In my last article “A Physicians Financial Plan: PART 1 - Building the Foundation”, we discussed the importance of laying out a plan for your financial future before charging headlong towards your objectives. As promised, Part 2 will entail many of the strategies that can be used to help you execute your plan in the most effective way possible. Keep in mind that these are general strategies and it’s likely that some won’t apply to your specific situation. This again highlights the importance of utilizing a financial planner who understands the financial environment that physicians experience. Failing to hire an expert to help you build and execute a plan is like using WebMD as your PCP. It might work sometimes, but it could cost you in a big way if you get it wrong!
Admittedly, there are many other aspects that go into a solid financial plan that won’t be discussed today. Also, an important viewpoint to remember (as I wrote in Part 1) is that your life aspirations should be the driving factor in your financial strategy – not some arbitrary savings goal. Therefore, each plan for my clients is as unique as they are. Here are some of the ideas that we discuss when building their individual strategies. Let’s dive in!
Insurance
In most cases, the biggest aspect of a financial plan that can be executed up front is designing an insurance portfolio that protects against things unforeseen. Unfortunately, many physicians do not adequately protect themselves and their families from financial hardship. These hardships can come about from injury, illness, death, or even litigation. That’s where insurance comes in. By adding this protection, insurance can provide you and your family with the peace of mind knowing that all that you’ve worked for will not be lost if some sort of hardship befalls you.
These are things you can (and should) do before you even start building wealth, because without the proper insurance, you could work for years towards your goals only to be completely derailed by an unexpected financial hardship (disability, major property damage, being sued, etc.). Without the proper insurances in place, you could have a huge area of exposure in your plan without even knowing it – until it’s too late.
Investing
Before you even decide in what to invest, you’ll need to have a strategy of where to invest. As part of your plan, your advisor should be able to explain the pros and cons of each type of account and how they will better help you to efficiently accomplish the goals that you’ve set in place. There are many different types of account structures, but most fall into two main categories: Qualified and Non-Qualified. Qualified accounts have some sort of tax advantage (either tax deferment or tax-free growth or both) while Non-Qualified accounts can have annual tax implications based on the realized gains or losses of the positions held inside the accounts. While the Qualified accounts are great because of their tax advantages, they aren’t without limitations. Most Qualified accounts (like 401(k)s, 403(b)s, 457s, IRAs, and Roth IRAs, among others) have contribution limits and come with the caveat that you won’t be able to withdraw this money without a 10% penalty before the age of 59 ½. These are known as retirement accounts, because they aren’t very accessible until you get near retirement age. Except for Roth accounts, these accounts also carry a tax burden since you’ll need to pay income taxes on the money once you withdraw it sometime down the road. A Non-Qualified account uses “after tax” money, meaning that any income tax burden from that money has already been paid. However, you will also get taxed on the growth inside that account along the way. This is known as capital gains tax, and it comes in two forms: long-term capital gains or short-term capital gains. More on that in a minute.
This basic information is only the tip of the iceberg when it comes to the deciding where to invest. With each account type, there are several nuances and strategies that an advisor can help you implement to keep your tax burden low and keep more money in your pocket.
Tax Strategies
One of the main aspects of a financial plan should be the strategies being taken to reduce taxes and increase the amount of your money that stays in your pocket. Using the tax code to your advantage is something every investor should keep in mind. Too often, investors simply focus on the rate of return inside their accounts instead of the tax equivalent rate of return, which is your bottom line once you assess any taxes to that return. Using an investment strategy that runs hand-in-hand with a tax strategy is the best way to maximize your true return on investment. This is especially true for physicians as they tend to be high-income earners and high net worth investors.
The first strategy is as much a conceptual understanding as it is a strategy. As we hinted at previously, there is a difference between short-term capital gains vs. long-term capital gains. Understanding this difference will help you grasp the other strategies and possibly help you save on taxes resulting from transactions inside your investment account. The first thing you need to remember about either ST or LT capital gains is that they only apply inside Non-Qualified accounts and they only occur when an investment is sold. The next most important thing to know is that LT capital gains (or losses) are applied for investments that were held for a year or longer before they were sold. Likewise, anything that was sold after being held for less than a year would be considered ST gains/losses. Understanding the difference between ST and LT capital gains will help you understand the next tax saving strategy.
