Should Doctors Invest in Retirement Target Date Funds?

Note: This article originally appeared in Oncology Practice Management.

Physicians seem to have a natural affinity for complexity. That’s a good thing for patients with difficult diagnoses, but it’s a prescription for disaster when it comes to investing. Owning a myriad of securities spread across a dozen or more financial accounts usually means more taxes, more transaction costs, less clarity, and more time spent on investing.

How Much Time Should Doctors Spend on Investments?

It is this last bit, the time spent, that is the problem. Studies show that paying too much attention to the markets and your investments induces you to trade more often, and every time you trade, you run the risk of making a bad decision. Trading and “managing accounts” gives the illusion of control but usually delivers subpar results, studies show.

September 2016 marks the 40-year anniversary of the first index mutual fund, the Vanguard Index 500 Fund. It was Vanguard founder John Bogle who once said, “Don’t just do something, stand there.” This has proved to be some of the best advice ever given for physicians who owned the right investments in the first place.

What Is the Right Physician Investment for the Next 40 Years?

This question cannot be answered precisely but one thing is for certain: if an investment strategy is going to weather all the shocks of 4 decades worth of political change and economic upheaval, it has got to be diversified, very diversified.

Today it’s easier than ever for a physician to buy one or two mutual funds and hold those funds forever, knowing that you have made the right move.

What we are talking about is a mutual fund of mutual funds (aka a “fund of funds”). Although this may not ring a bell, the words “target-date retirement fund” are heard more loudly now than ever before as the likes of Vanguard, Fidelity, and T. Rowe Price have brought them to 401(k) accounts everywhere. In fact, these funds are so much a “best practice,” that they are often the qualified default investment option found in physicians’ workplace retirement plans. That means that if you are newly enrolled in a 401(k) plan, and you fail to make an explicit investment choice, you will likely end up with a target-date fund geared toward your age 65.

How Do Target Date Funds Work?

Target-date retirement funds own a mix of stock mutual funds and bond mutual funds, and that mix shifts gradually over time, becoming more conservative every year. For example, a physician in his or her mid-30s may own the Target Retirement 2045 Fund, which starts off owning mostly equities today, then shifts to a balance of stocks and bonds at age 65, and grows even more conservative as that doctor approaches age 80, when the fund holds mostly bonds.

When you look under the hood of these target-date funds, you can find a variety of exposure, including stocks of large, well-respected US blue-chip companies, tiny microcap stocks you have never heard of that will be tomorrow’s Google or Apple, international stocks, emerging market stocks, and even real estate investment trusts. All target-date funds will own bonds during their glide from aggressive to conservative, and these may include US treasuries, corporate bonds, emerging market bonds, TIPS, and even floating rate bonds. Some target-date funds will also own commodities.

One of the best-known target retirement funds, the Vanguard Target Retirement series, owns 4 of Vanguard’s “total” funds, including their Total Stock Market Index, Total International Stock Index, Total Bond Market Index, and Total International Bond Index funds. That last fund was added to the lineup only a few years ago. 

Doctors who invest in these funds own practically all the stocks and all the bonds available, which means they should either worry about everything or nothing at all, and worry has never been as profitable as optimism.

So what does this worry-free investing cost? With index-based target-date funds, the cost is very, very low. For example, a $100,000 investment usually costs approximately $150 annually, or 41 cents a day. Professional management, uber-diversification, and peace of mind can be had for less than the price of a cup of coffee. You don’t even need to pay an investment advisor to “manage” it for you, because it is already managed.

Target Date Funds Not a Great Investment for Every Physician

There are at least two situations that are not a great fit for a target-date fund approach to investing. The first case is money invested in a taxable account, such as a joint, individual, or trust account. In these accounts, the income from bonds held inside the mutual fund is taxed as ordinary income. For physicians in high tax brackets and high-tax states, such as California, New York, Wisconsin, and Minnesota, this may mean sacrificing 50% of the interest to the “tax man.”

