-friendly state such as Nevada, South Dakota, and Wyoming. Thank you.”
If this were such a good deal, we'd all be doing it. We'd be talking about it on the podcast all the time. I'd be writing blogs about it. That tells you right there, there's a problem here, and I don't understand what the problem is. Let's talk about these corporate entities and the tax code and how everything works. I think you'll see what the problem is with the strategy. First of all, an LLC is not taxed as an LLC. An LLC is a disregarded entity when it comes to taxes. An LLC is taxed either as a sole proprietorship, a partnership, or a corporation. If a corporation, you can make an S declaration and have it taxed as an S Corp, or it can just be taxed as a regular old corporation, aka C Corp. In this case, that sounds like that's what you're talking about is essentially forming a corporation or an LLC that elects to be taxed as a corporation in order to put your investments in there.
Let's talk about taxation of a corporation. We're just talking about C Corps here. We're not talking about an S Corp, which is what many of you use quite wisely to save on Medicare taxes. A C Corp pays taxes at corporate rates on its profits. The corporate rate is 21%. Any retained earnings that stay in the corporation from its profits, 21%. The corporation can pay its employees, and that's a deduction to the corporation that then becomes taxable income to its employees. Some people do that and basically take all the money out of their C Corporation every year as salary. Then, the corporation doesn't have any income and it doesn't pay any taxes, and you just pay on that on your personal taxes. But obviously, that's not a huge savings and not really a great point to forming a corporation.
But as far as if it retains these earnings, those can then be invested. You pay your 21% on those, then they can be invested inside the corporation. Every year when it has income, you pay 21% on whatever the earnings are inside that corporation. But when you take the money out of the corporation, it gets taxed again. First, the corporation pays taxes on it, and now, you're pulling this money out as a dividend. What are dividends taxed out? Well, in your case, they're taxed at 23.8%. That's assuming you're in Nevada and don't have to pay state income tax on it. Now, you pay at 21%, then you pay it at 23.8%. What's the total? 44.8%. Does that sound like a great deal to you? You can pay at a lot lower rate if you don't put your investments inside a corporation. If they're not inside that corporation and they make money, what do you pay: 23.8%.
Why would you put them inside a corporation? It doesn't make any sense whatsoever. There are no tax savings there. As far as the trust, you didn't mention what kind of trust it is or why you have the trust. Some people form a trust to avoid having to go through probate, and that's typically a revocable trust. Other people are trying to deal with estate tax issues or asset protection issues, and they use irrevocable trusts to do that. But I'm not seeing a great reason for you to take your brokerage account, your taxable investing account, and put it inside a corporation, right? Maybe you can find some sort of asset protection benefit for it, but there's no case to be made for this as some sort of tax savings play and whoever told you to do that has given you lousy advice. I hope you're not paying them anything.
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Milestones to Millionaire Podcast
#105 — Public Health Dentist Pays Off Student Loans
Today we hear from a general dentist who works in public health. She explains her path to paying off her student loans only 4 1/2 years into practicing. This dentist shows us that you don't have to be making a huge salary to tackle your loans. She combined several methods to pay off her student debt—including the NHSC loan repayment program, inheritance money, and putting all of her extra income toward the loans. Her tips? Live like a resident, get advice from people who know more than you, budget, and make sure your spending matches your values.
Listen to Episode #105 here.
Sponsor: All Global Circle
Full Transcript
Transcription – WCI – 302
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.
Dr. Jim Dahle:
This is White Coat Investor podcast number 302.
Dr. Jim Dahle:
As we enter 2023, tax regulations have shifted in the past year. It's more important than ever to ensure you're taking advantage of the available strategies. By reviewing your tax plan at the beginning of the year, you can ensure you're not missing out on opportunities.
Dr. Jim Dahle:
If you haven't heard about Cerebral Tax Advisors, physicians all over the country work with them to lower their personal and business taxes through court-tested and IRS-approved tax strategies. Cerebral services are flat rate. They're focused on their client's return on investment. If you'd like to find out more, schedule a free consultation, visit their website at www.cerebraltaxadvisors.com.
Dr. Jim Dahle:
Hey, if you're looking for ways to make a little bit more money, and when I say a little bit more, I know some White Coat Investors have made as much as $30,000 more in a year doing this. But we have a number of partners that want your opinion and will pay you for it by having you do paid surveys at your own convenience. While you're walking across the hospital if you got a mile walk to see your next patient, while you're standing on the bus, while you're whatever. Whenever you have free time. While you're watching TV at night, you can do a survey.
Dr. Jim Dahle:
But if you're looking to make a little bit more money, maybe have some self-employment income, you can do that. You can meet our partners at whitecoatinvestor.com/paidsurveys.
Dr. Jim Dahle:
All right. Today we're just going to be answering a whole bunch of your questions, and we've got a ton of them. Lots coming in by email, a whole bunch on the SpeakPipe. If you're interested in getting your questions on the White Coat Investor podcast, the easiest way is to do it on the SpeakPipe. Go to whitecoatinvestor.com/speakpipe. You can record a question up to a minute and a half. You don't have to use the whole minute and a half. And we'll try to get it answered right here on the podcast.
Dr. Jim Dahle:
Thanks for those who have done this in the past. It has made for a fun podcast to listen to. And I think it's fun for the experienced listeners to try to guess what I'm going to answer as before I answer it. And when you get to the point where you know all the answers, you can feel pretty good about your level of financial literacy, I think.
