Can You Stump the Chump, aka Jim? Plus, a Day in My Life as I Answer Questions | White Coat Investor – The Global Tofay

Can You Stump the Chump, aka Jim? Plus, a Day in My Life as I Answer Questions | White Coat Investor - The Global Tofay Global Today

By Dr. Jim Dahle, WCI Founder

Today, we’re going to go back to my email box for a discussion of a potpourri of financial topics, but let’s do this one as a “day in the life” type piece from a Monday morning in February 2023.

Can You Stump the Chump, aka Jim? Plus, a Day in My Life as I Answer Questions | White Coat Investor - The Global Tofay Global Today

5:30am: Katie rolls out of bed to go work out with a friend. I roll over and go back to sleep.

6:40am: I wake up to my alarm (love it when that happens!) and head downstairs. Katie and I read a little scripture (John 2 today) with the teenagers and pray together before they head out the door to school.

7am: I head out the door for a run. It’s snowing heavily. Awesome! Katie has already shoveled the driveway and walks, but it is falling hard. I stop every half mile to do a set of 50 lunges. I stop in at the church building, because I found a text on my phone that a light was left on last night and I’m one of the few with keys to the building. It’s off now.

7:30am: Back home. Katie is clearing an inch off the driveway again with our fancy 4-foot snowpusher. I’m hungry and wolf down a bowl of Life cereal while looking at and responding to a few WCI blog comments that came in overnight. Then, I head to the garage to work out. Do my first set of pull-ups (only 13) wondering if that’s enough for someone who wants to make it up the face of Half Dome that summer with 20 pounds of aluminum, 20 pounds of rope, and two days’ worth of water on his back (spoiler alert: I did it).

Between sets, I answer WCI emails from readers.


529 vs. UGMA

“Thanks for all the updated information on the 529 changes. For those of us wanting to leave a solid foundation for our children, the new changes seem to make even more sense to flood the 529 with funds as now up to $35,000 can be later rolled into a Roth IRA. And as you’ve said, any unused funds could just be rolled into a grandchild’s name as a new beneficiary in the future. My question is what if we want to leave a trust-type fund that could be used ad lib. In this case, let’s assume a 23-year-old who is still in college and considered a dependent but wants to use a large chunk to take a year abroad or buy a car. One could create a Uniform Gift to Minors Account (UGMA) and fund it with a tax-advantaged mutual fund to avoid the Kiddie Tax along the way.

However, in the above situation, if the 23-year-old took out the funds at a time when they presumably have little income, the large accumulated capital gains would likely be subject to the Kiddie Tax at the parent’s potentially high marginal rate. What if one uses extra funds in the 529 for the same purpose? The child should then be able to draw out up to $44,000 at the current 12% bracket. The 10% 529 penalty for non-education expenses would apply, but this rate of around 22% would likely still be much lower than the Kiddie Tax at 32%-37%. Does it just make more sense than to keep putting large amounts into the 529 and not create a separate UGMA? I guess the caveat being that if the 23-year-old could just wait a couple of years until they had income, they could then avoid the Kiddie Tax and withdraw some of the UGMA while they were in a low or zero capital gains bracket.”

Whether the Kiddie Tax applies has nothing to do with their income but only with their maintenance. If they’re your dependent, it applies. If they’re not, it doesn’t. I don’t get much of a tax advantage for having dependent children, so as soon as I can justify them not being my dependent, great!

Remember, there is no such thing as a “tax-advantaged” mutual fund, only tax-advantaged accounts. There are tax-efficient mutual funds, which I think is what you mean. Also, remember when the Kiddie Tax applies, it’s your tax bracket, not some other new set of tax brackets. Your tax brackets for money coming out of a UGMA are mostly the qualified dividend and long-term capital gains tax brackets, i.e. no more than 23.8% federal, not the 32%-37% you were thinking. That 23.8% really is about the same as 22%.

Time for another set of pull-ups. Only got 10 this time.


A Wealthy Physician Trying to Do Roth Conversions Right

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“I am a long-term listener and follower of the WCI blog and podcast. I have a desire to convert some or all of my traditional IRAs to Roth IRAs. I hope you can help. I am a physician in the Midwest in my middle 60s with a current income of $600,000. I am looking to retire in the next 18 months. My net worth is $12 million, primarily in taxable brokerage accounts at Vanguard. I have $3.5 million in rollover IRAs at Vanguard from previous retirement plans. I also max out contributions to my current 403(b) and non-governmental 457(b). In addition, I have $400,000 in a non-deductible IRA, which is in a stock mutual fund. My spouse has $200,000 in a non-deductible (spousal) IRA, which is also in a stock mutual fund.

