Today we are talking all about 401(k)s. We answer your questions about IRA rollovers, the Mega Backdoor Roth, when to tax-shelter inside your 401(k), and how to manage a 401(k) with your side hustle income. We finally dispel the myth of the 401(c)(u) after receiving a lot of questions about what it is. We talk with Joe Ollis who shares some great information about the Peak Housing REIT. The Peak Housing REIT offers a great point of entry for single family homes with a fairly low minimum investment. Joe talks about the movement from industrial and multi-family units to single family homes and why this is the time to invest.
IRA Rollovers
“Good morning, Dr. Dahle. I have a question I hope you can answer. I sold my practice serendipitously just before the pandemic lockdown and transferred my 401(k) and cash balance money into my traditional IRA. My new employer does not offer me a 401(k) option for this year, and I prefer to self-direct anyway. I would like to get that retirement money back into a 401(k) for possible enhanced asset protection—I live in Pennsylvania—as well as avoidance of UBIT and leveraged debt funds. I'm the manager of an LLC through which I invest in commercial equity real estate deals. Could I open a solo 401(k) for myself in the name of that LLC and roll my IRA money into it? Thanks for all that you do.”
When you leave an employer, you probably don't want to roll your money into an IRA. Laws could change at any time and maybe this won't be so bad for doctors to do later, but for the most part, you don't want to do that. The reason why is because it keeps you from being able to do the Backdoor Roth IRA process each year. When you have money sitting in a traditional IRA, it messes up that process in that the conversion step becomes prorated, and you don't want that to happen. As a general rule, if you're leaving a company, they'll tell you, you can roll over your money into an IRA. A lot of people giving money advice that is not doctor specific will tell you to go ahead and do that. That's not necessarily great advice for doctors—not only for potential asset protection concerns, but also just because it messes up your Backdoor Roth IRA. What should you do instead? Usually leave the money in the 401(k) until you have another one available to you, whether it's at a new job, whether it's a solo 401(k) or whatever else.
In this case, the doc is hoping to get a few other advantages out of it. He didn't even mention the Backdoor Roth IRA. Maybe he doesn't care. Maybe he's got another IRA out there that's going to keep him from doing a Backdoor Roth IRA. Maybe he doesn't know about the Backdoor Roth IRA. I don't know, but that was the first thing I thought about when I heard of the IRA rollover issue.
Let's first talk about this asset protection that he thinks he's going to get in Pennsylvania from having his money in a solo 401(k) instead of an IRA. That's pretty much bunk. If you look up Pennsylvania asset protection law, what you will find is that IRAs are basically 100% protected by the state except for amounts contributed in the previous year or more than $15,000 contributed in a single year. That's issue No. 1. The IRA shouldn't be an issue. If you're just looking for asset protection, the IRA does just fine in Pennsylvania. Issue 2, keep in mind that solo 401(k)s are not necessarily put in the same category as an employer-provided 401(k) as far as IRA accounts and as far as your asset protection goes.
A regular real 401(k) enjoys 100% federal asset protection. That's not always the case for a solo 401(k). You may get a little bit less. It may be the equivalent of the IRA protection in your state. What having your money in a 401(k) does do, particularly a self-directed 401(k) that you want to invest in real estate, is it allows you to avoid UBIT. Which is basically a tax that applies in IRAs, but it does not apply in 401(k)s. That's why, if you can put the asset in a 401(k), then you can save that tax. UBIT—Unrelated Business Income Tax is what it stands for. Basically, if you have leveraged equity real estate in an IRA, you may end up paying this tax. If it's in a 401(k), you don't pay it. It's basically an avoidable tax, and that's why he's interested in getting the money into a 401(k). That makes sense for his purposes.
Personally, I think it's worthwhile just having your debt real estate inside retirement accounts and putting equity real estate just in a regular taxable account. A lot of that income is generally sheltered by depreciation. Set up properly, a lot of times you get many years of basically untaxed income from that property. You can depreciate, depreciate, exchange, depreciate, depreciate, exchange, depreciate, depreciate, and die, and your heirs get a step up in basis. And nobody ever pays that depreciation back, much less any capital gains. I’m generally not a huge fan of putting equity real estate into IRAs or 401(k)s. If it's the only money you have, then it can make sense. And obviously, there are the IRA and 401(k) tax benefits of having it in there. But if you're going to have stocks and bonds in your portfolio anyway and you have a taxable account anyway, then it can make a lot of sense to just have the equity real estate be outside the 401(k)s.
Here's the bigger issue, though. Remember, a 401(k) is a retirement plan. You can only put earned income into a retirement plan. You cannot start an LLC and invest it in a bunch of stocks or in a bunch of real estate and call that earned income. It's not earned income. It's rental income. It is portfolio income. It is unearned income. It is not earned income. That's why you don't have to pay Social Security and Medicare tax on it. That's also why you can't use it to contribute to a solo 401(k). Now, you don't have to have much of a company to open a solo 401(k) from it. If you're taking surveys, that's probably enough. Some people argue about this, that you have to have regular income and have plans to make a profit and to be in business long term in order to do this. But practically speaking, nobody is looking at how long you're in business. There's no requirement of how much income you have to earn in order to be a business and in order to open a solo 401(k) for that business.
If you don't make much in your business, you're not going to be able to contribute much to the solo 401(k), but that's not the purpose here. The purpose here is to facilitate an IRA rollover. Even if you can't contribute anything new to it, you still have the ability to roll hundreds of thousands of dollars into it from your IRA and then be able to invest that in equity real estate and not have to pay UBIT tax. That's your bigger issue. With this LLC, if all it's doing is investing in commercial real estate and it isn't providing you any earned income—unless you're somehow doing something more where it's actually an earned income kind of situation—maybe you can justify it if you're doing short-term rentals in it, for example. But just classic real estate investing, whether you're doing syndications and funds or whether you're investing directly, that's not earned income. That's good because it saves you the payroll taxes. It's bad because it doesn't allow you to contribute to a 401(k). I hope that's helpful. Good luck with figuring out where you want to go with this moving forward.
More Information Here:
How to Do a Backdoor Roth IRA [Ultimate Guide & Tutorial]
17 Ways to Screw Up a Backdoor Roth IRA
Is a 401(c)(u) a Real Thing?
“What is the difference between a 401(k) and a 401(c)(u)? And is a 401(c)(u) bad?”
This one's a little bit of a tricky question. I actually get questions like this all the time. A 401(c)(u) is nothing that I know of. Google returns nothing for that search string that has any meaningful anything. 401(c) is a section of the internal revenue code. Not to be confused with 501(c)(3)s, which are non-profits. But 401(c) just refers to a qualified pension or profit-sharing or stock bonus plan. That's the section of the internal revenue code. But a 401(c)(u) is not any type of a retirement plan that I know of. Keep in mind that lots of different companies call plans by different names. The commonly used names—which are often these numbers 401, 403, 457—is not necessarily what they call your plan. That is one of those things. Maybe you're confused; maybe they're calling your plan by something weird. But you just have to go in there, talk to HR, get the plan document, figure out what kind of plan this is. But a lot of times for a doc, it's some sort of 401(k) combined with a profit-sharing plan, that sort of a thing.
You just have to go in and get the plan document and figure out what these options are that are available to you from your employer and really understand what you can do with it, how much you can contribute to it, what the methods are that you can use to get the money out, what you can invest it in, how much control you have over it, what kind of a match they're going to put in on it. But I think you're going to find all the information you're looking for in that plan document.
Tax Sheltering in a Solo 401(k)
“I wanted to ask a question for your podcast or blog about setting up a specific solo 401(k). My wife and I started our first short-term rental that is titled in a Wyoming LLC for asset protection. We also did a cost segregation analysis, and we'll take 100% bonus depreciation for 2021. We will have a large tax write-off this year. In the next years, we would like to put the money we get from the short-term rentals into a solo 401(k) as a tax shelter. Is that something we can do? And if so, what do I need to do to set one up? Are there specific brokerage accounts—E-Trade, Fidelity, etc.—that allow this? We anticipate getting between $50,000-$80,000. So, it would be nice if we could find a way to tax shelter. My wife works part-time for a place that does not offer her 401(k), so we would like to put as much of the profit into that account as we can.”