Dr. Jim Dahle:
This one is from the email box and it's about Venmo changes. “There was a lot of chatter in December about Venmo, Zelle, et cetera, and changes in how these are taxed. I'm having trouble finding reliable resources. Some say anything under $600 Venmo transactions is fine. Others say it's a gift. So, anything under $16,000 is fine. Could you please shed light on these digital transfer services? I think a lot of listeners, especially the millennials use these tools on a regular basis.”
Dr. Jim Dahle:
Okay. I think people have read some press releases and gotten a little bit confused about what's going on here. Nothing has actually changed from a tax perspective here. All that has changed is what Venmo or Zelle or whoever reports to the IRS. If you weren't cheating on your taxes before, you're not cheating on your taxes now.
Dr. Jim Dahle:
When we get paid via Venmo or PayPal, etc, for earned income or work we do, we pay taxes on. Whether it's $600 or more, or whether it's less than $600, that's taxable income. Just because Venmo doesn't tell the IRS about it, doesn't mean you're not supposed to tell the IRS about it.
Dr. Jim Dahle:
On the other hand, if you get a gift via Venmo, you don't pay taxes on that. It's not taxable. It's a gift. That wouldn't change if Venmo mistakenly sent me a 1099 or something saying it was a transaction. It's not a transaction. I didn't sell my time. I didn't sell a product for that money. It's not earned income. It's not taxable income. It's a gift.
Dr. Jim Dahle:
I use Venmo all the time to transfer money. For example, I now have some of my nieces and nephews and my daughter in college, and so, we're starting to spend down some 529s. Well, what do I do? When they have an expense, they send me a receipt. I Venmo them the money out of my checking account, and then I take the money out of the 529 into my checking account. None of that is taxable. It wasn't taxable before. It's not taxable now.
Dr. Jim Dahle:
On the other hand, if I was having somebody pay me on Venmo for their advertising at WCI, that's taxable. And there was a time many years ago where we used PayPal for that. We have different vendors now. But that was all taxable. And we reported that to the IRS, which was part of the income of WCI. And all that changed is that basically, the threshold for Venmo to have to report this sort of income to the IRS came down. But if you weren't paying on that income before, you're a tax cheat, and I hope you get caught, quite honestly.
Dr. Jim Dahle:
Okay. What does Venmo say about this? Well, they clarify that it's $600 in payments for goods and services. So, you don't need to worry if you're just gifting money back and forth with the nurses because you pulled your money together to get lunch today.
Dr. Jim Dahle:
Basically, what is the change? Well, Venmo has a nice FAQ page on their site, and it's basically said that the IRS has delayed implementation of the $600 reporting threshold for payment transactions for goods and services for one year.
Dr. Jim Dahle:
So, for the year 2022, the IRS will use a $20,000 and 200 transaction limit. That doesn't mean it's not taxable if you have fewer than 200 transactions, or if you have less than $20,000. It just means they're not going to tell the IRS about it. Of course, some states do have lower reporting thresholds.
Dr. Jim Dahle:
But for 2023, the requirement only pertains to payments received for sales of goods and services and does not apply to friends and family payments. But if you collect $600 or more for the sales of goods and services through a payment services company without first providing your tax info, that payment services company, i.e. Venmo is required to withhold 24% of those payments and send it to the IRS for backup withholding. That's required by the IRS, helps to make sure that the applicable taxes due on those payments are paid.
Dr. Jim Dahle:
You can avoid backup withholding, of course, if you provide your tax ID in the Venmo app. So, the question is, are you doing business on Venmo? If you are, you need to do business on Venmo in the right way.
Dr. Jim Dahle:
Their second FAQ is, I've sold lots of stuff in the past. Why haven't I had to do this before? Well, the IRS has always required payment settlement entities to report earnings and issue 1099-Ks. But until 2023, the threshold was much higher, $20,000 or 200 transactions. So, it didn't affect nearly as many people.
Dr. Jim Dahle:
All right. I hope that's clear. If you're doing business using Venmo, using PayPal, you need to pay taxes on it, you're more likely to get caught now than you used to be.
Dr. Jim Dahle:
All right, next question. This one comes in via email and so many of the questions I get by email I can actually just respond to with a link to a blog post that I've written in the past. And this is kind of the case with this one. Here's the question. “Whole life insurance, when is it a reasonable idea?” is the title. “There's been plenty of material on the blog and podcast about why permanent whole life insurance policies are bad investment options for 99% of your readers. However, I was wondering if you could give an example of the 1% of scenarios in which it would make sense to purchase a permanent or whole life plan.”
Dr. Jim Dahle:
And what do you know? I've got a blog post originally published in 2015 called “Appropriate Uses of Permanent Life Insurance.” And I certainly am in agreement that we're talking about 1% of docs, maybe this is a good idea. Most people do not need permanent life insurance. Permanent means it's going to pay out whenever you die. So, this is a whole life insurance or it's cousins, index universal life, other types of universal life, variable life, variable universal life, all these variations on a lifelong insurance policy combined with some sort of savings or investment component where you can use the cash value during your life if you wish to.
Dr. Jim Dahle:
Okay. So, what are some scenarios where this makes sense? Well, here's one. If you want to reduce your estate tax, but you don't want heirs to be able to access the money until you die, life insurance can work for that. This is for someone with an estate tax problem. What's an estate tax problem? Well, if you're single, if you’ve got, it's almost 13 million now, an estate of at least 13 million, double that if you're married, then you might want to think about something like this. Keep in mind, some states also have a lower exemption amount.
Dr. Jim Dahle:
But basically, the way that you avoid that is you give money away before you die. You give to charity, you give it to your heirs, you're allowed to gift a certain amount each year, but there's limits to how much you can give each year. I think it's $17,000 for 2023. Or maybe they're not mature enough to use it right now. You don't want to give it to them now for whatever reason.
