Physicians have been the core of ABFS’ clientele for 30 years. They face many of the same challenges as our other clients, especially business owners, and they also face some unique issues. After dedicating more than a decade to education, just to begin practicing, most physicians work long hours for increasingly less pay these days, and their dedication to the well-being of patients often comes at the cost of maintaining their own family’s financial health. Increasing bureaucracy, and the need to see more patients in less time (and for less money), leaves little time and energy for a spouse/family, let alone researching financial strategies. This special series provides some key information for physicians on tax savings, asset protection, and more. Much of it, however— like this first one— applies to many others as well.
Are you truly maximizing your tax-deductible contributions? Almost everyone puts some money into “qualified” retirement plans (pension, profit sharing, IRA, etc.), but some physicians and other business owners fail to maximize the amount (potentially over $100,000 a year!) they contribute.
Qualified plans are perhaps the most effective of all tax saving strategies. That is because they are triply powerful—they not only provide current tax savings, but a huge up-front “return,” and (of particular importance to physicians) asset protection in most states. (Asset protection is the topic of the second article in this series.)
A 50% Return…The First Day?!
The most important concept to remember is that the return of any security is dramatically magnified if it is purchased with contributions to qualified accounts rather than with after-tax dollars. The reason is that the “government’s portion” of that money remains under your control, and keeps working (likely for decades) for you.
Each dollar you contribute to a tax-deductible plan immediately produces a great “return,” even before you invest it! In a 33% tax bracket, for example, the 67 cents of each dollar you would have kept (after paying 33 cents in taxes), effectively increases by roughly 50% the first day, even if you just put it into a money market! That’s because the entire dollar—not just “your” 67 cents—begins earning and compounding, and can do so for decades, until you’re forced to take it back out in your 70s, 80s and 90s. Sure, you’ll eventually have to pay back that 33 cents to the IRS (maybe even more than 33, if tax rates keep rising), but by then, those dollars could have grown many times. Remember, even when you do pay the government back its 33 cents, you get to keep all of the money it earned over all of those years. For example, if you can legally contribute $30,000 per year more than you do now—assuming a 33% tax bracket and 8%/year returns—will save you $9,900 in taxes. If you aren’t forced to withdraw those dollars for 25 years, the government’s share ($9,900) of each contribution would, at that time, have earned you an additional $70,000! That’s money you wouldn’t have at all if you made the same investments outside the qualified plan.
Could You Contribute More?
Even if you do already contribute to retirement plans, you might be able to do more. Depending on your practice/business structure, you might have access to a Health Savings Account, a cash balance/defined benefit plan, and a 401(k)/Profit Sharing plan. Utilizing all three (and/or others) could enable you to shelter over $100,000 a year from taxes now, resulting in many hundreds of thousands of dollars more in your nest egg when you retire.
It is surprising how many physicians go through amazing contortions, investing in questionable ventures that promise tax savings, when such a simple tax shelter (and asset protection vehicle) remains under-utilized. One ABFS physician-client, against our advice, moved much of his money into an offshore (Caribbean) insurance scheme, both for asset protection and tax savings. He ended up with (in his words) a “huge mess,” with the money now out of his control—and beyond the reach of U.S. courts to help him retrieve it.
What Can You “Afford”?
Some physicians don’t feel like they can afford to contribute as much to qualified plans as is legally permissible. Perhaps they want to get medical school loans paid off as fast as possible, so that’s where discretionary dollars go. Or maybe living expenses require those dollars. In most instances, neither of those is a good enough reason.
Using after-tax money to make larger student/med-school loan payments is far inferior (from a long-range financial standpoint) to using those dollars to fund qualified plans. Of course, you should make payments on those loans as scheduled, but don’t pay more than the minimum unless/until each year’s qualified plan contributions are fully funded. In fact, that’s the case with almost any debt, with the exception of revolving credit (i.e., credit cards, merchant cards, etc.), which should be paid off every month in order to avoid high (10-20%) interest rates.
What if you simply need those dollars (that could have gone into qualified plans) for living expenses? Well, in that case, you might be living “beyond your means.” We recognize that Obamacare is putting substantial (for some physicians drastic) pressure on physicians’ incomes, so you simply might not be able to do this now, but should strive to do it as soon as possible. We’ll discuss the long-term implications of physicians living beyond their means (a surprising number do so) later in this series. But, in the long run, if you can’t at least fully fund qualified plans to which you have access, you’ll need to consider maintaining a tighter “lifestyle” budget. Ideally, you should even be setting aside and investing money besides qualified plans, but at a minimum, max out those qualified plan contributions.
If you have questions about the above, please consult with your ABFS advisor. We can team with your attorney and/or CPA to make sure you are maximizing your retirement plan dollars.
Bruce Yates, president and founder of ABFS, has worked primarily with physicians and their families since founding ABFS 30 years ago. Bruce spent 12 years on the faculty of the American Association of Senior Physicians (until the AASP was absorbed by the AMA), speaking at all of their conferences around the country regarding the financial changes faced by physicians and their spouses when retiring from medical practice.