Keep in mind that if your wife's business does not offer a 401(k), a traditional IRA is actually deductible to her, and that would be an option if she doesn't just want to do what we usually do in the White Coat Investor world, which is a Backdoor Roth IRA. But if that goes away for some reason, that is an option for her to have a traditional IRA. Anyway, the point here is most of the time rental income is not eligible to go into a retirement account of any kind. It's not earned income. You don't pay Social Security tax or Medicare tax on it and you can't use it for retirement account contributions. However, when you are running a short-term rental, it's not exactly the same thing. You're really in the hotel business and it's far more active income, because you're having to do all these things. Certainly, at least a portion of that money should be considered earned income.
That, of course, has pluses and minuses. The minus is you pay payroll taxes on it, especially if you haven't already maxed out your social security tax, and that is not an insignificant amount of tax. The plus, of course, is you can use it to make retirement account contributions. You can open up a solo 401(k) just about anywhere. You can go to Vanguard, Fidelity, E-Trade, etc. That's no big deal. You fill out 10 or 15 pages of paperwork. You send it back to them, and within a few weeks they've opened a solo 401(k) for you. Don't wait until December to do this because you need to establish it during the calendar year. You don't get all kinds of time after the end of the year like you do with an IRA or a SEP IRA, but it's pretty easy to do. It just takes a few weeks.
The real question that you have to determine, though, is whether that money is earned income or not. For a long-term rental, it definitely isn't. For a short-term rental, it's much easier to justify, especially if you're doing the booking, managing, cleaning, etc., yourself. I found a nice blog post from markjkohler.com that talks about the taxability of these sorts of short-term vacation rentals. He says if you either don't stay on the property at all or rent it out at market rates for more than 14 days in a year, then the income from your short-term rental is undoubtedly taxable. Remember, you can rent something out that you own for 14 days a year and you don't have to pay tax on it at all. That's a really great deal. For example, we rent our house to the White Coat Investor for 14 days a year. That actually works out way better for us than the home office deduction does. Keep that in mind, if it's kind of a vacation property, you just rent out a little bit.
It really comes down to whether it is passive rental income, which gets reported on Schedule E, or active business income, which is reported on Schedule C. And the answer to that depends on whether you provide substantial services to your guests, not just a nice place to stay. When you're providing substantial services to them, then the income you make needs to be reported on a Schedule C and is subject to self-employment taxes. Examples of services that would be considered substantial are cleaning the rental each day while the property is occupied by the same guest. Changing bed sheets and other linens each day, while the property is occupied by the same guest. Concierge services, conducting guest tours and outings, and providing meals and entertainment like a bed-and-breakfast. If you're providing breakfast every morning, it's an active income. The more you look like a hotel or a true bed-and-breakfast, the better the chance that you'll need to report your income from the rental on a Schedule C and pay self-employment taxes on it. You can contribute to a retirement account for it.
If you're not doing any of that other stuff, if it doesn't look like a hotel what you're doing—even if it's short term—maybe it still goes on Schedule E. It's not earned income. You don't pay payroll taxes and you can't use that money to contribute to a 401(k). There's pluses and minuses either way in the situation for most people, even if they're doing the cleaning after the guests move out, even if they're doing the booking, maybe that's not quite enough to be substantial services and you put it on Schedule E and you don't get the 401(k) for it. I don't know that the IRS cares all that much. They get money either way. You get a benefit either way, whether you're skipping out on those payroll taxes, or whether you're getting the benefit of being able to use a 401(k). Maybe it's sixes when you put it all together.
More Information Here:
Your Guide to Short-Term Rentals
401(k)s and Side Hustles
“Hello, Jim. This is John. I have some questions on side hustles and solo 401(k)s. No. 1, at what income for a side hustle does one need to pay quarterly taxes? I've looked everywhere and cannot find a good answer. No. 2, assuming that I'm maxing out the employee contribution of my 401(k) through my W2 employer, how much can I put into my solo 401(k) under the employer contribution? No. 3, when would you recommend making these employer solo 401(k) contributions? Should I do them quarterly, at the end of the year, or at some other time? No. 4, finally, how do I even make these solo 401(k) contributions? Is it a simple business account transfer to my solo 401(k)? Or are there some special forms that I need to fill out? Thanks for all you do.”
Let's take these questions one at a time. The first one is what income do you need to do quarterly estimated tax payments. The reason you can't find an answer is there is no answer. Basically, it comes down to being in the safe harbor. You have to pay enough tax during the year that you're in the safe harbor or else you'll end up having to pay not just any taxes you owe at the end of the year but penalties and potentially interest. You have to get into what's called the safe harbor.
Now, for the safe harbor, there's several different variations of it. One way you can get into it is by owing less than $1,000. If you owe less than $1,000 in tax in April, you're in the safe harbor, you don't have to pay. No. 2, you've got to pay at least 110% of what you paid last year. That's another way to be in the safe harbor. It's only 100% for low earners. For most docs who listen to this podcast, it's 110%. You take what your tax due last year was. You multiply it by 110%. You divide it by four, and there is your quarterly estimated payments. But that assumes that you don't have any sort of a W2 job withholding money. The truth is at the end of the year, you add this together, what you're having withheld, and what you send in as quarterly estimated payments.
You might be able, if you're not making that much at the side hustle, to just turn your exemptions that you report on your W4. Is that what they're called these days? Whatever they're called right now, you turn them down to zero. So, they're withholding as much as possible from your W2 pay checks. Then you might be able to get enough withheld that you don't have to do quarterly estimated payments at all. Then you're in the safe harbor for all your income just from withholdings from your W2 job. That's a pretty easy way to do it if it's a relatively minor side gig. If it's a big side gig, that's not going to work out. You're going to have to make estimated quarterly payments. The fun thing about this is the IRS doesn't look at when money is withheld from paychecks. If you have it all withheld in December, that's just like you had it withheld throughout the entire rest of the year.
That is not the case, however, with quarterly estimated payments. They like to see you making even quarterly payments throughout the year. That's probably the easiest way to do it, but it does cause some cash flow issues for lots of people—especially if the business is not earning evenly throughout the year, like White Coat Investor income. It ebbs and flows throughout the year. Sometimes, we have lots of income in one month. Other months, we might not have a lot of income. There's a way you can pay as you go. That's basically the federal income tax system. If you don't make much money in the first quarter, you don't pay much in the first quarter. If you make more in the second quarter, you pay more in the second quarter. There's a form you submit with your taxes that basically shows that, but it's easier not to do that and just pay the same amount each quarter, if you can possibly estimate that enough to be in the safe harbor.
It's a tricky thing. Those of us who are self-employed, we're constantly monkeying with this, constantly trying to figure out what the right amount is. Even this year, I haven't even done my taxes for 2021 yet, and I'm having to make quarterly estimated payments for 2022. I can't even calculate what my quarterly estimated payments have to be to be in the safe harbor. Remember all of that has nothing to do with how much tax you may owe. You may have to write a check for half a million dollars in taxes at the end of the year, if your business did really well. Even though you're in a safe harbor, you still have to write this huge check. You want to make sure you have the money available to write the check for what you actually owe on your taxes. There is not an income, but basically, if it's a sizable side gig—I'd say more than about 10% of what you're making at your regular job—I'd probably plan on paying quarterly estimated payments. They give you a little bit of a break the first year, but after that, they're not very merciful on these at all. So, make sure you're paying them.
The next question is how much can go into a solo 401(k) as an employer contribution? If you've used your maximum employee contribution, which is $20,500 for those of us under 50 this year, then all you can put in is the employer contribution, which is essentially 20% of your net income. That's net of all your business expenses, including the employer half of your payroll taxes, like Social Security and Medicare tax. Twenty percent of that.
The third question is when do you make those contributions? You can make them whenever you want throughout the year. If you're not sure how much you're going to be able to put in there, then you might want to wait until about the time you're doing your taxes to at least do the last contribution, so you can adjust it as needed. You could put it in there on January 3. If you know you're going to be able to max it out, you could put it in there really early in the year. Again, it's supposed to be a kind of pay-as-you-go system, but the IRS is not watching if you want to max that thing out in January. I can tell you that from personal experience. Nobody sends you any letters or anything about whether you'd actually earned that much that year or not. You can put it in there anytime you want. But if you're not making a ton of money in the side gig, you want to be careful not to over contribute, which means your last contribution probably doesn't go until pretty late in the year or maybe even into the next year before you file your taxes. Remember with the employer contribution, you get a little more time to get it in there.