Dr. Jim Dahle:
So, what do you do? Well, you start an irrevocable trust and put the money in there. An irrevocable trust can invest in anything. They can invest in stocks and bonds and mutual funds and real estate or whatever, small businesses, etc, but they can also invest in life insurance. And since life insurance generally grows in a tax-protected way, the cash value on it, there's no tax due as it grows, which is good because trust tax rates tend to be relatively high. You get to the top tax bracket pretty quickly with trust income.
Dr. Jim Dahle:
And so, the idea here is that you have this trust, this irrevocable trust by a permanent life insurance policy. So, you're paying premiums on it. Maybe there's $17,000 a year premiums, and then when you die, all of the benefit, the death benefit is in this trust. It's not part of your estate. And so, you've taken that money out of your estate and the heirs get it when you die. That's one reasonable use of whole life insurance that can help you to reduce your estate tax due at your death.
Dr. Jim Dahle:
Another nice thing about the death benefit from a life insurance policy, it takes you a week or two to get it or whatever. You got to send them a death certificate, but when it comes, it's liquid. They're not sending you shares of a mutual fund. They're not giving you a family farm. They're not giving you a really illiquid small business. You're not getting a bunch of syndications that you can't sell for five years. You're getting liquid money.
Dr. Jim Dahle:
And if there is a need for liquidity at death, life insurance can really provide that. Let me give you an example. Maybe the main asset being passed on is a family farm. Say this family farm is worth $15 million. And there's three heirs and only one of them wants the family farm. And so, the idea is to try to give this family farm to one of the heirs, but you want to be able to buy out the other heirs. Well, you need some liquid cash to do that, and life insurance can provide that.
Dr. Jim Dahle:
So, if you need liquidity at death for whatever reason, that can be helpful. Sometimes there's some business uses that's related to that as well. Maybe to be able to buy out the heirs of your business partner, you can see a use for a permanent life insurance policy for that.
Dr. Jim Dahle:
Obviously, if you're not going to be in business when you're old, you can use a term policy for that as well but it does work if you're going to be owning this business till late in life.
Dr. Jim Dahle:
Okay, here's another one. Providing for a disabled heir when you're never going to be financially independent. If you're financially independent and you can live off your nest egg for the rest of your life, your heir probably can too if you leave it to them if you die.
Dr. Jim Dahle:
But if you're never going to be financially independent, if all you're living on is social security, for instance, and you want to be able to provide for that disabled heir once you're gone and that social security won't be going to the disabled heir, well, life insurance benefit can provide for that. And obviously, if you die when you're 90, you're probably going to want to use a whole life insurance for that benefit rather than a term life insurance.
Dr. Jim Dahle:
I mentioned a business use key man insurance, key person insurance, somebody really important to the business, late in life. You may want to be able to, the company wants to be able to find somebody else like that or needs to be able to recover from the business hit they're going to take from this key person dying off. You can replace at least their financial value with life insurance.
Dr. Jim Dahle:
Here's another one. Some people want to take an annuity. Whether it's from their pension or whether it's an annuity they buy from an insurance company, but they want to just have it be a single life annuity, so it pays out the maximum amount. Well, the problem is, what's your spouse going to live on if you die? And that annuity stops paying out when you die.
Dr. Jim Dahle:
Well, if you also have a permanent life insurance policy that pays off when you die, then your remaining spouse can take that pool of money and buy another annuity with it. And so, they have something for them to live on for a while. So that could be a reasonable use if you don't want to do a dual life annuity, you could buy a single life annuity and combine it with a life insurance policy.
Dr. Jim Dahle:
Okay. Here's another one. You can combine it with a charitable trust. If you have an estate tax problem, you're planning to give some money to charity, you've got some highly appreciated shares of an investment you'd like to sell, and you still want to maximize how much your heirs get, you may be able to combine a permanent life insurance policy with the charitable trust.
Dr. Jim Dahle:
You could take the highly appreciated shares, put them in a charitable remainder annuity trust, you'd avoid capital gains taxes on the asset. You'd get an income tax deduction this year for the remainder portion. You'd avoid estate taxes on the money since it's now out of your state. And then you use the annuity payments from the trust to buy a life insurance policy in an irrevocable trust for your heirs to replace the money you gave to charity.
Dr. Jim Dahle:
So, the devil is in the details here, but it's possible that this complicated process can enable you to help your favorite charity and still pass more money to your heirs than you could have if you had not given anything to charity. The free lunch there comes from the taxes avoided. So, it's a fairly complicated setup, but there are obviously some estate planning uses to a permanent life insurance policy.
Dr. Jim Dahle:
The next one, there are a lot of people that are into banking on themselves. Bank on yourself as a brand name, Infinite Banking is another brand name, sometimes it's called LEAP. And the idea here is that you overfund or maximally fund a life insurance policy.
Dr. Jim Dahle:
And the point here isn't the death benefit. The point here isn't the investment return necessarily on it. The idea is to get to break even very quickly. So, instead of breaking even in 10 or 15 years, like on a typical policy, you might break even 4, 5, 6 years. And at that point, your cash sits in the whole life policy, maybe making 4, 5, 6% instead of whatever you're getting in the bank.
Dr. Jim Dahle:
Now, these days I'm getting 4% plus in the bank just out of a money market fund. And so, this doesn't look nearly as good as it might when interest rates were 1%. But people were really excited to be making money long term on their cash at 4% or 5% instead of 0.2% in their bank.
