Why tax planning matters for your retirement

November 8, 2020
Julianne F. Andrews, MBA, CFP, AIF

Medical Economics Journal, Medical Economics November 2020, Volume 97, Issue 15

Despite recent pressures on physician profit margins, a physician’s income remains relatively high compared with that of the general public. Without the proper tax planning strategies in place, a physician could face some costly surprises.

Despite recent pressures on physician profit margins, a physician’s income remains relatively high compared with that of the general public. Without the proper tax planning strategies in place, a physician could face some costly surprises.

Understanding taxation

In 2020, a physician filing a joint tax return with taxable income exceeding $414,701 is taxed at the 35% federal tax bracket, which goes to 37% if taxable income exceeds $622,051. The physician would also be subject to Social Security, Medicare and state income taxes, as well.

For most working physicians, the majority of their income will come from their paycheck or practice revenue. In retirement, though, physicians will likely rely on multiple different sources to generate income including investment income, IRAs, social security, and possibly even pension plans. Each type of income incurs different tax liabilities and will affect your “take-home” amount in different ways.

For example, contributions made to traditional retirement plans with pre-tax dollars during your working years will be taxed upon withdrawal in retirement as ordinary income, but Roth IRA contributions made with post-tax dollars will not be taxed when withdrawn. A portion of your social security benefit is taxed based on your overall income (from 0%-85% of the benefit), which means physicians’ benefits will likely be heavily taxed.

Understanding how your retirement income will be generated will give you an overall plan for how to withdraw the funds with the least amount of tax liability chipping away at your resources. It will also allow you and your financial adviser to plan ahead — working to avoid becoming “tax deferred” rich and owing a huge chunk of change each year in retirement.

Capital gains & tax-loss harvesting

When selling a security, the tax rate on the gain in a taxable account is determined by the length of time you have owned the security. Since selling securities may be part of your draw-down plan for generating retirement income, you’ll need to know at which rate your securities will be taxed. Long-term capital gains are taxed up to 15%-20% depending on income, and short-term capital gains are taxed as ordinary income, which could be as high as 37% depending on your marginal tax bracket. A security qualifies for long-term gains when it has been held for over a year.

Sometimes, it may be advisable to take tax losses to offset capital gains elsewhere. This is known as “tax loss harvesting” and involves the selling of certain investments that show a loss in order to offset the high capital gains rates on other securities being sold or taxed that year.

Be aware of the “wash sale rule,” which prohibits individuals from claiming a loss if the same or substantially similar security is purchased within 30 days of the sale.

Maximize contributions

Other tax-minimizing strategies are related to the practice retirement plan, and thanks to provisions of the 2019 SECURE Act, can now be implemented both in the accumulation and decumulation phases so long as the physician is earning wages from noninvestment income.Physicians should maximize their annual contributions to their retirement plans to:

  • adequately prepare for retirement;
  • variegate their retirement income between tax-free, tax-deferred, and tax-advantaged accounts;
  • and lower their taxable income during their working years.

In 2020, physicians under 50 can contribute $19,500 each year to their 401k accounts while physicians over 50 can put aside that same amount plus an additional $6,500 each year, which makes them able to contribute a total of $26,000 to a 401k annually. Pairing a 401k with a profit-sharing plan can further increase the annual contribution to $57,000 for those under 50 and $63,500 for those over 50.

Any amount that is contributed to a 401k is made with pre-tax dollars.

In previous years, physicians could only continue contributing to their IRAs until age 70½ when they were forced to begin taking Required Minimum Contributions (RMDs). However, the 2019 SECURE Act both extended the RMD age to 72 and eliminated the curtail on making contributions.

One caveat: the physician can only continue to make contributions past this date if he or she shows earned income not generated from investment accounts. This change will especially benefit those individuals who continue to work past age 72 in some fashion and allow a tax deduction for contributed funds.

Julianne F. Andrews, MBA, CFP, AIF, is a principal and co-founder of Atlanta Financial Associates. Send your financial questions to medec@mjhlifesciences.com

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