The solution for these situations is to own two funds. The first fund can be a tax-exempt bond fund, maybe a fund that holds bonds issued by the state where you live, so that the interest paid is exempt from federal and state income tax. The second fund may be a global stock fund, such as the Vanguard Total World Stock Index or the DFA Global Equity Fund, both passively managed funds that tend to be naturally tax-efficient. Physicians can combine these funds in any ratio to match their appetite for risk.

The other case in which a target-date fund may not be a good fit is when a physician who wants a steady and unchanging exposure to risk, meaning that the mix of stocks and bonds does not change as you age. For this, there is another category of funds-of-funds known as “life stage” or “target risk” funds. With these funds, investors usually have a choice of aggressive, moderately aggressive, balanced, or conservative funds that own a static ratio of stocks and bonds, usually ranging from 80% stocks and 20% bonds and all the way down to 20% stocks and 80% bonds.

Look Before You Leap

Although all retirement target-date funds work essentially the same way, they are not all the same. The underlying funds can vary greatly. For example, actively managed funds from Fidelity may lean toward growth stocks, whereas T. Rowe Price’s target funds hold junk bonds in their fixed-income sleeve, something not seen in the Vanguard funds, which take a middle-of-the-road approach.

The way in which each fund family shifts the investment mix over time, known as the “glidepath,” varies substantially. Although all 3 company’s funds begin with a 90/10 mix of stocks and bonds, Vanguard and T. Rowe Price begin adding more bonds 25 years before the retirement target date, whereas Fidelity begins adding bonds 20 years before retirement. The retirement end point allocation varies too. Fidelity and Vanguard hold a 50/50 allocation at retirement, whereas T. Rowe Price is 60/40.

In most cases, you will not get a choice about glidepaths, because the suite of target-date funds is chosen by a plan administrator, and there is usually only one suite from one company.

Target Date Investing is Smart Choice for Most Physicians

Although physicians often come up with far more elaborate ways to invest, it would be difficult to come up with a strategy of investing that is as simple, practical, and cost-effective as investing in a fund-of-index-funds. And this way of investing can save you more than time. It can lead physician investors  to avoid the mistakes that lead to worse outcomes.

15 Ways New Physicians Can Get On Track Financially

Your first year in practice is busy. In fact, you may have overlooked a few financial moves that can save taxes, avoid problems and lead to success. While financial planning for doctors is not complicated, it does require time and energy that’s in short supply during the first year or two of practice. To start making progress, you can use the following steps as a checklist to get on track with your finances.

1. Choose your family’s financial leader.

Your finances will run more smoothly when you choose one family member to be responsible for your money. That doesn’t mean they make all the decisions alone. It means all financial communications and major decisions pass through their hands so that they can keep your family moving in the right direction. If you are not sure whether you or your spouse will be better at this, pick the person who is more organized, the person who checks the mail, or the one who is most plugged in to the online world.

2. Find a competent, caring financial advisor.

Your family CFO may need someone to act as their eyes and ears, to keep them informed, and give them guidance. When you select an advisor look for one who will listen to you, speak clearly, and make themselves available to help when needed. Be certain the advisor is a fiduciary who is compensated on a fee-only basis with at least ten years experience and the Certified Financial Planner™ mark.

3. Find a bank that will save you time.

Look for a bank that’s large enough to handle your needs, but small enough to offer responsive service. If a “relationship banker” is available to you, be certain to spend some time getting to know them and what they can do to make your financial life run more smoothly. If you are banking your medical practice, a community-based bank might be a good fit for you. If you have minimal banking needs, consider using a credit union instead. They tend to offer higher rates on deposits and lower rates on consumer loans and lines of credit. The best bank won’t make you money but it will save you time.

4. Find a responsive, knowledgeable tax preparer.

Medical specialists earn more than 95% of all other taxpayers. That’s the good news. The bad news is that you will give up about half your earnings to the taxman over the next 20-40 years of your practice but a solid tax person can help you pay no more than you absolutely must. To find the right tax preparer, get a name or two from your colleagues and ask your financial advisor for a third name. Interview all three candidates and choose the one who makes you feel most comfortable. Avoid tax advisors who sell insurance and investments. Schedule a November tax planning session for the current tax year.