My question is should I attempt to do a Roth conversion now or wait until after retirement when my tax rate will be lower? I had targeted the money in the non-deductible IRAs to convert now and wait until after retirement to tackle the rollover IRA funds. Am I correct that I would only owe taxes on the gains in the non-deductible IRAs? How would my rollover IRA money affect the taxes I owe on the Roth conversion of my non-deductible IRAs (pro-rata rule)? I value your opinion and would love to hear how you would tackle this ‘problem.’”

Follow these steps:

  • Step #1: Determine how much of the pre-tax money in your rollover IRA you want to convert THIS year.
  • Step #2: Roll the rest of the pre-tax money in the rollover IRA into your 403(b).
  • Step #3: Convert your entire non-deductible IRA to a Roth IRA, paying tax on any earnings
  • Step #4: Convert whatever portion of that pre-tax IRA you want to do this year to a Roth IRA, paying tax on all of it.
  • Step #5: Convert your spouse’s entire non-deductible IRA to a Roth IRA, paying tax on any earnings.
  • Step #6: Next year and every year after and perhaps even after you retire, carefully consider doing additional Roth conversions each year until at least age 70 when you start taking Social Security.

What you should not do:

  • Do a Roth conversion on the non-deductible IRAs without rolling that rollover IRA into your 403(b). This will result in a pro-rated conversion, and you don’t want that.

Time for another set. Only eight pull-ups this time.


Pay Off Debt or Invest

“Let me start by saying I’m pretty debt-averse. I paid off my student loans and dental practice loan before I started investing in a taxable account. I currently max out my and my spouse’s 401(k) and Backdoor Roth. We also now contribute to a taxable account which is earmarked for retirement. Hopefully retirement by 55. I am currently in my early 40s.

Here is the scenario and question. I refinanced to a 10-year mortgage about 18 months ago. I have 8.5 years left (it will be paid off five years before retirement). It’s at 2.0% flat. It’s my only debt. I will have enough in my taxable account in about six months to pay off my mortgage. Part of me wants to do it, because I am debt-averse, and being totally debt-free is an awesome accomplishment. However, there is also math. And I’m not so debt-averse that I don’t care about math. The likelihood of my taxable account beating 2.0% over the next 8.5 years is pretty high. Not guaranteed, but high.

I know you’re not my financial advisor. But if we were colleagues in the doctors lounge, what would you recommend? Is it stupid to pay it off (yes, assume my entire mortgage payment would then get invested in my taxable account each month)? There’s a good chance I’d miss out on a lot of gains. Also, my taxable account is only two years old. Does my decision matter if at that time (in six months) I have overall capital gains vs. losses vs. basically even? If so, how would it affect the decision?”

Haha. This dilemma doesn’t go away until you’re debt-free. EVERYBODY struggles with something similar to this. We had a 2.75% mortgage. We decided we’d invest instead of paying it off. Two years later, we just paid it off because we were sick of it and we were making more money. We didn’t liquidate the taxable account to do it; we just did it out of cash flow. If you do liquidate the taxable account, you’ll have to pay taxes on any capital gains there. Obviously, you only want to pay long-term gains, if any at all. Good luck with your decision. It’s not binary either. You can split the difference and do some of each. Some things to think about can be found in this post on paying off debt or investing.

Next set of pull-ups was only good for six of them.


Staying the Course

stump the chump

“I was looking at your parents’ portfolio yesterday, because I have to decide what to do with my own parents’ bond portfolio. I decided to split them into 50% intermediate Vanguard bond fund and 50% intermediate Vanguard TIPS fund, similar to your own. My email is just to inquire as to if your parents’ bond portfolio is still the same as on the 150 portfolios article.”

No changes. Sometimes I wonder if I should invest it more aggressively since they’re not spending any of it. We take RMDs and just reinvest them in taxable.

Time to start into the shoulder workout. Doing some internal/external rotations with big rubber bands and some dumbbell shoulder flys.


SEP-IRA and Solo 401(k) Maximum Contributions

“I recently began doing a part-time side gig on a 1099. For my main job, I am a partner in a group with a 401(k) that we max out each year. When I read through the solo 401(k) vs. SEP-IRA blog post, I am not sure that my specific situation is covered. Can I place up to 20% of my profits from the side gig into a solo 401(k) or SEP even though my my primary 401(k) will have the maximum contribution each year? If so, which type of account would allow me to maximize my contribution? For background, I am mid-40s and married. My spouse does not work outside of the home. We currently do Backdoor Roth accounts for each of us, in addition to the 401(k) and an HSA. The group recently dissolved a cash balance plan.”

Yes, you can contribute 20% of net profits into either a solo 401(k) or a SEP-IRA in addition to your main 401(k). In your unique case, the contribution will be precisely the same to either account and no more than $69,000 for 2024. However, if you do the SEP-IRA instead of the solo 401(k), you can’t do a Backdoor Roth IRA each year without getting pro-rated. Unless you use the new Roth SEP that was created as part of the Secure Act 2.0 or you convert your SEP to Roth every year. More info in these links:

OK, time for another set of shoulder exercises.