And finally, how do you make them? Well, it depends on the solo 401(k). At Vanguard, they have a separate Vanguard site for the employers. You log in, you go in there and you mark, “This is an employee contribution. This is an employer contribution. It's for 2021, it's for 2022,” or whatever you are doing. Then the money gets sent in there from your bank account. It shows up in the solo 401(k), which you see not on that site, not on the employer’s site, but on the regular Vanguard site when you log in. But it's probably a little bit different at Fidelity and probably a little different at Schwab or wherever you open your solo 401(k).
More Information Here:
Forgot to File Quarterly Estimated Taxes? The IRS May Have Mercy on You
After-Tax 401(k) Contributions
“Hi. Thanks for all you do and keeping us up to date on the Mega Backdoor Roth. If the Mega Backdoor Roth does go away eventually, which seems likely, do you think there's going to be any benefit at all to the after-tax 401(k) contributions? For example, since there's no early withdrawal penalty, it doesn't seem like the worst emergency fund, particularly for someone who might be undisciplined and/or may not be in the absolute highest tax bracket. Thanks.”
You're right that if you withdraw the after-tax contributions that there is no tax or penalty due on that, but all the earnings that contribution may gain are subject to the 10% penalty for early withdrawals as well as any taxes. Keep that in mind. Would it work for an emergency fund? Well, I guess if you left it in cash or something not aggressive. But with an emergency fund, it's more about the return of your principle than the return on your principle. I suppose that would be one use for it. It also likely provides significant asset protection being inside a 401(k). That's another benefit of it.
But really what we're talking about here is if, heaven forbid, the ability to convert those after-tax contributions went away, which I don't know if that's likely or not. That tax bill doesn't seem like it's going anywhere right now as I record this in March. But if that goes away, that's obviously the best use of after-tax contributions to immediately convert them to a Roth. Even if it goes away, there are other things that can happen. You can leave the employer, for instance, isolate the basis and convert it to a Roth IRA yourself if that's still permitted. Maybe the law changes back in a few years, and you can do conversions at that point. If you are talking about truthfully long-term investing in an after-tax 401(k), it's just like non-deductible IRA contributions. Over a certain period of time, decades, the tax-protected growth becomes worth more than the fact that the withdrawals are subject to ordinary income tax rates rather than capital gains rates.
You can be better off investing after-tax money in a 401(k) or IRA than in a taxable account, especially if it's not a very tax-efficient investment, but over time, the tax-protected growth can make up for the additional tax at withdrawal time. It is possible. This could still be part of your plan. But the best option, of course, is just to do a Mega Backdoor Roth IRA with it for as long as that is permitted.
More Information Here:
Understanding the Mega Backdoor Roth IRA
What to Do If You Overcontribute to Your 401(k)
“I'd like to contribute the maximum employer/profit sharing contribution to my solo 401(k) for 2021. I do my taxes in TurboTax, and I've calculated what our max contribution is going to be. I'd like to get this money into the market now, but I haven't submitted my taxes yet because my state won't start accepting returns for another couple of weeks. What would happen if, after submitting my taxes, they get returned and I end up having made a mistake that results in me having overcontributed to my solo 401(k)? Can I recharacterize some of the 2021 contributions to 2022 contributions? Or should I just wait to contribute until my tax return is submitted and accepted? What if I find out I screwed up my taxes and end up overcontributing for 2021? Can some portion of 2021 contributions be recharacterized as 2022 contributions?”
8606 Form
“Hi. I converted my traditional 401(k) to a traditional IRA. And then from a traditional IRA within a few days, maybe 8-10 days, I converted it into Roth. Do I have to fill out a 8606 because I did not convert the traditional 401(k) directly to Roth, but it went through my traditional IRA? Thank you.”
If you're ever wondering if you have to file a tax form, go to the instructions for that form. Usually on the first or second page of those instructions, you will find a section the IRS puts together called “Who must file.” In the case of form 8606, it says this, “File form 8606 if any of the following apply.” The first one is, “You made non-deductible contributions to a traditional IRA.” That's not you. “You received distributions from a traditional SEP or SIMPLE IRA in 2021 and your basis in these IRAs is more than zero.” That's not you either. “You or your spouse transferred all or part of your traditional SEP or SIMPLE IRA to the other spouse under a divorce agreement.” That's not you. “You converted an amount from a traditional, SEP, or SIMPLE IRA to a Roth IRA in 2021.” That's you. That means you have to file. If you'd gone directly from the 401(k), I don't think you would've had to. By taking that step, by going into the traditional IRA and then converting, you're going to have to fill out this form as part of your tax return.
Peak Housing REIT with Joe Ollis
I want to welcome a special guest back to the White Coat Investor podcast, Joe Ollis. He is the chief investment officer for one of our real estate investing partners, the Peak Housing REIT. We should warn people that we are recording this on February 2. This isn’t going to be live on the podcast for a few weeks. If any of the data seems a little bit stale because something crazy happened in the markets in the last six weeks, then that's why, because we recorded this at the very beginning of February. It's been a pretty crazy year so far in the markets. In the last three months, cryptocurrency is down 50%, stocks were down over 10% at one point year-to-date during January. It has a lot of people thinking, “Wow, do I have to deal with that sort of volatility? What other kinds of investments are out there that provide solid returns that don't make me so queasy?” A lot of them turn to real estate. They turn to single-family homes, which is what the Peak Housing REIT specializes in. We were talking before we went on air that there's some interesting data out of the fourth quarter of 2021 about single-family homes. Do you want to tell us a little bit more about that?
“I think one of the key aspects of investing in real estate is the stability it provides. Especially when investors start to think about the day-to-day volatility of the stock market, being able to look at your portfolio of real estate and knowing that those values are staying pretty constant helps out a lot. Single-family rental homes as an industry has continued to just completely take off both from the aspect of the amount of institutional investors that are coming into it but also investors like white coat investors. That's really helped support the single-family values of these homes, but also really kind of created a great investment opportunity for investors to join us while it's still early in this game.”
It's interesting. I'm in the Salt Lake Valley. I think they just said we have the second fastest-growing housing prices in the country, right behind Boise or something. I think a lot of the price increase for single-family homes has been the housing crunch, particularly in places where people are moving like Idaho and Utah and Arizona and Texas and places like that. Because you're sharing this market, not just with investors, but you're sharing with people looking for a place to live, how much of that do you think impacts the rates of returns those investors in this space see?
“That's a really good question. You're right. I think the analysis that has come out from the last year is that about 17% of single-family homes were purchased by institutional investors for the purpose of being a rental home. It's still a pretty small percentage in the total scheme of things, but it is definitely starting to show that there's more competition. Because of the supply constraints, which have just continued in the last year, I think this is going to continue for quite a bit longer. When I think about supply constraints, if you really reflect back to the previous year, every time there was a supply shortage or a commodity price increase—like you think about lumber, just exploding higher for a period of time last May—that led to builders just slowing down production of new housing, which is further constraining supply. We're really not even feeling that yet, and that's just going to continue for multiple years.”
It makes the existing homes more valuable when it costs so much more to make a new home. I had a call with the insurance company that insures my home, and they wanted to go over everything again because the cost of replacing the home has gone up so much. We actually had to go through the whole insurance process again which I thought was pretty interesting. In places like Salt Lake, especially a little bit like the Bay Area, it becomes constrained by geography. But even in other places, it's constrained by supply. You're right. With everything sitting on ships off of the port of LA, it's a little bit harder to get the materials you need to build a home, and it makes the ones that are selling that much more valuable. A real tailwind, particularly in single-family rental homes.
A lot of real estate investments are industrial or retail or multifamily, which are especially popular among white coat investors. But single family is this great space that's been hard for people to get into. Why do you think it's been so hard up until the last few years for funds, REITs, and institutional investors to get into this space? What's changed that now they're all going for it?
“That's a really good question. I'd like to even back up further than that and really look at even multi-family apartment complexes clear back in the 1980s. Those were really primarily owned by what we call the smaller investor or even the mom-and-pop investor. That shift to where institutions, which are like the Blackstones and the Pensions of the world, now own 95%-plus of all apartment complexes. That shift took about 30 years. That shift just began in 2011 with a single-family rental market. Today, about 95% of all single-family rental homes are really owned by smaller investors. People who might own one to five homes. Institutions started to step into this because they realized a few things. One, tenants of single-family rental homes are really sticky. They want to be in the home. They're raising their family in these homes. They're choosing to be renters. They can't afford the neighborhood, but they really like the neighborhood. All very good reasons for them to be in these homes. That stickiness is a really attractive investment return for all investors, but then what really changed the equation for institutions and for this whole industry is the inclusion of a lot of technologies, making it easier to manage what we refer to as scattered-site homes.