5. Use a reasonable, approachable attorney.

The best way to use an attorney is early and often. To find the right one, ask your colleagues who they use, ask your tax preparer for a referral, and ask your financial advisor who they prefer, then select your attorney before you really need their help. The best choice is likely to be a business attorney who also handles trusts and estates. Ask them to prepare a simple will for you now, and plan to do more complex estate planning as your net worth grows.

6. Re-examine your disability insurance.

You may have purchased disability insurance as a resident, but you’re probably not “covered.” Why? Because your income has increased now that you’ve begun to practice. Disability coverage is one of the most complex forms of insurance and special provisions apply to physicians. Seek the help of a disability insurance specialist who has at least 10 years experience with disability insurance for doctors and ask them to explain the “definition of disability” for any policy you own or may be asked to purchase.

7. Form a general financial game plan.

Before you make any major financial decision, find out how much it will cost to achieve the goals that lead to financial security for your family. Ask your financial advisor to help you put together a plan to refinance your student loans, save for college, and build a fund for retirement. Try to answer the question, “How much do I need to save each month to make sure I’m on track?”

8. Purchase a reasonable home.

Note that we didn’t say, “Build the nicest home you can afford.” Many, many physicians jeopardize their ability to achieve financial security by buying an expensive home whose payments make it challenging (or impossible) to save for other goals like college and retirement. Think about what your family needs in a home, form a budget, and stick with it. Once you become accustomed to living in a larger home, there’s no going back to a smaller one.

9. Load up on life insurance… term life insurance, that is.

Ask your financial advisor to help you calculate how much money you may need in order to pay off your home, create a college savings fund, establish an income for your survivors, and cover the cost of their retirement. Remember to diversify your policies the same way you would diversify an investment portfolio. Plan to pare back your coverage over time as you make progress toward your goals. Avoid permanent or “cash value” life insurance, especially variable universal life (VUL).

10. Re-discover your employee benefits.

If you work for a hospital or clinic, ask your human resources person to provide a list of all the benefits available to you – retirement, insurance… even parking passes – and schedule a time to meet with them to review the list. Make sure you’re getting the benefits you earned. If you are self-employed, talk to your financial advisor about ways to save taxes while you save for retirement, including a solo 401(k), profit sharing plan and defined benefit plan or “cash balance” plan.

11. Get a PLUP.

No self-respecting physician would willingly go without malpractice insurance but many will drive cars, walk dogs and coach sports teams without the type of insurance that protects them from claims that arise from accidents in these activities: a Personal Lines Umbrella Policy (PLUP). Ask your property and casualty agent to integrate your PLUP’s coverage with your home and auto insurance.

12. Establish an emergency savings account.

If you and your spouse/partner both work, set aside at least three months worth of living expenses. If only one of you earns an income, set aside six months worth of living expenses. Put this money in a safe place like a bank certificate of deposit or money market fund. You may never need it, but if you do you’ll have it.

13. Get a handle on your student loans.

Refinancing a student loan means getting a new loan to pay off an old one. The key is to get better terms—a lower interest rate or a lower payment—on the new loan without sacrificing protections, pledging more collateral or adding a co-signer to the new loan. A sound refinancing decision requires physicians to know the costs and benefits of their current student loans and be able to compare them to the costs and benefits of options for new loans. Think twice before you refinance federal loans using a private loan.

14. Start saving for college.

Kids grow up in a hurry, and the cost of college education has historically grown at a rate more than twice the average rate of inflation (about 7% per year). After you’ve fully funded your retirement plan and your emergency savings account, this is probably the next best place to be saving and, for most physicians, a Section 529 college savings plan is the best vehicle. Check to see if your state’s 529 plan offers tax incentives.