This strategy is called Tax Loss Harvesting. This is a simple concept that keeps in focus how a Non-Qualified investment account is taxed. Remember that NQ accounts will have tax implications each year based on their realized gains and losses. Gains or losses become “realized” when the investment position is sold. The difference between what you paid for it and what you sold it for becomes your realized gain or loss (depending on whether you made a profit or took a loss). If you have realized gains inside an account, then it will be taxed as either long-term or short-term capital gains depending on how long you’ve held the investment. Short-term capital gains are taxed at your income tax bracket, so this is especially important to keep in mind for high-income earners who are getting taxed at a higher rate. Long-term capital gains are taxed at either 0%, 15%, or 20% depending on your income. Realized losses inside the account create the opposite effect. They can count against your income and can actually lower your tax burden. Not that anybody wants to see losses inside your account, but if they do occur, you can “harvest” those losses by selling the positions you own and locking in the losses as “realized” losses. Remember, your gains and losses don’t create a tax implication until they are “realized”. You’ll just have to make sure you don’t purchase that same position again in the next 30 days, because your realized losses could be wiped out by wash sale rules. See how this can get complicated!?
Another concept that often works well for physicians is what’s known as the Backdoor Roth. This is considered by many to be a tax loophole that legislators have never closed. Essentially, the Roth IRA is designed so you can take “after tax” money and put it inside a Qualified account and never have to pay taxes on that money again. You can also take other Qualified money and convert it to Roth (known as a Roth Conversion) at any time with few restrictions as long as you pay income tax on the money converted, which becomes a key step of the Backdoor Roth. The original tax law intended to keep high income earners from being able to participate in Roth IRAs because contributions to a Roth IRA aren’t technically available for single earners who make more than $144,000 annually or for a married couple who earns more than $214,000 annually. On the flip side, you are allowed to make traditional IRA contributions at any income level, but after you earn more than $76,000 as a single filer or $125,000 as a married couple, you are no longer allowed to deduct your contribution from your income (thus eliminating much of the tax benefit). Based on this info, it would seem that high-income earners, like most Attending Physicians, get excluded from these tax benefits. But this is where the “loophole” becomes apparent. Although not the intention of these tax laws, it was never prohibited for a high-income earner to contribute to a traditional IRA and then immediately convert it to Roth. Essentially, high-income earners need to take an extra step to make a Roth contribution, but they can do it through the Backdoor Roth method.
Staying the Course
What are you doing today that’s going to take you where you’d like to be tomorrow? Too often we make financial decisions without understanding or even considering what the long-term ramifications of these decisions could be. These often come as a result of emotionally based justifications for bad financial decisions. You wouldn’t advocate for this type of decision making in the field of Medicine, so don’t let it dictate your financial workup when faced with a financial hurdle. Most people’s main financial enemy is themselves, so stick to your plan and don’t let yourself talk you out of it. If this is something you might struggle with, here are a few tips to help you stay out of your own way:
As we’ve discussed already, make sure you have proper insurance in place to protect from the big, unforeseen financial hurdles. Get your policies set up and put your premium payments on auto pay.
If monthly investing or debt payments are part of your plan, put them on auto pilot so you don’t have to convince yourself to enact your plan each month. Set up automatic contributions that get pulled from your checking account and automatically contribute to your success.
Review your plan at least every six months to make sure you are still on track, and nothing has changed.
Review your plan before you make any large purchases or financial decisions, like taking a new job. This will help you keep your plan in mind as you make your life choices.
As always, if you could benefit from a financial advisor who understands the unique financial challenges of physicians, don’t hesitate to reach out by clicking on the big yellow button below.
Thanks for reading! For more articles geared toward young physicians and their money, click here or check out The Money Malpractice Podcast on any of the major platforms.
Until next time…KEEP SAVING LIVES AND KEEP SAVING MONEY!
Disclosures
• RichMark Private Wealth Management. LLC is registered as an investment adviser with the State of Michigan, and only transacts business in states where it is properly registered, or is excluded or exempted from such requirements.
• Content should not be viewed at personalized investment advice. Market events and other factors may affect the reliability of the potential outcomes. Simulated growth is purely hypothetical and does not represent actual performance.
• Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client's portfolio.