Dr. Jim Dahle:
Now, there's some downsides. You got to qualify for life insurance if you do that. You got to go through the negative return years, which are the first few years, and you got the hassle of dealing with it. But it's a way long term to earn a little bit more on your cash. So, instead of keeping a bunch of money in the bank, you keep it in your insurance policy.
Dr. Jim Dahle:
Now, the insurance policy needs to be designed to do this. That usually means getting wash loans, having non-direct recognition, using the maximum number of paid-up additions, so that the policy is designed to do this. But this isn't unreasonable. You just got to decide whether the trade-off is worth it to you. The trade-off of having to get an insurance policy, the trade-off of having a few negative return years in exchange for a little bit higher rate on your cash long term.
Dr. Jim Dahle:
Okay. Here's another one. Some people really value asset protection. And in many states, maybe close to half of them, life insurance cash value is very much a protected asset. And so, if you, heaven forbid, were in an extremely rare situation that you had to declare bankruptcy due to bad policy limits judgement that wasn't reduced on appeal, you'd get to keep everything in your retirement accounts usually and sometimes some of your home. And in some states, the money, the cash value in a life insurance policy.
Dr. Jim Dahle:
So, some people who really value the asset protection more than a better return on their money might choose to buy a whole life insurance policy for that reason. Those are all some reasonable uses of a whole life insurance policy. Notice that one of them is not “You're a doctor.” You don't need one of these just because you're a doctor.
Dr. Jim Dahle:
I still think it's probably 1% of doctors that need this. Most doctors don't even have an estate tax problem. Only 10% of doctors have more than $5 million. And you can have $10 million. If you're married, you could have $20 million and you still don't have an estate tax problem.
Dr. Jim Dahle:
And so, all these niche business uses, niche estate planning uses, they just don't apply to most docs. Don't believe the salesman that comes in and tells you “You're a doctor now you need a whole life insurance policy” and meanwhile, you're paying 7% on your student loans. It doesn't make any sense whatsoever. All right. I hope that answers your question, Brian.
Dr. Jim Dahle:
Quote of the day. This one's from Ben Graham. He said, “The individual investor should act consistently as an investor and not as a speculator.” And a speculator is someone who's just trying to make a quick buck, who's buying things just in hopes that somebody later will pay them more than they paid for it. Whereas what they're putting their money in doesn't actually generate any sort of money. It doesn't generate interest. It doesn't generate earnings or dividends or rents or anything like that. That's a speculator.
Dr. Jim Dahle:
All right, next question. This one is also out of the email box. Where to keep your money? “When my mother died, I inherited her brokerage account with Merrill Lynch. I decided to sell some of the stock and was floored to learn that one transaction would cost me $800 in fees. This was 10 years ago when Fidelity cost $8 per trade, now zero. So, the decision was easy. I transferred all of our holdings to my Fidelity account.
Dr. Jim Dahle:
Recently, the kind folks at Wells Fargo sent me an email announcing that because I was such a valued customer, they were changing my free checking account, which needed a balance of about $30,000 to a higher level, which would now demand a daily balance of $250,000 or else I would be hit with a monthly fee. I sent them a nasty email and they reverted my account.
Dr. Jim Dahle:
Last week, I received a renewal email for renter's insurance. We sold our house and are waiting for the market to soften in the DC area. The fee was very small, $14.50 a month. But when I inquired about why it was billed monthly, I learned that a $5 fee was being applied. That was more than a 50% increase. Not a lot of money, but nothing irks me more than being nickeled and dimed.
Dr. Jim Dahle:
As you can guess, I would never be a Fisher Investments client paying 1% or 1.5% win or lose. I would love to see a spreadsheet of a $1 million account over 10 years. Did someone make an excess $100,000 to $150,000 with Fisher? Who is the best deal for storing your money? Does Fidelity have better brokerage CD rates than Schwab? By paying hidden fees when I buy tax-free bonds within my account, am I losing out by being too cheap to invest with the likes of Fisher?”
Dr. Jim Dahle:
There are a lot of questions in that particular email. I don't know that I'm going to answer all these questions, but let's go through a few of them. First, where do I keep my money right now? And this varies. You asked me again in a month, it might be somewhere else.
Dr. Jim Dahle:
But for the most part, my money moves, at least my cash moves between three different places. Right now, it's sitting in the Vanguard Municipal Money Market Fund. It's making, I don't know, 3.6%, 3.7% federal tax-free. That's an equivalent due to being in the high tax bracket of a taxable yield of something like 4.5%. That's where it is a lot of the time.
Dr. Jim Dahle:
There are sometimes though, where it actually makes sense for it to be sitting in the Vanguard Federal Money Market Fund, which is just their sweep account. Right now, that's paying like 4.3%.
Dr. Jim Dahle:
There are times actually where those yields vary between the municipal account and the regular taxable federal account where it actually makes sense for me to be in the federal and just pay the taxes. Sometimes I transfer them back and forth there.
Dr. Jim Dahle:
There are other times, particularly in the last few years when money market yields have been pretty low due to the Fed keeping interest rates low, but it actually made sense to just keep it in a high-yield savings account. And I've had that at Ally for many years. And so, I would transfer money back and forth there. I just have the accounts even though there's no money sitting in my Ally account right now. But if it were paying 4.8%, I'd transfer the money over to Ally.
Dr. Jim Dahle:
So, I don't know. I might look at that every two or three months and if it makes sense, transfer money back and forth between those. But those are my usual choices.
