Laying your path to early retirement

Putting the maximum into your qualified plan is smart, but may not get you where you want to go fast enough. These tactics can help.

By Brad Burg

Maybe you're in your 50s, and packing it in looks appealing. Or you're in your 30s or 40s and wondering about jumping ship at 55 or 60. Could you stay afloat financially? For many doctors, that's a daunting question. Even if you've accumulated substantial assets, you may fear the twin devils of inflation and taxes. And if you're still trying to build that nest egg, you may doubt that you can do it fast enough to retire early.

So what should you do? We'll assume you're already choosing the obvious ways to get tax-sheltered growth, like putting the maximum into your qualified plan. But there's a whole range of other tactics that might help you. Let's look at some of the best.

Use a plan's shelter where it does the most good

What if your annual savings won't fit into a qualified plan, because of the contribution limits? Then consider carefully the tax implications of where you hold what, says Medical Economics columnist Lewis J. Altfest, a New York City financial planner.

"Growth assets are already tax-favored by a capital gains tax capped at 20 percent," he explains. "The more of those you have in your plan, the less room you have for bonds, which need the plan's tax-deferral more. For most doctors, bond earnings are taxed at higher personal-income-tax rates."

Altfest's advice: "Buy more equities outside the plan and more bonds inside." (An obvious exception: Tax-free municipal bonds are sheltered anyway, so they should never be in a plan.)

There are other reasons to adopt this approach, adds New York City financial planner Gary H. Schatsky. "You can't write off losses inside the plan, so you should keep less-risky assets there. And if you realize gains outside the plan, you have several options. Sell, and take advantage of capital gains rates. Or defer the sale until you have losses to absorb that gain. Or make a gift of the appreciated assets."

Find out what makes an annuity tick

Annuities give you tax-deferred growth, and you can buy them on an installment basis, even varying what you pay each time. Also, you may have a choice of holdings.

Many fees are involved, though, which is why annuities generally must do 1.5 to 1.75 percent a year better than other investments to provide the same return. Moreover, surrender charges in early years may be 7 percent. (They generally decline 1 percent a year.) Could annuities help you save for retirement? "They might," says Gary Schatsky. "But scrutinize the charges and the company's rating, and be sure you're putting in cash you won't need for at least 10 years." It's not just a matter of avoiding surrender charges; you need that time to amortize sales and other initial expenses.

After accumulating money in an annuity, you can then convert it to the "immediate" kind that starts making payments to you. Or you can start by purchasing an immediate annuity with a lump sum. "Payments can extend over your lifetime, or over the lifetimes of yourself and your spouse," says New York insurance analyst Glenn S. Daily. So buying a variable immediate annuity can be an efficient way to turn a nest egg into an income you can't outlive."

Don't keep excessive life insurance

"If your children are independent, it's time to start thinking about yourself," Altfest says. "Suppose you're keeping a second-to-die policy to pay off estate taxes and benefit your heirs. You might cash it in and use the proceeds to help fund your retirement."

You might also simply change your policies. One pediatrician in his 40s needed lots of coverage, but also wanted to retire early. "His $1.5 million policy was whole life, which costs much more than term insurance," Altfest recalls. "He'd already paid the load, so I didn't advise cashing it all in. But I did suggest that he cash in half the policy, substituting $300,000 in term insurance." That will save him $4,000 a year. "Invested consistently, that money can help him retire sooner."

There are other options, too. "You might reduce a policy's death benefit and turn it into a paid-up policy, relieving yourself of the premiums," says Glenn Daily. "Or suppose you have a cash-value policy that's worth less than you've paid in. The loss isn't deductible, but if you convert the policy into an annuity, that loss will shelter the annuity's profits."

Benefit from charitable trusts

Giving away assets can be another shortcut to retirement. Say you own stock that grew from $50,000 to $500,000. Its dividend wouldn't be enough to do much for your early-retirement plans, and selling would cost you a big capital gains tax.

Here's a solution: Give the stock to charity, via a "charitable remainder unitrust." The charity named in the trust can then sell the stock without paying any tax and buy income-producing holdings to pay you a richer return. The charity keeps the assets when you die, but you get substantial income for life. You get a sizable tax deduction, too.

Such a trust can also aid you in putting more away than your plan allows. To do that, you can fund a charitable trust, which might hold a deferred annuity, so it won't create income for you before retirement. You'll save much more that way than with a comparable investment outside, which would be subject to taxes.

Consider the repercussions of moving

Relocating can help make early retirement financially feasible. But do your homework before you move. Various states will still tax some kinds of retirement income, even if you move away. Consider local living costs, too. A lifestyle that would cost $100,000 in one city might require only $75,000 in another. To get the picture on areas that interest you, call local brokers or chambers of commerce—or better yet, visit.

Check out reverse mortgages

As with an ordinary mortgage, a reverse mortgage involves pledging your house for a loan, but there's a major twist: You need not repay anything until you move out or sell. With some deals, you repay nothing during your lifetime. You can take the money in monthly checks, a lump sum, or occasional withdrawals from a line of credit—or some combination of the three.

At first glance, this isn't exactly an early-retirement option, since you're not eligible for most plans until age 62; and the earlier you take out a reverse mortgage, the less cash you can get. Still, checking out this option might help you make early-retirement plans—even if you keep it in mind only as a possible source of emergency cash.

Move plan money into IRAs

Once you reach 55, you can retire and withdraw money from your practice's plan, subject only to the plan's own rules, with no 10 percent early-withdrawal penalty. Better yet, after you leave your practice or other employer, you can take out retirement-plan money at any age in substantially equal periodic payments. Those payments must reflect assumptions about earnings and life expectancy, but there's lots of leeway.

Still, the decision isn't simple. You don't want to deplete your plan any faster than necessary. And you can't change your withdrawals freely. You'd owe a penalty if you didn't stick to your chosen amount for five years, or until you reached 591Ž2.

One way to find flexibility within this maze is to roll over plan money into IRAs. The same withdrawal options that apply to qualified plans apply to them, so you could use several IRAs and handle withdrawals from them in various ways.

Look into deferred compensation plans

A deferred compensation plan is like a qualified plan in that your practice or other employer puts away money that grows tax-deferred. But two main protections of a qualified plan are missing: You may not be vested until retirement, disability, or death, and plan money isn't shielded from creditors.

Nevertheless, there are advantages: The qualified-plan contribution limits don't apply, and a deferred-compensation plan can include doctors only, not employees. So such a plan can be a solution if you're bumping up against 401(k) or IRA contribution caps, or if your group is restricting its 401(k) contribution for doctors because of the cost of contributing for staffers.

True, a professional corporation can't deduct its corporate contributions until the funds are paid out. But many practices will make those contributions anyway, to keep doctors happy. A deferred-compensation plan can help in other contexts, too. For example, you might use one as part of the payment you receive if you retire and sell your practice. "You get to spread out income, which can be a big tax advantage," explains management consultant Michael D. Brown. "The buyer gets a break, too, by postponing some payments until a time when they may be more affordable."

The author is a former Senior Editor of this magazine.

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Brad Burg. Laying your path to early retirement. Medical Economics 2002;7:47.