If you think about a multifamily apartment complex, you can have 100 homes in just a single area. It's really easy to manage everything when it's just 100 homes under one roof. To manage 100 homes that are scattered throughout a city, it takes a lot more infrastructure. There's just been so much innovation in technology that allows for the economics of that management to come down in cost. The example I love to give is we use a door lock service called Rently. What that does is it allows us to essentially have remote access to locks. We never have to go and change a lock when a tenant leaves a door. That's a really powerful savings tool. But it's even better, because from a scattered-site portfolio perspective, if we need to send a plumber out to that house, we can actually arrange with the tenant, have the tenant talk with the plumber to arrange a time, and then we can remotely unlock the door without having to send a property manager out there. Just that one little savings is just a prime example of where we’ve seen a lot of innovation.”
It's never been a very efficient market, and technology and innovation can make a lot of new efficiencies there, for sure. It sounds to me like there's been a lot of interest among white coat investors for the Peak Housing REIT. What kind of interest are you guys seeing on your end?
“It has been a lot of interest. I'm a data guy. I'm just going to give you today's numbers. We have 62 investors from The White Coat Investor who, when they signed up and invested with us, they actually marked themselves as white coat investors. That's fantastic. That's nearly $3 million of investment. And we're really excited to embrace this network. The list of questions that come through from white coat investors really show the level of diligence and intelligence that your investors have. That means a lot to us. We look at this as a partnership with our investors, and we love it when people align both with the vision of what we're trying to do, the tailwinds of single-family rentals, and then, of course, to invest right alongside us. So, it's been a great, great, response.”
I think there's three things that particularly make the Peak Housing REIT attractive to our folks. The first is just the opportunity to do single-family homes. The vast majority of people we partnered with aren't in the single-family home space. The second, though, is the relatively low minimum investment. Now, $25,000 is still a lot of money, but it's dramatically less than the minimum investment with the number of funds out there. It gives people a chance. It's not quite “try before you buy,” but it's try for a little bit of money before you put a lot of money in. Doctors can afford that. That's a typical one-month salary amount for a doctor, and that allows them to see it and watch it and see how it goes. If they're like most investors, they end up investing more later over time. I think the minimum is pretty attractive.
The other thing that a lot of people have commented to me about is that they like the idea that it is a REIT, and they're just getting a 1099. That they're not going to get a K1 and have to file in eight states from it. Once somebody has a few private real estate investments and has to go hire somebody to do their taxes because they got twelve K1s in eight different states, all of a sudden the REIT tax structure becomes much more attractive, too.
“That is definitely true. As our investors will see, we are expanding our REIT into multiple different states in the next year. That will become even more important as a tax strategy, that 1099 is much more favorable.”
If you want to learn more information about the Peak group, about the Peak Housing REIT, the easiest way to do that is to go to whitecoatinvestor.com/peak. You’ll get all the information there about terms, etc, and sign up to invest if you find it attractive. But thanks so much, Joe, for coming on the podcast and for giving us a little bit of an update on the single-family home market.
I hope you enjoyed that interview. If you like learning about these private real estate opportunities, make sure you're signed up for our real estate newsletter. If you're not signed up for the White Coat Investor newsletter, make sure you're signed up for that. You can sign up for both of those at whitecoatinvestor.com/free-monthly-newsletter.
Sponsor
Studentloanadvice.com is a White Coat Investor company created to help doctors, dentists, and other high earners tackle and defeat their student debt. Letting a professional guide you through the best options to manage your loans will save you hours of research and stress and potentially save hundreds to thousands of dollars with your custom student loan plan. Book a consult with the student loan consultant at studentloanadvice.com today.
Quote of the Day
Henry David Thoreau said,
“Success usually comes to those who are too busy to be looking for it.”
I think there's a lot of truth to that. Most of the successful people I know aren't out there chasing success. They're out there trying to do something else with their lives and accomplish other goals, some other passion or vision that they may have.
Milestones to Millionaire
#58 – Physician Assistant Millionaire
Everyone’s pathway is a little bit different. Short term rentals were responsible for a huge portion of this guest’s success. They used a fair amount of leverage in a very opportune time in the real estate market to get there. Figure out what your pathway is going to be and make sure you balance your life, your need for income to build wealth, and everything you want to do with your life. Certainly a lot of physicians have found success with short term rentals.
Sponsor: Locumstory
Full Transcript
Intro:
This is the White Coat Investor podcast, where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high-income professionals stop doing dumb things with their money since 2011. Here's your host, Dr. Jim Dahle.
Dr. Jim Dahle:
This is White Coat Investor podcast number 255 – 401(k) questions.
Dr. Jim Dahle:
We're recording this on March 8th. It's going to run on March 24th. Welcome back to the podcast. It's been a really fun time here at the White Coat Investor. In the last few weeks, we've been wrapping up from our conference. The conference turned out spectacularly.
Dr. Jim Dahle:
If you haven't taken a look at that content that's available as an online course, be sure to check that out. And of course, it's awesome because it's not only got a ton of financial material, but it's got a bunch of wellness material too. And at the end of the pandemic, that's something all of us kind of need.
Dr. Jim Dahle:
If you haven't been feeling the stress in the last couple of years, consider yourself lucky. Every time I look at a survey, it seems like doctor burnout has gone up by 10% or even 20% over the course of the pandemic. If no one said, thanks, let me at least tell you, thanks for what you do.
Dr. Jim Dahle:
Let's have a word from our sponsor. Studentloanadvice.com is a White Coat Investor company created to help doctors, dentists and other high earners tackle and defeat their student debt.
Dr. Jim Dahle:
Letting a professional guide you through the best options to manage your loans will save you hours of research and stress, and potentially, save hundreds to thousands of dollars with your custom student loan plan. Book a consult with a student loan consultant at studentloanadvice.com today.
Dr. Jim Dahle:
Not only does that get your step reviewed, but you also get to spend an hour with a student loan consultant. And perhaps most importantly, you get six months of free email questions afterward, which is a great resource to have to continue to make sure you got your plan going the way it should.
Dr. Jim Dahle:
All right, we got lots of questions from you guys today. We're going to get on the Speak Pipe and listen to some of them. Here's our first one talking about the IRA rollovers.
Speaker:
Good morning, Dr. Dahle. I have a question I hope you can answer. I sold my practice serendipitously just before the pandemic lockdown and transferred my 401(k) and cash balance money into my traditional IRA.
Speaker:
My new employer does not offer me a 401(k) option for this year and I prefer to self-direct anyway. I would like to get that retirement money back into a 401(k) for possible enhanced asset protection. I live in Pennsylvania as well as avoidance of UBIT and leveraged debt funds.
Speaker:
I'm the manager of an LLC through which I invest in commercial equity real estate deals. Could I open a solo 401(k) for myself in the name of that LLC and roll my IRA money into it? Thanks for all that you do.
Dr. Jim Dahle:
Okay. There's a lot in this question that we need to cover. For example, when you leave an employer, you probably don't want to roll your money into an IRA. Now, laws could change at any time and maybe this won't be so bad for doctors to do later, but for the most part, you don't want to do that.
Dr. Jim Dahle:
And the reason why is because it keeps you from being able to do the backdoor Roth IRA process each year. When you have money sitting in a traditional IRA, it messes up that process in that the conversion step becomes prorated and you don't want that to happen.
Dr. Jim Dahle:
As a general rule, if you're leaving a company, they'll tell you, you can roll over your money into an IRA. And a lot of people giving money advice out there that is not doctor specific will tell you, “Go ahead and do that.” And that's not necessarily great advice for doctors, not only for potential asset protection concerns, but also just because it messes up your backdoor Roth IRA.
Dr. Jim Dahle:
What should you do instead? Usually leave the money in the 401(k) there until you have another one available to you, whether it's at a new job, whether it's a solo, 401(k), whatever. In general, try not to do that. If you're in this situation, you can avoid having this dilemma.