Dr. Jim Dahle:
What you don't want to do is have it sitting in the savings account at your credit union paying 0.2% or to have hundreds of thousands of dollars sitting in your checking account earning nothing. For the most part, any of those reasonable high-yield options are okay. You don't need to be checking every other day to make sure you're in the very highest account. You don't want to be opening 20 accounts every year to do this. But if you have a high-yield savings account at a bank and you've got an investing account at Vanguard, Fidelity or Schwab, or whatever, you may want to have both of those open and occasionally transfer money between the two and you'll be fine.
Dr. Jim Dahle:
Now, does Fidelity have better brokerage CD rates than Schwab? I doubt it. I have no idea. I haven't looked into the brokerage CD rates. These days with a money market fund paying over 4%, I don't see a lot of point in messing around with the CD anyway. It doesn't seem like the CDs I've seen pay much more than that anyway.
Dr. Jim Dahle:
“Am I paying hidden fees when I buy tax-free bonds within my account?” I don't know. You would have to check. I don't actually buy individual municipal or tax-free bonds. I just use the excellent municipal bond funds at Vanguard. They're very low cost. It's almost free to have a diversified investment there. I don't see any reason to try to build your own bond fund.
Dr. Jim Dahle:
As far as Fisher Investments, let's just say they wouldn't be approved to be on the WCI recommended financial advisors list. If you're wondering what is on that list, just go to the website, go to the recommended tab, scroll down to Financial Advisors and you'll see who's on the list.
Dr. Jim Dahle:
They're all fee only advisors. Some just do second opinion kind of things, where for people who are mostly do-it-yourselfers, other people want to manage your money. So, it just depends on how full of a service you're looking for, which advisor you want to pick there.
Dr. Jim Dahle:
But Fisher is definitely not on that list. At least the Fisher that sends you all these notices in your mail and you're not going to see people on there charging you 1.5% of assets under management. Obviously, for people that have a multimillion-dollar account, like many White Coat Investors, that can get to be an outrageous price pretty darn quickly. I hope I answered all of those questions.
Dr. Jim Dahle:
All right. Let's take this one off the SpeakPipe. This one's from Trish. Another question about CDs.
Trish:
Hello, Dr. Dahle. It's Trish from Arizona. I was wondering if you can do a segment on CDs, the difference between a brokered CD and a bank CD, and also CDs and Laddered CDs. I was looking at Fidelity's website and it's a little bit too much information, but the yields are pretty good. Some of the new issue CDs are going up as high as 4.9% on a three-year CD. And then when you ladder it, it's coding up to 4.72% on a laddered CD for two years. So maybe a little bit more information. I'm confused. I mean, if this is a good investment, then why aren't many people talking about it? Thank you so much.
Dr. Jim Dahle:
Okay, let's talk about CDs. A CD or a certificate of deposit is an investment product or a savings product depending on how you want to look at it, offered by a bank. Basically, you give them money, they hold onto it for the term of the CD, one year, two years, three years, five years, seven years. Those are pretty typical terms. Then they give you the money back. In the meantime, they pay you interest, periodically, I don't know, quarterly, maybe, on the CD. Maybe they pay it monthly, whatever.
Dr. Jim Dahle:
It's a very low-risk way to invest. As a general rule, you'll get paid a little bit more with a CD than you will with a money market fund or a savings account. And the reason why is because your money is tied up. You've agreed to be less than liquid.
Dr. Jim Dahle:
And typically, you will lose something if you break that CD before the term is up. There's usually some sort of penalty. It might be three months of interest, it might be a year of interest, whatever.
Dr. Jim Dahle:
There's going to be some sort of penalty if you don't wait the full term because that's why you're getting paid more is because you're willing to not have the money back for five years. Whereas with a money market fund or a savings account, you can request it all back tomorrow to do whatever you want with it. So that's what a CD is.
Dr. Jim Dahle:
A bank CD is issued by a bank. A brokered CD, you buy through a CD broker. At the end of the day, it's usually still a bank in the back that is the one who has your money. These generally do have FDIC, Federal Deposit Insurance Corporation insurance. So that's up to $250,000. If you got you and your spouse on it, it might be twice that. So, you get some FDIC insurance with it that you might not have with a money market fund or with a short-term bond or something like that.
Dr. Jim Dahle:
A CD ladder, like a bond ladder is you are simply just buying a bunch of different CDs of different durations. So, if you had a one-year CD and you had a two-year CD and you had a three-year CD and you had a five-year CD and you had a seven-year CD, that's a CD ladder.
Dr. Jim Dahle:
And why would somebody ladder these investments? Well, the reason you would ladder them is because you can get a higher yield on the longer-term ones than you can on the shorter-term ones most of the time. As I'm recording this, I think the yield curve is probably inverted. And so, that's not necessarily true, but most of the time you can.
Dr. Jim Dahle:
And so, the idea is, let's say you're getting 5% out of a seven-year CD and you're only getting 4.8% out of a five-year CD and you're only getting 4.5% out of a two-year CD. Well, if you owned all seven-year CDs, you'd be making 5% out of all of them, but you'd buy them all a year apart. So, maybe if you wanted to set up a ladder, you'd buy a seven and a six and a five and a four and a three and a two and a one. Now, you've got a seven-year CD ladder. And then every year you take the money that came out of the one that just matured and you buy a new seven-year one.
Dr. Jim Dahle:
And so, that's an approach a lot of bond investors and CD investors use with their CDs to try to earn a little bit higher yields in the long run, but still have some money coming out every year. That's the point of a ladder.