529 Withdrawals When Pre-Paying Tuition

“I have a question about distributions from a traditional 529 savings plan (NOT a prepaid 529 plan). After enrollment into the university, we had the option of prepayment of 3.5 years of tuition for $220,000. We signed a contract with the university and took a complete distribution from the 529 plan for $152,000 in September 2022. We received the 1098-T form in January 2023 that reflects only one year of tuition fee at $62,000. We are out of the 60-day window to perform any rollover of excess distribution. The 1099-Q form states the earning was $23,000. Our cost basis is $129,000. Based on IRS Pub 970, the “excess” contribution is taxed as follows: earning * (adjusted qualified education expense/ distribution). Assuming a tax rate of 37% + a 10% penalty (not sure if NITT is applied), that would calculate to 23 * (62/152) = $9,400. Total tax $9,400 * 0.47 = $4,400.

Can You Stump the Chump, aka Jim? Plus, a Day in My Life as I Answer Questions | White Coat Investor - The Global Tofay Global Today

The university will not provide a 1098-T for $220,000 for tax year 2022. They will give us an annual 1098-T that aggregates to the total prepayment. They recommended using the signed prepayment contract as the document that proves payment toward qualified education expenses. My question is: will this serve as proof of payment? Is it similar to if you bought a laptop and used the receipt to prove a qualified expense? I also figured out (after the fact) that I should have requested a 1099-Q distribution to the student who is in a lower tax bracket as opposed to myself. Although I am happy that we locked in the tuition/fee with the prepayment, it seems that I may be penalized by the IRS. Any comment would be welcome and thank you for all that you do, Dr. Dahle. You have elevated my financial literacy significantly.”

Congratulations! You have stumped the chump. This is the first time I have ever been asked this question, and I don’t know the answer. However, I think the fairest thing is to be able to pull that money out of the 529 without penalty so I think that’s what I would do. If/when you get audited on this point, I would produce the contract. In fact, I might even include it in my tax return as additional documentation. Typically it’s fine to have the money and a 1099-Q sent to you. That’s what I do. And you are the owner of the account anyway, so I don’t think just having it sent to the kid would change anything unless you made the kid the 529 owner.

Searching the internet, I found this relevant article, which said:

“Some private colleges allow students to prepay for upcoming academic terms, at a fixed or discounted price. Families may take a qualified 529 plan distribution to pay for a prepayment plan of a qualified school. If a student is prepaying college tuition, the form 1098-T that they receive from the college should include the total amount of tuition costs being paid upfront. The family should confirm with the college that this will occur.”

I suggest you keep pushing on the college. But if they won’t give you a 1098-T for $220,000, I would still claim it on my taxes, and my argument to the IRS would be that the college did their paperwork wrong, not you. I think it’s a strong argument, but I cannot promise you it will work. It might help to have your accountant call the college accountant and explain why they’re doing it wrong.


8:57am: Now, I’m moving into shoulder presses and single-arm bent-over dumbbell rows. But wait, what’s this message from our producer Megan Scott sending me podcast recording notes? What does my schedule show? Oh no, I have a podcast interview at 9am. Rush upstairs, change my shirt, and sit down in front of the camera. Luckily Megan has everything ready to go. Lights on, mic working, camera good, and teleprompter set up. Lights, camera, action!

9am: Interview with Michael Episcope of Origin Investments to insert into Podcast #307. We laugh for a while about his recent ski trip and how bad ski traffic in front of my neighborhood is right now. He gives me the snow report—13 inches of fresh powder just eight miles away. Why we’re sitting here doing a podcast interview instead of skiing is beyond me, but we do it anyway.

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9:39am: Might as well record the rest of podcast #307 since Megan is here. It’s mostly real estate questions off the Speak Pipe so this will go well with Michael’s interview.

10:17am: Rush back down to finish my workout. Four more sets of shoulder presses and three more of bent-over rows. Katie comes down to remind me to get on the WCICON24 planning meeting Zoom call.

10:30am: Six of us spend an hour and a half trying to decide whether to give up some of the space we have reserved for the next WCICON to save money (the answer was no), whether to stick with three tracks or cut back to two tracks (we went with two), whether to continue to offer a virtual option, and how to price the conference (about the same as before). Eventually, we figured out how to provide an awesome experience that will still be in the black even if it doesn’t sell out.

12:10pm: Slack discussion with Brett (COO) and James (CTO) about email unsubscribes and how we can keep our subscribers happy, balancing free content with our need to actually be a profitable business. We decide to dig hard into the numbers, take a look at the emails we’ve been sent, and consider changes to our email practices and subscription options.

12:30pm: I write this blog post.

2:39pm: Off to eat some lunch! Hopefully the second half of the day is just as fun as the first half.

What do you think? Did I get the answers right? How would you have answered these emails? Why can’t I lay off the cookies so I can do more pull-ups? Comment below!

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