"Off the Rack" Financial Planning Not Appropriate for Physicians - Part 2

What do long term care and cash value insurance have to do with you? More than you think. Part two of this article focuses on tax, investment, and insurance issues that differ greatly for physicians.

In Part 1 of this article, we explained that physician families have substantially greater liability risk and retirement challenges than average American families do. This segment of our article will focus more on tax, investment, and insurance issues that differ greatly for physicians and non-physicians. Let’s get right to some of the mistakes that doctors make and offer you some helpful hints to avoid these pitfalls.

Mistake #4Paying full price when the government offers to pay half.

Technically, the Internal Revenue Service is not paying half of anything. However, if they offer you a tax deduction and your combined state, federal, and local marginal tax rate is close to 50%, you can think of a tax-deductible purchase as being 1/2 as expensive for you because the government will allow you to deduct this purchase. Let’s look at an example.

Suggestion: Buy Long Term Care insurance (LTCi) through your practice and let the government pay half. Over 60% of American households will require some sort of long term care assistance. This can be a short-term, relatively inexpensive proposition, or a devastating long-term liability that may cost hundreds of dollars per day for a decade or more. In either case, without LTCi, you will have to pay for this assistance from your savings.

If you purchase LTCi through your medical practice, you do not have to offer this for your employees. Further, you can cover yourself and your spouse through the practice even if you are not both physicians. Lastly, you get a tax deduction for 100% of the premiums if they are paid by your practice if it is a C corporation.

We understand that you will not practice medicine forever; this is not a problem. You can pay your entire life’s premiums over a 10 or 20 year period so that all premiums come from your operating practice (before you retire) and are 100% tax deductible. This way, when you retire, your premiums are paid in full and the government will have subsidized all of your payments. Unlike traditional retirement plans where contributions that are tax-deductible and benefits are taxable, LTCi premiums can be tax-deductible and the benefits are 100% tax-free. Because most doctors recognize the increasing costs of healthcare, this is a very popular strategy for our physician clients.

There are also non-traditional non-qualified retirement plans that also allow physicians to make contributions of $100,000 to $1,000,000 per year, discriminate to only include the doctors or key employees, and access the funds before age 59½ without penalty. These plans can be set up to be very important pieces of a family’s estate plan without sacrificing tax deductions or control of the assets by the doctor. For further information on these plans that are beyond the scope of this article, please contact the authors at (877) 656-4362 or Mandell@ojmgroup.com.

Mistake #5Wasting money on taxes and term insurance premiums.

A famous female financial advisor with her own TV show is one of many advisors to tout, “Buy term insurance and invest the difference.” This is excellent advice for the average American family who earns $42,000 per year, pays 12% in federal income taxes, and has no liability or estate tax risk whatsoever. The average family pays very little tax on investment income. It is possible that their tax on investment gains ranges from 10% to 15%. The average family is not worried about having its assets taken through a lawsuit. Further, the average family buys insurance solely for temporary income protection against the premature death of the breadwinner.

The Average American family also has no interest in long term liquidity for estate planning purposes because it will never have an estate large enough to warrant any estate tax. Does this sound like the typical physician situation? Of course, it doesn’t. This is a perfect example of how “Off the Rack” planning doesn’t work for you when it seems so popular for most people.

Suggestion: Buy cash value life insurance for tax savings and asset protection. If you are skeptical of this advice, ask yourself whether you are skeptical because you did the calculations yourself (or reviewed a careful analysis by an expert) or because you have heard, “Buy term insurance and invest the difference” so many times that you have just accepted it as fact.

Both authors have MBAs in finance and one has a degree in applied mathematics, so we feel our calculations are reliable in our proof that this advice is incorrect. To spare you the pain of a long mathematical proof, let us offer the following simplified analysis:

1. Mutual funds growing at 8% (taxable) are worth 5-6% (after taxes) to high income taxpayers like you and worth 7% or more to the average American.

2. Investment gains within cash value life insurance policies are not taxed.

3. For the relatively healthy insured, the annualized cost of all internal expenses within a life insurance policy range from1-1.5%.

4. For families in high marginal tax brackets, the cost of the insurance policy is less than the cost of taxes on the same investment gains within mutual funds.

Without even factoring in the cost of the term insurance (which would reduce the total amount in the mutual fund portfolio), the cash value insurance investment outperforms buying term insurance and investing the difference. Yet another benefit is that life insurance is protected from creditors, and even from bankruptcy creditors, in many states. This is a benefit that may interest a physician family, but be seen as worthless to the average American family who has no real financial threat of a lawsuit.

Example: Consider a 45-year-old healthy male who wants to invest $25,000 per year for 15 years before retirement and then withdraw funds from ages 61 to 90. Assume this individual’s tax rate on investments is 31% (50% from long term gains and dividends, 50% from short term gains, plus 6% state tax). Assume the gross pretax return of both taxable mutual fund investments and cash value life insurance are 8% per year.

  • The individual who invests in mutual funds on a taxable basis will be able to withdraw $37,000 per year after taxes (without factoring in the costs of purchasing ANY term life insurance or the cost of creating legal structures for asset protection — which a doctor may need to do to protect assets from lawsuits).
  • The individual who invests in cash value life insurance withdraws $42,500 per year (no taxes on policy withdrawals and loans) and has $1,000,000 of life insurance protection.

In the example above, it is obvious that buying term and investing the difference in taxable investments was not better than investing in tax-efficient life insurance for a highly compensated physician in a high tax bracket. The authors welcome your questions. You can contact them at (877) 656-4362 or through their website.

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.