Dr. Jim Dahle:
Are these awesome investments? No, these are safe investments. If you want to earn a safe return for tying your money up for this period of time, this is a reasonable thing to do. Sometimes CDs are better than bonds, sometimes they are not. You can do the same thing with a bond. You can go buy a treasury bond, you can ladder them just like you can a CD. Sometimes bonds pay more, sometimes CDs pay more. It just depends. So, you have to look if this is the sort of investment you're looking for.
Dr. Jim Dahle:
On the other hand, if you just want something a little more liquid, you're willing to earn a little bit less on them. You can make something like 4.3% right now out of money market fund. You can get it all back tomorrow if you want.
Dr. Jim Dahle:
So, the way I kind of look at it is my longer-term money, I tend to invest more aggressively, and not necessarily have in a bunch of bonds and CDs and cash and that sort of stuff. And so, I don't invest in CDs myself, but they're not a bad investment. You just got to understand what you're buying. If that's what you want for part of your portfolio, then buy it.
Dr. Jim Dahle:
It's okay to invest in CDs. You probably shouldn't have all your money in there. You need an investing plan. You need to follow your investing plan. If your investing plan says build a CD ladder with 20% of your portfolio, then do that. It's a totally reasonable way to invest. Hope that's helpful.
Dr. Jim Dahle:
All right. By the way, I recorded a masterclass a few years ago about real estate investing. It's totally free. If you thought I might want to get into real estate investing, but I don't really know a lot about it. I'm not really willing to commit to buy a full class like the one we offer, we have a No Hype Real Estate investing course. It's not our cheapest course, it's our longest course in fact, and took the most work to put together. So, it's actually our most expensive course.
Dr. Jim Dahle:
But if you're not really ready to commit to that sort of thing or you just want to learn more and kind of dip your toe and see if this is for you, this masterclass is for you. It's three sessions long. You can take them at your leisure, they just get emailed to you. They're pre-recorded. You can sign up for that at whitecoatinvestor.com/remasterclass. And at the end of it, there might be a discount to taking the full course if you're interested in that. So, be sure to check that out.
Dr. Jim Dahle:
All right. Our next question off the Speak Pipe is from Stella. Let's take a listen. This one's also about safer investments.
Stella:
Hello, Dr. Dahle. This is Stella. I would like to get your opinion on money market mutual funds, please. Would you kindly describe what they are, what kinds of MMFs are available, and whether or not they're a good option for temporary cash holding, such as for our emergency funds? With the Fed raising interest in earnest, are money market funds back in the game? Thank you.
Dr. Jim Dahle:
All right. Near and dear to my heart. I like money market funds. I have a lot of money sitting in money market funds right now. I use them all the time. So, I think money market and mutual funds are great. I'm particularly fond of the ones at Vanguard. I think they do an excellent job with their money market funds. Always have.
Dr. Jim Dahle:
These are safe investments. They're very short-term liquid, low-risk investments. Now, I'm not saying they're back in the game because interest rates are up now. I was using them when interest rates were 1% or 0.5% or whatever they were, because it was still the best thing you could get on safe liquid money. Sometimes a high-yield savings account is a little bit better. But most of the time they're pretty similar. High-yield savings accounts and money market mutual funds.
Dr. Jim Dahle:
So, there's a lot of different kinds. There are prime money market funds. And Vanguard had one of these until a few years ago. I was kind of disappointed to see it go. They're usually the highest-yielding ones. That's because they're technically the riskiest ones. Because anytime you have a fixed income investment like this, you got to ask, “Well, who am I loaning money to?” And with a prime money market fund, you were generally loaning money short-term to corporations mostly.
Dr. Jim Dahle:
And so, they'd borrow money for a few days or a few weeks or a few months even. And that short-term paper is what that money market fund held. And because you can charge more to a corporation than you can to a government, you tend to have the highest yields in those.
Dr. Jim Dahle:
Now, they're still very safe. It was very rare for a money market fund to break the buck. This is part of why 2008 was such a big deal because there was a money market fund that broke the buck. You only got 98 cents back of your dollar. And that's the kind of risk we're talking about with the money market fund. It's just very, very low risk.
Dr. Jim Dahle:
The next step down is something like Vanguard's current sweep account, which is their federal money market fund. And this is basically money that's loaned to the US government and its agencies. There are also treasury money market funds, which is another step down in risk where these are just loans to the US government, not to its agencies.
Dr. Jim Dahle:
And so, that tends to be the lowest yield of the money market funds, but there's usually not a huge difference even between a prime and a treasury money market fund. Treasury money market funds, and any treasury bonds or bills, I guess, they would be in this case since they're shorter than a year, inside that money market fund are state tax-free as well. So that's the other benefit of a treasury money market fund is it's state tax-free, the interest. Those are all taxable for the most part though, at least on the federal level.
Dr. Jim Dahle:
On the other side are municipal money market funds. These are tax-free. And the reason why is because these are short-term loans to state and local government entities. And the way the tax laws are written, when you loan money to state and local entities, government entities, you don't have to pay federal income tax on that income.
Dr. Jim Dahle:
And so, it can be that even though you're earning a lower yield than you would on a federal or a prime or a treasury money market fund, you actually come out ahead after tax if you're in one of the higher tax brackets. And that's the case right now as I record this on January 18th. You are better off if you're in the highest tax bracket being in a municipal money market fund than if you are in a taxable money market fund.
Dr. Jim Dahle:
And keep in mind that there are also state-specific municipal money market funds that only do loans to government entities in California or Massachusetts or wherever. And if you're a California resident or a Massachusetts resident, you invest your cash in this fund. Not only do you not pay federal income taxes on that interest, but you don't pay state income taxes on that interest.