15. Organize your financial life.

At home, make a place for everything: bank statements, investment records, estate planning documents, insurance policies, tax documents, etc. Develop a system for keeping track of passwords so that you and your spouse/partner both know how to access your online accounts. Consider the installation of a safe for valuables and extra boxes of checks. (Most embezzlement situations we see begin when the nanny or housekeeper steals a spare set of checks.) If you use a cloud-based service to store everything, make sure your spouse has access in case something bad happens to you.

Get Started!

As a new physician, it may be challenging to find the time and energy to pull all of this together. Set aside some time this weekend, tackle one of these items, then come back to this list every now and then until you manage to get your family’s financial planning all done.

What is a doctor loan?

A “doctor loan” or physician home loan is a mortgage that makes it faster and easier for residents, attending physicians and other medical professionals to buy a home with a low down payment while avoiding mortgage insurance.


What are the advantages of a doctor loan?


Doctor loans—which have been around for decades—were originally designed to lure soon-to-be affluent medical professionals into the banks. Physicians represent not only a profitable niche but also a good risk for the banks since doctors default on their loans at the lowest rate of any profession. All of these advantages hail from the bankers bending over backward to win your business, and the advantages are real.


1. Doctor loans avoid principal mortgage insurance (PMI)

Principal mortgage insurance (PMI) is an insurance policy that protects the bank if you, the mortgagee, “default” or fail to make the promised payments on your home loan. PMI is expensive, does you zero good and it’s not even tax deductible, so physicians should avoid it when they can.

You can dodge PMI if you put 20% down on a home but many young doctors simply don’t have that kind of cash. With a doctor mortgage loan and a decent credit score, physicians can borrow 95% to 100% of the home’s purchase price with no PMI. A low or zero down payment leaves more money for other goals like paying off student loans, investing for retirement or saving for college.


2. Doctor mortgage loans help physicians get into a home sooner

Since they use a physician-specific loan approval process, the lenders behind doctor loans may allow you  to close on your home up to two months before you actually begin your practice.

These lenders use your employment contract as proof of income instead of relying on two years worth of tax returns. Josh Mettle, who handles doctor loans nationwide at Fairway Independent Mortgage Corporation, notes that “this is huge for physicians relocating across the country, needing to get their family settled and house in order before they start a busy work schedule.”

Bear in mind, no two physician employment contracts are created equally.  When applying for a home loan, even a doctor mortgage, you should have your employment contract reviewed by the lender as early as humanly possible so you can plan accordingly. Mettle advises his clients to make sure that their employment contract is not only reviewed and approved by the loan officer, but also by the underwriter who will eventually have the ultimate power to approve the loan.


3. It’s easier for debt-ridden physicians to qualify for a doctor loan

Many doctor mortgages do not include deferred student loan payments when they calculate the debt-to-income (DTI) ratio that bankers use to make lending decisions. This can make the difference between qualifying for a loan or being shut out of your dream home. For physicians early in their attending careers or carrying heavy student loan burdens, this factor can make a doctor mortgage loan the only option since conventional and jumbo mortgage loans are not nearly as accommodating to those with medical school debt.
 

What are the disadvantages of a doctor loan?


While there’s nothing inherently “wrong” with these loan products, they make it easier for unwary doctors to get into financial trouble both now and for years to come. The disadvantages of doctor loans have everything to do with how they are used.


1. Physicians get in over their heads when doctor loans go wrong

The appeal of a “nothing down loan” or a low down payment conceals the downside risk of a leveraged real estate purchase.

Consider this example. A physician buys a one million dollar home with a one million dollar doctor loan with a zero down payment.  Then, when the real estate market hits a bump and home prices drop by an average of 10%, she will own a $900,000 house with a $1,000,000 loan, which results in  $100,000 of negative equity. This condition, known as “being upside down in your home,” was quite common during the post-2008 housing crisis.

Young doctors who sold homes like these were required to come to the closing table with a check for $100,000 just to be able to consummate the sale of their home. And remember, that’s $100,000 in after-tax money, which is about $200,000 in pre-tax earnings, or the equivalent of one year’s salary for the average physician. Ouch!