Dr. Jim Dahle:
In this case, the doc is hoping to get a few other advantages out of it. He didn't even mention the backdoor Roth IRA. Maybe he doesn't care. Maybe he's got another IRA out there that's going to keep him from doing a backdoor Roth IRA. Maybe he doesn't know about the backdoor Roth IRA. I don't know, but that was the first thing I thought about when I heard of the IRA rollover issue.
Dr. Jim Dahle:
Let's first talk about this asset protection that he thinks he's going to get in Pennsylvania from having his money in a solo 401(k) instead of an IRA. That's pretty much bunk. If you look up Pennsylvania asset protection law, what you will find is that IRAs are basically 100% protected by the state except for amounts contributed in the previous year or more than $15,000 contributed in a single year.
Dr. Jim Dahle:
That's issue number one, the IRA shouldn't be an issue. If you're just looking for asset protection, the IRA does just fine in Pennsylvania. Two, keep in mind that solo 401(k)s are not necessarily put in the same category as an employer-provided 401(k) as far as IRA accounts and as far as your asset protection goes.
Dr. Jim Dahle:
A regular real 401(k), enjoys 100% federal asset protection. That's not always the case for a solo 401(k). You may get a little bit less. It may be the equivalent of the IRA protection in your state. So, keep that in mind as well.
Dr. Jim Dahle:
What it does do, however, having your money in a 401(k), particularly a self-directed 401(k) that you want to invest in real estate is it allows you to avoid UBIT. Which is basically a tax that applies in IRAs, but it does not apply in 401(k)s. That's why, if you can put the asset in a 401(k), then you can save that tax. UBIT – Unrelated Business Income Tax is what it stands for.
Dr. Jim Dahle:
Basically, if you have leveraged equity real estate in an IRA, you may end up paying this tax. If it's in a 401(k), don't pay it. It's basically an avoidable tax and that's why he's interested in getting the money into a 401(k) and that makes sense for his purposes.
Dr. Jim Dahle:
Personally, I think it's worthwhile just having your debt real estate inside retirement accounts and putting equity real estate just in a regular taxable account. A lot of that in income is generally sheltered by depreciation. Set up properly a lot of times you get many years of basically untaxed income from that property. You can depreciate, depreciate exchange, depreciate, depreciate exchange, depreciate, depreciate, and die, and your heirs get a step up and basis. And nobody ever pays that depreciation back, much less any capital gains.
Dr. Jim Dahle:
And so, I’m generally not a huge fan of putting equity real estate into IRAs or 401(k)s. If it's the only money you have, then it can make sense. And obviously, there are the IRA and 401(k) tax benefits of having it in there. But if you're going to have stocks and bonds in your portfolio anyway, and you have a taxable account anyway, then it can make a lot of sense to just have the equity real estate be outside the 401(k)s.
Dr. Jim Dahle:
Here's the bigger issue though. In order to have a 401(k), remember this is a retirement plan. You can only put earned income into a retirement plan. You cannot start an LLC invest it in a bunch of stocks or in a bunch of real estate and call that earned income. It's not earned income. It's rental income. It's portfolio income, whatever you want to call it, unearned income, but it's not earned income. That's why you don't have to pay social security and Medicare tax on it. That's also why you can't use it to contribute to a solo 401(k).
Dr. Jim Dahle:
Now, you don't have to have much of a company to open a solo 401(k) from it. If you're taking surveys, that's probably enough. Now, some people argue about this, that you got to have regular income and have plans to make a profit and to be in business long term in order to do this. But practically speaking, nobody is looking at how long you're in business. There's no requirement of how much income you have to earn in order to be a business and in order to open a solo 401(k) for that business.
Dr. Jim Dahle:
Now, if you don't make much in your business, you're not going to be able to contribute much to the solo 401(k), but that's not the purpose here. The purpose here is to facilitate an IRA rollover. Even if you can't contribute anything new to it, you still have the ability to roll hundreds of thousands of dollars into it from your IRA, and then be able to invest that in equity real estate and not have to pay UBIT tax.
Dr. Jim Dahle:
That's your bigger issue. No, this LLC that all it's doing is investing in commercial real estate isn't providing you any earned income, unless you're somehow doing something more where it's actually an earned income kind of situation. Maybe you can justify it if you're doing short-term rentals in it, for example.
Dr. Jim Dahle:
But just classic real estate investing, whether you're doing syndications and funds or whether you're investing directly, that's not earned income. That's good because it saves you the payroll taxes. It's bad because it doesn't allow you to contribute to a 401(k). I hope that's helpful and good luck with figuring out where you want to go with this moving forward.
Dr. Jim Dahle:
All right, let's do our quote of the day. This is from Henry David Thoreau. “Success usually comes to those who are too busy to be looking for it.”
Dr. Jim Dahle:
I think there's a lot of truth to that. Most of the successful people I know aren't out there chasing success. They're out there trying to do something else with their lives and accomplish some of the other goals, some other passion or vision that they may have.
Dr. Jim Dahle:
All right. Let's take another question about a 401(k) off the Speak Pipe.
Speaker 2:
What is the difference between a 401(k) and a 401(c)(u)? And is a 401(c)(u) bad?
Dr. Jim Dahle:
All right. This one's a little bit of a tricky question. I actually get questions like this all the time. A 401(c)(u) is nothing that I know of. Google returns nothing for that search string that has any meaningful anything.
Dr. Jim Dahle:
401(c) is a section of the internal revenue code. Not to be confused with 501(c)(3)s, which are non-profits, but 401(c) just refers to a qualified pension or profit-sharing or stock bonus plan. And so, that's the section of the internal revenue code. But a 401(c)(u) is not out of any type of a retirement plan that I know of.
Dr. Jim Dahle:
Now, keep in mind that lots of different companies call plans by different names and the commonly used names, which are often these numbers 401, 403, 457 is not necessarily what they call your plan, that is one of those things. And so, maybe you're confused, maybe they're calling your plan by something weird, but you just got to go in there, talk to HR, get the plan document, figure out what kind of plan this is. But a lot of times for a doc it's some sort of 401(k) combined with a profit-sharing plan, that sort of a thing.
Dr. Jim Dahle:
And so, you just got to go in and get the plan document and figure out what these options are that are available to you from your employer and really understand what you can do with it, how much you can contribute to it, what the methods are that you can use to get the money out, what you can invest it in, how much control you have over it, what kind of a match they're going to put in on it. But I think you're going to find all the information you're looking for in that plan document. I hope that's helpful.
Dr. Jim Dahle:
All right. My next question comes in from an emailer. “I wanted to ask a question for your podcast or blog about setting up a specific solo 401(k). My wife and I started our first short-term rental that is titled in a Wyoming LLC for asset protection. We also did a cost segregation analysis and we'll take 100% bonus depreciation for 2021. We will have a large tax write-off this year.
Dr. Jim Dahle:
In the next years, we would like to put the money we get from the short-term rentals into a solo 401(k) as a tax shelter. Is that something we can do? And if so, what do I need to do to set one up? Are there specific brokerage accounts E-Trade, Fidelity, etc, that allow this? We anticipate getting between $50,000 to $80,000. So, it would be nice if we could find a way to tax shelter. My wife works part-time for a place that does not offer her 401(k) so we would like to put as much of the profit into that account as we can.”
Dr. Jim Dahle:
Keep in mind if your wife's business does not offer 401(k), a traditional IRA is actually deductible to her and that would be an option if she doesn't just want to do what we usually do in the White Coat Investor world, which is a backdoor Roth IRA. But if that goes away, for some reason, that is an option for her to have a traditional IRA.
Dr. Jim Dahle:
But anyway, the point here is most of the time rental income is not eligible to go into a retirement account of any kind. It's not earned income. You don't pay social security tax or Medicare or tax on it and you can't use it for retirement account contributions.
Dr. Jim Dahle:
However, when you are running a short-term rental, it's not exactly the same thing. You're really in the hotel business and it's far more active income. Because you're having to do all these things. And so, certainly, at least a portion of that money should be considered earned income.
Dr. Jim Dahle:
That of course has pluses and minuses. The minuses you pay payroll taxes on it, especially, if you haven't already maxed out your security tax, that's a not-insignificant amount of tax. The plus of course, you can use it to make retirement account contributions.