Dr. Jim Dahle:
Now, I don't know of a good one for Utah and so I just use the federal one. But if you know of a good one for your state, you may choose to use that. The one downside of it is you're not quite as diversified as you would be if you used a more general municipal money market fund.
Dr. Jim Dahle:
But in short, these are great investments. They're great for short-term holdings, liquid holdings, very safe holdings. You don't want to be saving the majority of your retirement money in a money market fund by any means. But if this is money you're going to need to pay your taxes in two months or to buy a house in four months, or you're just using this as your savings account for a little bit of extra cash, part of your emergency fund, these are perfect. These are great. These are one of my favorite short-term safe investments out there.
Dr. Jim Dahle:
Okay. It looks like we're going to talk about underinsured motorist coverage. Let's listen to a Speak Pipe from Tim.
Tim:
This is Tim in Salt Lake City. What do you think are the most cogent reasons for a high-income professional to carry on an underinsured motorist coverage? When might someone decide to drop that coverage? Thank you.
Dr. Jim Dahle:
It's a great question, Tim. Here's the truth of the matter. You're probably going to have to keep it and you're probably going to be forced to keep it by your umbrella policy. Your umbrella policy is probably going to require a minimum amount of uninsured and underinsured motorist liability coverage.
Dr. Jim Dahle:
I don't love this particular coverage. In some ways there's no real point to having it if you have comprehensive and collision coverage. Technically if your vehicle is damaged in a car accident where the other driver is at fault, but they don't have insurance that would be paid for by uninsured or underinsured motor vehicle coverage. Well, you've already got comprehensive and collision insurance that covers that stuff. My policy is going to be paid no matter what if they crash into me, no matter who's at fault. So, if I can get out of it, I do try to get out of it, but you may find that your umbrella policy requires you to have it.
Dr. Jim Dahle:
You can ask about dropping it. If you have comprehensive and collision, I don't think you can make a really great argument to have it. But I think you may end up still having it anyway. So, you'll have to ask your insurance coverage providers.
Dr. Jim Dahle:
If you're going to have it and they require it, it's probably going to be a big amount, like $300,000. I think that's what my umbrella policy requires me to carry in uninsured and underinsured. So, I think that's what I have.
Dr. Jim Dahle:
All right. Next question here. Oh, before we get into that, I want to talk a little bit about what might be the biggest risk to your income. We talk a lot about disability insurance and if you don't have disability insurance, go get disability insurance.
Dr. Jim Dahle:
There are doctors out there who are living on their disability insurance benefits. I have met many of them over the years and they are so glad they bought it. They all regret not buying more, in fact. And so, if you need disability insurance, you don't have any disability insurance and you have no way to support yourself and your family if you were to become disabled, buy disability insurance.
Dr. Jim Dahle:
However, an even more common threat than disability is burnout. Burnout is super common among docs. 60% or 63% is what the last survey showed. Now, all those docs aren't so burned out that they can't practice at all, but some of them are. And you need to have a strategy to deal with burnout.
Dr. Jim Dahle:
And if you find that you're maybe lacking the tools, maybe lacking the support, we have put together something called Burnout Proof MD. And this is basically a year-long experience in a community of docs dealing with this issue that will help you learn to deal with it. It may involve changing jobs and they can help you with that. About 30% of docs find they have to change jobs because they're simply in a toxic job. And this community can help you prepare for that change, get through that change, get the new job, etc.
Dr. Jim Dahle:
But for many docs, it's just a matter of dealing with charting, dealing with the stresses, changing the job, learning to manage your boss, those sorts of strategies that you can learn how to do this. And all of this is eligible for far more CME than you need in a given year. So, you can use your CME dollars to pay for it. If you would like to check that out, you can find it again under our recommended tab at whitecoatinvestor.com. It's listed under Physician Burnout Coaching. And you can go to whitecoatinvestor.com/physician-burnout-coaching directly if you want, and you can sign up for that. Burnout Proof MD.
Dr. Jim Dahle:
It's not free, but if the alternative is ditching this career that pays you $200,000, $300,000, $400,000 a year, it's going to be a heck of a value for you. Plus, just getting up to 100 hours of CME is a huge value as well. So, check that out. Burnout Proof MD.
Dr. Jim Dahle:
All right. Let's take one more question here. This one is about brokerage accounts and figuring out what to do with them when you have a trust, et.
Speaker:
Hi, Jim. Quick question. I was advised to change my brokerage account from being titled under my trust to an LLC so that my brokerage account will pay dividends and interests at the corporate rate, which is 21% rather than my personal rate, which is 35%. And my capital gains rate is 23.8% with the nit added on tax. It's very inexpensive to form the LLC and to maintain it year after year. And it seems like it would save me money.
Speaker:
Is this just like low fees and diversification a free lunch for investors in a high-income tax bracket, or is this not worth the trouble? I typically get about $70,000 a year in my brokerage account as far as income interests. And I do live in a corporate-friendly state such as Nevada, South Dakota, and Wyoming. Thank you.
Dr. Jim Dahle:
Okay. Great question. Here's the deal. If this were such a good deal, we'd all be doing it. We'd be talking about it on the podcast all the time. I'd be writing blogs about it. So that tells you right there, there's a problem here and I don't understand what the problem is. Well, let's talk about these corporate entities and the tax code and how everything works. And then I think you'll see what the problem is with the strategy.
Dr. Jim Dahle:
First of all, an LLC is not taxed as an LLC. An LLC is a disregarded entity when it comes to taxes. An LLC is taxed either as a sole proprietorship, a partnership, or a corporation. If a corporation, you can make an S declaration, have it taxed as an S-corp, or it can just be taxed as a regular old corporation, a.k.a C-corp.
