"Off the Rack" Financial Planning Not Appropriate for Physicians: Part 1

According to the US Census Bureau, the average American family earns less than $49,000. That translates to an income tax liability of less than 12 percent. 98 percent of American families will never be worth more than $2,000,000 and owe an estate tax. Lastly, the average American is an employee, not an employer, and doesn’t have the government determine how much income they receive for their work. As a result, most people will never be sued because of work-related activities and don’t have to worry about their income dropping substantially each year. Therefore, there is no need for most people to address protection from lawsuits or to take advantage of every possible tax benefit when times are good.

Does the situation above sound like your life? Of course it doesn’t.

As authors of books and articles, we regularly interact with publishers and talk show hosts. Radio and television stations, book & magazine publishers, and Internet content editors are looking for content for their “average” reader. They fear alienating their readers and listeners by including content for only the higher income audience. What this means for physicians is:

The financial and legal advice you get from television, radio, newspapers, and the Internet is most likely not appropriate for physicians.

By listening to such advice, you are like the patient who trusts their own self-diagnosis from a 10-minute internet search rather than trusting the experience of a specialist with decades of experience in the field.

A couple of mistakes many physicians make by listening to bad advice include:

Mistake #1 — Listening to a CPA or Attorney who says, “You don’t need a corporation for your medical practice.”

Despite what the CPA says, in most cases, the cost and aggravation of the corporation are far outweighed by the asset protection and tax benefits the corporation offers physicians. Though these solutions can often help reduce taxes by $5,000 to $25,000 per year, these particular strategies are outside the scope of this brief article. If you are interested in learning about these techniques, a copy of our book, For Doctors Only: A Guide to Working Less and Building More, is free if you call (877) 656-4362; pay only $9 S&H.

Mistake #2 — Owning any assets in your own name, jointly with your spouse, or in your spouse’s name.

We know that this is the most common ownership structure for real estate and bank accounts. This is ok for 90% of Americans. You have potential lawsuit risk, probate fee liability, and estate tax risk. If you don’t want to unnecessarily lose assets to lawsuits or taxes, you need to consider alternative ownership structures. Something as simple as a living trust or a limited liability company can often solve these problems.

These two mistakes above are commonly addressed by savvy advisors and concerned doctors. If you have followed the advice above, please call the authors for a free discussion. This is basic, but important, planning that you must understand before moving on to more powerful solutions. The remainder of this article will focus on three additional mistakes doctors make when they rely on “off the rack” planning that is appropriate for Average Americans — but often very detrimental to doctors who have unique needs, circumstances and goals.

Mistake #3 — Wasting time and money on retirement plans.

This is perhaps the single most important area of planning for doctors to address once they understand that they have unique financial situations. Typical retirement plans are great for rank-and-file employees because they force employees to put away funds for retirement. In addition, the employers may match some percentage of those funds. The money grows tax-free for employees and is available after age 59 1/2. When the employees pass away, there may be a very modest amount remaining, if any, for their heirs.

As the employer, you are responsible for those matching contributions. These can be very significant if you have a large or highly compensated employee base. You are also the person who will be responsible (in other words, “liable”) if employees do not get the proper allocations or contributions from your practice. Even if the plan administrator made the mistake, you ultimately may feel the wrath of the Department of Labor if your employees are not fairly treated under the plan.

Further, a hypothetical $40,000 per year of pension contributions from ages 35 through 60 growing at 7% will only be worth $2,750,000 at retirement at age 60. If you want this income to last until your 90th birthday, you will start drawing monthly retirement distributions of $12,564 (pre tax per month) and increase those withdrawals by 3% each year to account for inflation. That $12,654 withdrawal in 25 years will be worth only $6,000 in today’s dollars — and that is a pre-tax number!

After taxes, your $1,000,000 of retirement plan contributions over 25 years will be worth only $4,000 per month of after-tax, inflation-adjusted dollars. Since most doctors will not be happy working so hard for 25 years (after a decade of training) and only having $4,000 per month to enjoy in retirement, it is imperative that doctors use supplemental planning tools if they want to reach a decent quality of life in retirement.

There is another problem with traditional retirement plans. Let’s say that you accumulate significant non-pension assets to supplement your quality of life in retirement. If you make the mistake of taking only “minimum” distributions from your retirement plan, you could pass away with $1 million or more of retirement plan assets. Upon your death, these plan assets can be taxed at income tax and estate tax rates. It is possible, in some states, for this “double tax” to be as high as 70% to 80% of the total value. In other words, if you don’t spend these plan funds before death, most of these funds will be lost to taxes.

On top of that, we are in an economic crisis where taxes are almost certain to increase. It was not long ago when distributions from retirement plans with balances over $1,000,000 were subject to an additional 10% excise tax. We don’t recommend that you count on the government to make law changes to support your best interests in retirement. We're sure you didn’t pay all that money to fund your employees’ retirement plan only to lose 40%-50% of your distributions to taxes during your lifetime and lose an additional 3/4 of the balance to taxes at death. This is yet another problem with “off the rack” retirement planning that threatens doctors and doesn’t impact Average Americans.

Suggestion — Do not rely on traditional retirement planning to support your retirement.

Non-traditional planning can offer higher income physicians opportunities to contribute significantly larger annual contributions. If you want to increase your chances of having monthly retirement income in excess of $4,000, you must consider these options.

Whether you are using non-qualified plans, “hybrid” plans, or even a tool primarily designed for risk management benefits, like a captive insurance company, you could possibly deduct $100,000 to $1,000,000 or more annually. Most of these tools allow you access to the funds before 59 1/2, will not force you to take withdrawals at age 70 1/2 if you don’t need the money, and will not be taxed at rates up to 70% or 80% when you pass away. For these reasons, savvy doctors utilize nontraditional plans more than traditional retirement plans.

Note: Non-qualified or “hybrid” plans vary significantly in their design, their scope, and their applicability. Some plans work great for smaller practices with one or two partners. Others work best in practices with 3 to 20 partners. Still others may work best for the larger practices. To determine which one is right for you, contact the authors for a free no-cost consultation offered to readers.

Don’t Miss Part Two

This is the first of a two part article. More tips on tax reduction and other elements of financial planning that are specific to physicians and unnecessary for Average Americans will come in the subsequent part of this continuing article. The authors welcome your questions. You can contact them at (877) 656-4362 or through their website www.ojmgroup.com.

David B. Mandell and Christopher Jarvis are principals of the financial consulting firm O’Dell Jarvis Mandell LLC. Mandell and Jarvis have co-authored seven books for doctors. They are speakers for Guardian Publishing who offer CME seminars and other programs for groups, hospitals and societies. Disclosure:This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized investment or tax advice. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax laws change frequently, accordingly information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein. For additional information about the OJM Group, including fees and services, send for our disclosure statement as set forth on Form ADV using the contact information herein. Please read the disclosure statement carefully before you invest or send money.