Tax, investment and insurance mistakes doctors make when following advice that is designed for tens of millions of average Americans, and how to avoid these pitfalls.
In part one of this article you learned why the strategies and techniques used by most attorneys, accountants and financial advisers betray physician families that pay high marginal taxes, are subject to heightened government control and have greater liability risk and retirement challenges than average American families do. Part one offered three common mistakes doctor families make:
Not using a corporation (or using the wrong type of corporation).
Owning assets your name, spouse’s name, or jointly with spouse.
Wasting time and money on traditional qualified retirement plans.
Now we will focus more on tax, investment and insurance mistakes doctors make when following advice that is designed for tens of millions of average Americans. When professionals with significant tax, asset protection and retirement challenges use tools designed for people who pay little or no tax and will never be sued, problems are bound to arise. More importantly, this segment of the article will offer you some helpful hints to avoid these pitfalls.
Don't pay full price when the government offers to pay half
Technically, the government (Internal Revenue Service) is not paying half of anything. However, if it offers 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 half as expensive for you the government will allow you to deduct this purchase.
You must realize that nearly 50% of Americans do not pay any federal income tax, according to the IRS. In 2009, Exxon boasted $45 billion of profit to its shareholders — with $0 of U.S. income taxes paid. You can either look to advisers who can help you legally reduce any unnecessary taxes or you can let the system work for everyone else but you. Let’s look at an example of one simple way to use tax laws to your benefit.
Physicians can deduct Long Term Care insurance (LTCi) through their practices. Over 60% of American households will require some sort of Long Term Care assistance. Doctors, more than any other segment of the population, realize that longer life expectancies and skyrocketing medical costs significantly increase the probability of a family facing an illness with devastating financial consequences.
There are also non-traditional benefit plans that also allow physicians to make contributions of $100,000 or more per year, discriminate to only include the doctors or key employees, and access the funds before age 59-and-a-half 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.
Stop wasting money on taxes and term insurance premiums
A famous female financial adviser with her own TV show is one of many advisers to tout, “Buy term insurance and invest the difference.” This is excellent advice for the “Average American” family that earns $49,000 per year, pays 12% in federal income taxes and has no potential liability or estate tax risk whatsoever. This is a perfect example of good advice for most people being terrible advice for high-income specialists.
Without a shifting of risk through a long term care insurance policy, you will have to pay for this assistance from your savings. You can cover your spouse through the practice even if you both are not physicians or employees. If you are a C corporation, you may receive a tax deduction for 100% of the premiums and can pay all of the premiums over a 10-year period to take advantage of the deductions during your prime earning years (when the deductions are most valuable).By paying premiums over a short period of time, you will ensure that you will not have unexpected expenses for this insurance once in retirement. Unlike traditional retirement plans where contributions are tax-deductible and benefits are taxable, Long Term Care insurance premiums can be tax-deductible and the benefits are 100% tax-free
Most Americans pay very little tax on investment income and don’t care about asset protection, so the advice to disregard the tax-free accumulation and creditor protection benefits of cash value life insurance to maximize taxable investment accounts is fine … for those people.
Beyond temporary income protection against the premature death of the breadwinner, the Average American has little need for cash value life insurance. This advice is good if you have the following characteristics:
1. No concern over lawsuits against me, my partners, my employees or my family.
2. Not worried about 23% to 47% of my investment income going to taxes.
3. Don’t mind 40%-70% of certain assets in my estate going to taxes when I die.
Let’s look at it more closely:
Does this sound like the typical physician situation? Of course, it doesn’t. These completely different characteristics clearly illustrate how “off the rack” planning that is widely accepted by the media and the general population may not adequately help doctors address their unique challenges.Physicians should 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.
2. Investment gains within cash value life insurance policies are tax deferred and can be accessed tax-free.
3. For relatively healthy insureds, the annualized cost of all internal expenses within a life insurance policy range from 1% to 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.
1. Mutual funds growing at 8% (taxable) are worth 5% to 6% (after taxes) to high-income taxpayers like you and worth 7% or more to Average Americans.
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 Average American families who have no real financial threat of a lawsuit.
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 $36,940 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 $47,080 per year (no taxes on policy withdrawals of basis and loans) and has $511,833 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.
David Mandell, JD, MBA,
is a principal of the financial consulting firm OJM Group and author of
, which is available for free (plus $5 S&H) by calling (877) 656-4362. R. Paul Wilson, CRPC is a consultant with 10-plus years working with physicians.
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This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized legal or tax advice. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes 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.