Dr. Jim Dahle:
And in this case, that sounds like that's what you're talking about is essentially forming a corporation or an LLC that elects to be taxed as a corporation in order to put your investments in there.
Dr. Jim Dahle:
Let's talk about taxation of a corporation. And we're just talking about C-corps here. We're not talking about an S-corp, which is what many of you use quite wisely to save on Medicare taxes.
Dr. Jim Dahle:
A C-corp pays taxes at corporate rates on its profits. The corporate rate is 21%. So, any retained earnings that stay in the corporation from its profits, 21%. Now, the corporation can pay its employees and that's the deduction to the corporation, then becomes taxable income to its employees. So, some people do that and basically take all the money out of their C-corporation every year as salary. And then the corporation doesn't have any income and it doesn't pay any taxes, and you just pay on that on your personal taxes. But obviously, that's not a huge savings, and not really a great point to forming a corporation.
Dr. Jim Dahle:
But as far as if it retains these earnings, those can then be invested. You pay your 21% on those, then they can be invested inside the corporation. And every year when it has income, you pay 21% on whatever the earnings are inside that corporation. But when you take the money out of the corporation, it gets taxed again. First the corporation pay taxes on it, and now you're pulling this money out as a dividend.
Dr. Jim Dahle:
Now, what are dividends taxed out? Well, in your case, they're taxed at 23.8%. That's assuming you're in Nevada and don't have to pay state income tax on it. So now you pay at 21%, then you pay it 23.8%. What's the total? 44.8%. Does that sound like a great deal to you? You can pay at a lot lower rate if you don't put your investments inside a corporation. If they're not inside that corporation and they make money, what do you pay? 23.8%.
Dr. Jim Dahle:
So why would you put them inside a corporation? It doesn't make any sense whatsoever. There is no tax savings there. As far as the trust, you didn't mention what kind of trust it is or why you have the trust. Some people form a trust to avoid having to go through probate, a debt that's typically revocable trust. Other people are trying to deal with state tax issues or asset protection issues, and they use irrevocable trusts to do that.
Dr. Jim Dahle:
But I'm not seeing a great reason for you to take your brokerage account, your taxable investing account, and put it inside a corporation, right? Maybe you can find some sort of asset protection benefit for it, but there's no case to be made for this as some sort of tax savings play and whoever told you to do that has given you lousy advice. I hope you're not paying them anything.
Dr. Jim Dahle:
All right. I think we're coming close to the end here. Let me tell you again about our sponsor. Alexis Galotti, the founder of Cerebral Tax Advisors has more than two decades of experience in high-level tax planning strategies and multi-state tax preparation. Well, I feel for those of you who like me, have to file in multiple states these days.
Dr. Jim Dahle:
She's also the author of the book “Advanced Tax Planning for Medical Professionals”, grew up in a family of physicians, and is married to one. Medical professionals rely on Cerebral Tax Advisors for proactive tax planning strategies for doctors, helping them lower their effective tax rate and increase their wealth.
Dr. Jim Dahle:
If you'd like to find out more, schedule a free consultation, visit their website at cerebraltaxadvisors.com. You can also talk to Alexis at the WCICON this year, if you're coming to that.
Dr. Jim Dahle:
All right. Don't forget about our masterclass, whitecoatinvestor.com/remasterclass. Thanks for those of you who have been leaving us five-star reviews and telling your friends about the podcast.
Dr. Jim Dahle:
I really do appreciate those of you who spread the word, whether it's about the podcast or whether it's just about WCI in general. This is a big deal. It really is how we've grown over the years and how we've helped so many doctors. It's because one doc tells another about it.
Dr. Jim Dahle:
I got this in my email box the other day, just as part of a question that I was being asked. It said, “On an unrelated note, I told a second-year family medicine resident about the WCI, and she'd never heard of it before. And she left, she hugged me and was so thankful.”
Dr. Jim Dahle:
And you don't realize how just sharing a little bit of information can really change people's lives. So be willing to do that. It really is a huge benefit to those who have never heard any of this financial literacy stuff. It's like that first good financial book you read. How much was that really worth you over the course of your career? Maybe a couple of million dollars and just texting somebody a URL of the WCI could have that same effect on somebody. So, thank you for those of you who are doing that.
Dr. Jim Dahle:
But anyway, back to this review we got. This is from dhowell_realtor who said, “Great for a physicians spouse. Fantastic program. I’ve been listening for a year now. My wife is in her residency and seeing how hard she works I want to be able to take things off her plate so securing our financial plan has become my side job and I cannot say enough good things about this resource. Dr. Dahle has responded to my questions and I have reached out to the resources he has provided with good from all. Keep up the great work!” Thanks for that great review.
Dr. Jim Dahle:
I appreciate those five-star reviews. They do help spread the word about the podcast. We're ranked number 37th among investing podcasts in the world, which is pretty good for a little niche podcast that's mainly just aimed to high-income professionals. So, we thank you for that.
Dr. Jim Dahle:
We thank you for listening. We know you don't have to, but hope you're having a good day. If you're not, thanks anyway for what you're doing. Sometimes you do have a thankless job, and so, I thank you if nobody else does.
Dr. Jim Dahle:
Keep your head up and shoulders back. You've got this and we can help. We'll see you next time on the White Coat Investor podcast.
Disclaimer:
The hosts of the White Coat Investor podcast are not licensed accountants, attorneys, or financial advisors. This podcast is for your entertainment and information only. It should not be considered professional or personalized financial advice. You should consult the appropriate professional for specific advice relating to your situation.
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