Dr. Jim Dahle:
You can open up a solo 401(k) just about anywhere. You can go to Vanguard, Fidelity, E-Trade, etc. That's no big deal. You fill out 10 or 15 pages of paperwork. You send it back to them within a few weeks, they've opened a solo 401(k) for you. Don't wait until December to do this because you need to establish it during the calendar year. You don't get all kinds of time after the end of the year like you do with an IRA or a SEP IRA, but it's pretty easy to do. It just takes a few weeks.
Dr. Jim Dahle:
The real question that you've got to determine though, is whether that money is earned income or not. And for a long-term rental, it definitely isn't. For a short-term rental, it's much easier to justify, especially if you're doing the booking, managing, cleaning, etc yourself.
Dr. Jim Dahle:
I found a nice blog post from markjkohler.com that talks about the taxability of these sorts of short-term vacation rentals. And he says, if you either don't stay on the property at all or rent it out at market rates for more than 14 days in a year, then the income from your short-term rental is undoubtedly taxable.
Dr. Jim Dahle:
Remember, you can rent something out that you own for 14 days a year and you don't have to pay tax on it at all. That's a really great deal. For example, we rent our house to the White Coat Investor for 14 days a year. That actually works out way better for us than the home office deduction does. Keep that in mind, if it's kind of a vacation property you just rent out a little bit.
Dr. Jim Dahle:
But assuming you're doing that, you're renting it more than 14 days a year. It really comes down to whether it's passive rental income, which gets reported on Schedule E, or active business income, which is reported on Schedule C. And the answer to that depends on whether you provide substantial services to your guests, not just a nice place to stay. When you're providing substantial services to them, then the income you make needs to be reported on a Schedule C and is subject to self-employment taxes.
Dr. Jim Dahle:
Examples of services that would be considered substantial are cleaning to the rental each day while the property is occupied by the same guest. Changing bed sheets and other linens each day, while the property is occupied by the same guess. Concierge services, conducting guest tours and outings, providing meals and entertainment like a bed and breakfast. If you're providing breakfast every morning, it's an active income. Providing transportation, providing other hotel-like services.
Dr. Jim Dahle:
The more you look like a hotel or a true bed and breakfast, the better the chance that you'll need to report your income from the rental on a Schedule C, pay self-employment taxes on it and you can contribute to a retirement account for it.
Dr. Jim Dahle:
But if you're not doing any of that other stuff, if it doesn't look like a hotel what you're doing, even if it's short term, maybe it still goes on Schedule E. It's not earned income. You don't pay payroll taxes and you can't use that money to contribute to a 401(k) etc.
Dr. Jim Dahle:
So, there's pluses and minuses either way in the situation for most people, even if they're doing the cleaning after the guests move out, even if they're doing the booking, maybe that's not quite enough to be substantial services and you put it on Schedule E and you don't get the 401(k) for it.
Dr. Jim Dahle:
I don't know that the IRS cares all that much. They get money either way. You get a benefit either way, whether you're skipping out on those payroll taxes, or whether you're getting the benefit of being able to use a 401(k). Maybe its sixes when you put it all together.
Dr. Jim Dahle:
All right. Our next question comes from John. This one's about, again, 401(k)s, but also about side hustles. Let's take a listen off the Speake Pipe.
John:
Hello, Jim. This is John. I have some questions on side hustles and solo 401(k)s. Number one, at what income for a side hustle does one need to pay quarterly taxes? I've looked everywhere and cannot find a good answer.
John:
Number two, assuming that I'm maxing out the employee contribution of my 401(k) through my W2 employer, how much can I put into my solo 401(k) under the employer contribution?
John:
Number three, when would you recommend making these employers solo 401(k) contributions? Should I do them quarterly, at the end of the year or at some other time?
John:
Number four, finally, how do I even make these solo 401(k) contributions? Is it a simple business account transfer to my solo 401(k)? Or are there some special forms that I need to fill out? Thanks for all you do.
Dr. Jim Dahle:
All right. Great questions. Let's take them one at a time. The first one is what income do you need to do quarterly estimated tax payments. And the reason you can't find an answer is there is no answer.
Dr. Jim Dahle:
Basically, it comes down to being in the safe harbor. You got to pay enough tax during the year that you're in the safe harbor or else you'll end up having to pay not just any taxes you owe at the end of the year, but penalties and potentially interest. So, you got to get into what's called the safe harbor.
Dr. Jim Dahle:
Now, for the safe harbor, there's several different variations of it. One way you can get into it is by owing less than $1,000. If you owe less than $1,000 in tax in April, you're in the safe harbor, you don't have to pay. Number two, you've got to pay at least 110% of what you paid last year. That's another way to be in the safe harbor. So, it's only 100% for low earners, for most docs who listen to this podcast it's 110%.
Dr. Jim Dahle:
You take what your tax due last year was. You multiply it by 110%. You divide it by four, there's your quarterly estimated payments, but that assumes that you don't have any sort of a W2 job withholding money. Because the truth is at the end of the year, you add this together, what you're having withheld and what you send in is quarterly estimated payments.
Dr. Jim Dahle:
And you might be able to, if you're not making that much at the side hustle, you might be able to just turn in your exemptions that you report on your W4. Is that what they're called these days? Whatever they're called right now, you turn them down to zero.
Dr. Jim Dahle:
So they're withholding as much as possible from your W2 pay checks, then you might be able to get enough withheld that you don't have to do quarterly estimated payments at all. That you're in the safe harbor for all your income just from withholdings from your W2 job.
Dr. Jim Dahle:
And so that's a pretty easy way to do it if it's a relatively minor side gig. If it's a big side gig, that's not going to work out, you're going to have to make estimated quarterly payments.
Dr. Jim Dahle:
Now, the fun thing about this is the IRS doesn't look at when money is withheld from paychecks. If you have it all withheld in December, that's just like you had it withheld throughout the entire rest of the year.
Dr. Jim Dahle:
That is not the case however with quarterly estimated payments. They like to see you making even quarterly payments throughout the year. That's probably the easiest way to do it, but it does cause some cash flow issues for lots of people, especially if the business is not earning evenly throughout the year, like White Coat Investor income. It ebbs and flows throughout the year. Sometimes we have lots of income in one month, other months we might not have a lot of income.
Dr. Jim Dahle:
And so, you can, there's a way you can pay as you go. And that's basically the federal income tax system. It’s a pay as you go system. And if you don't make much money in the first quarter, you don't pay much in the first quarter. If you make more in the second quarter, you pay more in the second quarter.
Dr. Jim Dahle:
And there's a form you submit with your taxes that basically shows that, but it's easier not to do that and just pay the same amount each quarter, if you can possibly estimate that to be enough to be in the safe harbor.
Dr. Jim Dahle:
But it's a tricky thing. Those of us who are self-employed, we're constantly monkeying with this, constantly trying to figure out what the right amount is. Even this year, I haven't even done my taxes for 2021 yet and I'm having to make quarterly estimated payments for 2022. So, I can't even calculate what my quarterly estimated payments have to be in the safe harbor.
Dr. Jim Dahle:
And remember all of that has nothing to do with how much tax you may owe. You may have to write a check for half a million dollars in taxes at the end of the year, if your business did really well. Even though you're in a safe harbor, you still got to write this huge check. So, you want to make sure you have the money available to write that you actually owe on your taxes.
Dr. Jim Dahle:
So, keep that in mind. I hope that's helpful. There is not an income but basically, if it's a sizable side gig, I'd say more than about 10% of what you're making at your regular job, I'd probably plan on paying quarterly estimated payments. They give you a little bit of a break the first year, but after that, they're not very merciful on these at all. So, make sure you're paying them.
Dr. Jim Dahle:
Okay. How much can you go into a solo 401(k) as an employer contribution? If you've used your maximum employee contribution, which is $20,500, for those of us under 50 this year, then all you can put in is the employer contribution, which is essentially 20%. 20% of your net income. That's net of all your business expenses, including the employer half of your payroll taxes, like social security and Medicare tax. 20% of that.
Dr. Jim Dahle:
Third question. When do you make those contributions? Well, you can make them whenever you want throughout the year. If you're not sure how much you're going to be able to put in there, then you might want to wait until about the time you're doing your taxes to at least do the last contribution so you can adjust it as needed.
Dr. Jim Dahle:
But you could put it in there on January 3rd. If you know you're going to be able to max it out, you could put it in there really early in the year. Again, it's supposed to be a kind of pay as you go system, but the IRS is not watching if you want to max that thing out in January. I can tell you that from personal experience, nobody sends you any letters or anything about whether you'd actually earned that much that year or not.
Dr. Jim Dahle:
So, you can put it in there anytime you want. But if you're not making a ton of money in the side gig, you want to be careful not to over contribute, which means your last contribution probably doesn't go until pretty late in the year or maybe even into the next year before you file your taxes. Remember with the employer contribution, you get a little more time to get it in there.
Dr. Jim Dahle:
And finally, how do you make them? Well, it depends on the solo 401(k). At Vanguard, they have a separate Vanguard site for the employers. You log in, you go in there and you mark, “This is an employee contribution. This is an employer contribution. It's for 2021, it's for 2022”, whatever.
Dr. Jim Dahle:
And then the money gets sent in there from your bank account. And it shows up in the solo 401(k), which you see not on that side, not on the employer’s site, but on the regular Vanguard site when you log in. But it's probably a little bit different at Fidelity, probably a little different at Schwab, wherever you open your solo 401(k). I hope that's helpful.
Dr. Jim Dahle:
All right, we've got another question off the Speak Pipe, about after-tax 401(k) contributions. Let's take a listen.
Speaker 3:
Hi. Thanks for all you do and keeping us up to date on the mega backdoor Roth. If the mega backdoor Roth does go away eventually, which seems likely, do you think there's going to be any benefit at all to the after-tax 401(k) contributions? For example, since there's no early withdrawal penalty, it doesn't seem like the worst emergency fund, particularly for someone who might be undisciplined and/or may not be in the absolute highest tax bracket. Thanks.
Dr. Jim Dahle:
Great question. You're right that if you withdraw the contributions, the after-tax contributions themselves, that there is no tax or penalty due on that, but all the earnings that that contribution may gain are subject to the 10% penalty for early withdrawals as well as any taxes.
Dr. Jim Dahle:
Keep that in mind. Would it work for an emergency fund? Well, I guess if you left it in cash or something not aggressive, but the issue is with an emergency fund, it's more about the return of your principle than the return on your principle. And so, I suppose that would be one use for it. It also likely provides significant asset protection being inside a 401(k). So that's another benefit of it.
Dr. Jim Dahle:
But really what we're talking about here, if heaven forbid the ability to convert those after-tax contributions went away, which I don't know if that's likely or not. That tax bill doesn't seem like it's going anywhere right now as I record this in March. But if that goes away, that's obviously the best use of after-tax contributions to immediately convert them to a Roth.
Dr. Jim Dahle:
But even if it goes away, there are other things that can happen. You can leave the employer, for instance, isolate the basis and convert it to a Roth IRA yourself if that's still permitted. Maybe the law changes back in a few years and you can do conversions at that point.
Dr. Jim Dahle:
But if you are talking about truthfully long-term investing in an after-tax 401(k), it's just like non-deductible IRA contributions. Over a certain period of time, decades, the tax-protected growth becomes worth more than the fact that the withdrawals are subject to ordinary income tax rates rather than capital gains rates.
Dr. Jim Dahle:
So, you can be better off investing after-tax money in a 401(k) or IRA than in a taxable account, especially if it's not a very tax-efficient investment, but over time, the tax-protected growth can make up for the additional tax at withdrawal time. Its possible, this could still be part of your plan, but the best option, of course, is just to do a mega backdoor Roth IRA with it for as long as that is permitted.
Dr. Jim Dahle:
All right, we're going to have an interview now with Joe Ollis. Let's get him on the line here.
Dr. Jim Dahle:
All right. I want to welcome a special guest back to the White Coat Investor podcast. This is Joe Ollis. He is the chief investment officer for one of our real estate investing partners, the Peak Housing REIT. Welcome back to the podcast, Joe.
Joe Ollis:
Thank you. It's great to be here with everybody at the White Coat Investor.
Dr. Jim Dahle:
Now, we should warn people that we're recording this on February 2nd. This isn’t going to be live on the podcast for a few weeks. So, if any of the data seems a little bit stale because something crazy happened in the markets in the last six weeks, then that's why, because we recorded this at the very beginning of February.
Dr. Jim Dahle:
But it's been a pretty crazy year so far in the markets. In the last three months, cryptocurrency is down 50%, stocks were down over 10% at one point, year to date during January. And it's got a lot of people thinking, “Wow, do I have to deal with that sort of volatility? What other kinds of investments are out there that provide solid returns that don't make me so queasy?”
Dr. Jim Dahle:
And a lot of them turn to real estate. They turn to single-family homes, which is what the Peak Housing REIT specializes in. We were talking before we went on air that there's some interesting data out of the fourth quarter of 2021 about single-family homes. Do you want to tell us a little bit more about that?
Joe Ollis:
Yeah. Well, it's great to be back Jim, and you're exactly right. I think one of the key aspects of investing in real estate is the stability it provides, and especially when investors start to think about the day-to-day volatility of the stock market, being able to look at your portfolio of real estate and knowing that those values are staying pretty constant helps out a lot.
Joe Ollis:
Single-family rental homes as an industry has continued to just completely take off both from the aspect of the amount of institutional investors that are coming into it, but also investors like White Coat Investors. And that's really helped support the single-family values of these homes, but also really kind of created a great investment opportunity for investors to join us while it's still early in this game.
Dr. Jim Dahle:
It's interesting, I'm in the Salt Lake Valley, which I think they just said, we're like second fastest-growing housing prices in the country right behind Boise or something. I think a lot of at least price increase for single-family homes has been the housing crunch, particularly in places where people are moving like Idaho and Utah and Arizona and Texas and places like that. Because you're sharing this market, you're sharing it, not just with investors, but you're sharing with people looking for a place to live. How much of that do you think impacts the rates of returns those investors in this space see?
Joe Ollis:
Yeah, that's a really good question. You're right. I think the analysis that has come out from the last year is that about 17% of single-family homes were purchased by institutional investors for the purpose of being a rental home. It's still a pretty small percentage in the total scheme of things, but it is definitely starting to show that there's more competition.
Joe Ollis:
And because of the supply constraints, which have just continued in the last year, I think this is going to continue for quite a bit longer. And when I think about supply constraints, if you really reflect back to the previous year, every time there was a supply shortage or a commodity price increase, like you think about lumber, just exploding higher for a period of time last May. That led to builders, just slowing down production of new housing, which is further constraining supply. And we're really not even feeling that yet. And that's just going to continue for multiple years.
Dr. Jim Dahle:
Yeah. It makes the existing homes more valuable when it costs so much more to make a new home.
Joe Ollis:
It does. It does. Yeah.
Dr. Jim Dahle:
Yeah. I had a call with the insurance company that insures my home and they wanted to go over everything again because the cost of replacing the home has gone up so much. We actually had to go through the whole insurance process again which I thought was pretty interesting.
Dr. Jim Dahle:
But you're right. In places like Salt Lake, especially a little bit like the Bay Area, it becomes constrained by geography. But even in other places, it's constrained by supply and you're right, with everything sitting on ships off of the port of LA, it's a little bit harder to get the materials you need to buy a home, and makes the ones that are selling that much more valuable. A real tailwind, particularly in single-family rental homes.
Dr. Jim Dahle:
A lot of real estate investments are industrial or retail or multifamily, I think is particularly popular, especially among White Coat Investors, but single family is this great space that's been hard for people to get into. Why do you think it's been so hard up until the last few years for funds, REITs, and institutional investors to get into this space? What's changed that now they're all going for it?
Joe Ollis:
Yeah. That's a really good question. I'd like to even back up further than that, and really look at even multi-family apartment complexes clear back in the 1980s. Those were really primarily owned by what we call the smaller investor or even the mom-and-pop investor.
Joe Ollis:
That shift to where institutions, which are like the Blackstones and the pensions of the world, now own 95% plus of all apartment complexes. That shift took about 30 years. That shift just began in 2011 with a single-family rental market.
Joe Ollis:
Today about 95% of all single-family rental homes are really owned by smaller investors. People who might own one to five homes. Institutions started to step into this because they realized a few things. One, tenants of single-family rental homes are really sticky. They want to be in the home. They're raising their family in these homes. They're choosing to be renters. They can't afford the neighborhood, but they really like the neighborhood. All very good reasons for them to be in these homes.
Joe Ollis:
That stickiness is a really attractive investment return for all investors, but then what really changed the equation for institutions and for this whole industry is the inclusion of a lot of technologies, making it easier to manage what we refer to as scattered site homes.
Joe Ollis:
If you think about a multifamily apartment complex, you can have 100 homes in just a single area. It's really easy to manage everything when it's just 100 homes under one roof. To manage 100 homes that are scattered throughout a city, it takes a lot more infrastructure. And there's just been so much innovation in technology that allows for the economics of that management to come down in cost.
Joe Ollis:
The example I love to give is we use a door lock service called Rently. And what that does is it allows us to essentially have remote access to locks. We never have to go and change a lock when a tenant leaves a door. That's a really powerful savings tool, but it's even better because from a scattered-site portfolio perspective, if we need to send a plumber out to that house, we can actually arrange with the tenant, have the tenant talk with the plumber to arrange a time, and then we can remotely unlock the door without having to send a property manager out there. Just that one little savings is just a prime example of where we’ve seen a lot of innovation.
Dr. Jim Dahle:
Yeah. It's never been a very efficient market, and technology and just innovation can make a lot of new efficiencies there, for sure. It sounds to me like there's been a lot of interest among White Coat Investors for the Peak Housing REIT. What kind of interest are you guys seeing on your end?
Joe Ollis:
Yeah, it has been a lot of interest. I'm a data guy. I’m just a total data nerd here. I'm just going to give you today's numbers. We have 62 investors from White Coat Investor who when they signed up and invested with us, they actually marked themselves as White Coat Investors. That's fantastic. That's nearly $3 million of investment.
Joe Ollis:
And we're really excited to embrace this network. The list of questions that come through from White Coat Investors really show the level of diligence and intelligence that your investors have. And that means a lot to us. We look at this as a partnership with our investors, and we love it when people align both with the vision of what we're trying to do, the tailwinds of single-family rentals, and then, of course, to invest right alongside us. So, it's been a great, great, response.
Dr. Jim Dahle:
I think there's three things that particularly make the Peak Housing REIT attractive to our folks. The first is just the opportunity to do single-family homes. The vast majority of people we partnered with aren't in the single-family home space.
Dr. Jim Dahle:
The second though is the relatively low minimum investment. Now, $25,000 is still a lot of money, but it's dramatically less than the minimum investment with the number of funds out there. And so, it gives people a chance. It's not quite “try before you buy”, but it's try for a little bit of money before you put a lot of money in. And so, they can get in. Doctors can afford that. That's a typical one-month salary amount for a doctor, and that allows them to see it and watch it and see how it goes. And if they're like most investors, they end up investing more later over time. I think the minimum is pretty attractive.
Dr. Jim Dahle:
The other thing that a lot of people have commented to me about is that they like the idea that it is a REIT and they're just getting a 1099. That they're not going to get a K1 and have to file in eight states from it. And I think that's really attractive. Once somebody has a few private real estate investments and had to go hire now, somebody has to do their taxes because they got twelve K1s in eight different states, all of a sudden just the REIT tax structure becomes much more attractive to.
Joe Ollis:
Yeah, that is definitely true. And as our investors will see, we are expanding our REIT into multiple different states in the next year. And that will become even more important as a tax strategy, that 1099 is much more favorable.
Dr. Jim Dahle:
Yeah. All right. If you want to learn more information about the Peak group, about the Peak Housing REIT, the easiest way to do that is to go to whitecoatinvestor.com/peak. You’ll get all the information there about terms, etc, and sign up to invest if you find it attractive. But thanks so much, Joe, for coming on the podcast and for giving us a little bit of an update on the single-family home market.
Joe Ollis:
You're welcome. Thank you.
Dr. Jim Dahle:
I hope you enjoyed that interview. If you like learning about these private real estate opportunities, make sure you're signed up for our real estate newsletter. If you're not signed up for the White Coat Investor newsletter, make sure you're signed up for that. You can sign up for both of those at whitecoatinvestor.com/free-monthly-newsletter.
Dr. Jim Dahle:
And you can turn them on and off at will. We do not want to send you emails that you do not want to receive, so you can turn them off using the links at the bottom of every newsletter. There's no commitment here. Yes, we have ads in our newsletters. We're trying to run a for-profit business here, but the primary purpose of these is to educate you and to help you become financially successful.
Dr. Jim Dahle:
So, make sure you check that out. You'll get a list of people, most of which I've invested with personally, who are currently partnered with White Coat Investors, as well as their latest yields, funds, syndications, whatever, with that newsletter. We send it out about once a month.
Dr. Jim Dahle:
Our next question comes from the email box. “I'd like to contribute the maximum employer/profit sharing contribution to my solo 401(k) for 2021. I do my taxes in TurboTax, and I've calculated what our max contribution is going to be. I'd like to get this money into the market now, but I haven't submitted my taxes yet because my state won't start accepting returns for another couple of weeks.
Dr. Jim Dahle:
What would happen if after submitting my taxes get returned and I end up having made a mistake, that results in me having over contributed to my solo 401(k)? Can I recharacterize some of the 2021 contributions to 2022 contributions? Or should I just wait to contribute until my tax return is submitted and accepted? What if I find out I screwed up my taxes and end up over contributing for 2021? Can some portion of 2021 contributions be recharacterized as 2022 contributions?
Dr. Jim Dahle:
Yeah, the bottom line is they can. You just got to call up to the 401(k) provider, and they can work with you. They'll either send your money back or they'll apply it as a 2022 contribution. I've had that happen I don't know how many times in the last decade, two or three, four times, maybe, for whatever reason where it ended up being an over-contribution.
Dr. Jim Dahle:
And that was the easiest way for them to fix it. They just said, “Oh, we'll just make it a 2022 contribution.” So, no big deal. Technically you're supposed to make that contribution before you submit your taxes. I would not wait until your taxes are submitted and you got your refund back or whatever to do that. Just make the calculation, submit it. And if heaven forbid, if you screwed up your taxes and you got to redo it, then you have to redo it. Not that big of a deal.
Dr. Jim Dahle:
All right, our next question comes from Sangita off the Speak Pipe. Let's take a listen.
Sangita:
Hi. I converted my traditional 401(k) to a traditional IRA. And then from a traditional IRA within a few days, maybe eight, 10 days, I converted it into Roth. Do I have to fill up 8606 because I did not convert the traditional 401(k) directly to Roth, but it went through my traditional IRA? Thank you.
Dr. Jim Dahle:
Okay. If you're ever wondering if you have to file a tax form, go to the instructions for that form. The instructions for form 8606 in this case. And usually on the first or second page of those instructions, you will find a section the IRS puts together called “Who must file.”
Dr. Jim Dahle:
And in the case of form 8606, it says this, “File form 8606 if any of the following apply. And the first one is you made non-deductible contributions to a traditional IRA.” That's not you.” You received distributions from a traditional SEP or simple IRA in 2021 and your basis in these IRAs is more than zero.” That's not you either. “You or your spouse transferred all or part of your traditional SEP or simple IRA to the other spouse under a divorce agreement.” That's not you.
Dr. Jim Dahle:
“You converted an amount from a traditional SEP or simple IRA to a Roth IRA in 2021.” That's you. That means you got a file. If you'd gone directly from the 401(k), I don't think you would've had to. By taking that step, by going into the traditional IRA and then converting, you're going to have to fill out this form as part of your tax return. Sorry. I hope that's helpful.
Dr. Jim Dahle:
All right. I hope you've enjoyed this episode today talking about these 401(k) questions. 401(k)s can get surprisingly complicated. I'm always amazed at all the angles you guys can come up with, with the questions you've got for me on this. But truthfully, it's a pleasure to answer them and to help you find what you're looking for.
Dr. Jim Dahle:
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Dr. Jim Dahle:
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Dr. Jim Dahle:
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Dr. Jim Dahle:
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Dr. Jim Dahle:
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Dr. Jim Dahle:
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Dr. Jim Dahle:
Keep your head up, your shoulders back. You've got this and we can help. We'll see you next time on the White Coat Investor podcast.
Disclaimer:
My dad, your host, Dr. Dahle, is a practicing emergency physician, blogger, author, and podcaster. He’s not a licensed accountant, attorney, or financial advisor. This podcast is for your entertainment and information only, and should not be considered official personalized financial advice.
The post Answering Your Questions About 401(k)s and How to Manage Them appeared first on The White Coat Investor - Investing & Personal Finance for Doctors.