2. Doctor loans make housing decisions faster but not better

In his book, “Decisive: How to Make Better Choices in Life and Work,” behavioral economist Chip Heath points out that people (doctors included) are bad at imagining the future and worse at imagining how we will feel in that future. As a result, we tend to make decisions that we believe will make us happy but don’t.

This reality bears itself out in “the dream home” that many physicians envision for themselves while they are still in training. The perfect job and the perfect house in the perfect location might bring happiness but alas, perfection is far from perfect.

Sometimes young doctors take a job in a new city only to realize that the weather is not quite what they had imagined, the schools are not up to speed, or worse… they realize that their new partners are bilking Medicare. So they move, and they bear all the costs of a housing mistake.

The instant money that comes from doctor loans leaves no time for physician families to slow down, rent for a while, build up savings, pay off and refinance high interest rate loans, shop the market or really consider the things that are known to make people happy. One of these things is a sense of making real progress toward financial security.


Is a doctor loan a good idea?

Buying a home is a big decision with far reaching consequences. Physician mortgage loans are nothing more than a tool that may make things better or worse for you depending on how you use it. Take some time to consider not only the pros and cons of a doctor loan but the impact it may have on your life.

Josh Mettle, the author of “Why Physician Home Loans Fail: How to Avoid the Landmines for a Flawless Home Purchase”, is a mortgage lender with Fairway Independent Mortgage Corporation where he specializes in mortgage financing for physicians. Check out his podcast on Physician Financial Success. or visit his website about reverse mortgages.

7 Ways to Get Financially Organized Without Wasting a Bunch of Time

As a physician, it’s hard to make progress toward your goals if you’re lost in a sea of accounts and paperwork. Dealing with the scattered bits and pieces of your financial life make it impossilbe to see whether or not you're really on track.

But if you can get financially organized, you create a clear path in front of you that makes it easier to build financial security for your family.

Ready to get started? These seven strategies will allow you clean up your finances right now.

1. Go Paperless

Start the organization process by cutting off what supplies the clutter: an endless array of paper statements sent by every company you work with each month.

Turn off paper statements and get documents electronically. This limits the amount of paper you physically have sitting around on your desk. It’s also safer, since things won’t get lost or stolen in the mail.

Next, set up a cloud-based storage system to keep your information in a single, easy-to-access place. Google Drive is a great (and free) option, and you’ve already got it if you’ve got Gmail.

You can log into your cloud storage from any device -- laptop, smartphone, iPad -- and access all the same information anywhere.

2. Keep Your Information Safe and Secure

Managing everything online and electronically is a great method for staying financially organized -- but it’s not without its own risks and challenges. The biggest? Keeping all that information safe.

Use strong passwords, and assign a different password to every account. You don’t want to write these down in a place where someone else could see or take your notes, either.

So use a tool like LastPass to generate encrypted logins for every financial account you have. The service “remembers” all that data and manages it in one place for you. If you go this route, turn on 2-factor authentication for added security.

3. Throw Out What You No Longer Need

Even after you make the effort to go paperless, you’ll likely receive some physical documents by mail. Do you need to keep all that stuff?

It is important to hang on to certain documents, but you want to make sure you’re not just accumulating clutter. Go through your existing financial information and make sure you’re only keeping what you actually need:

  • Annual tax returns (always keep the returns; you can toss supporting documentation for individual returns after 3 years)

  • Year-end statements from investment accounts (keep for 3 years, then you can toss)

  • Documents that contain records that relate to your home, for as long as you live in or own that home

  • Forms that show contributions and withdrawals from IRAs and 401(k)s, and any 8606 forms (you’ll have these if you reported nondeductible contributions to traditional IRAs)

You can throw out things like receipts and deposit slips after you receive your monthly account statements (and ensure all the charges match up to your records). And you don’t need to keep pay stubs after you receive your W-2 for the year.

4. Create a Process for Paperwork and Documents

Keep the physical paperwork you do need to hang onto nicely organized. Our simple 3-step process for managing it all can help:

  1. Get a large box and label it. Write “Financial Records,” and the year.

  2. As you receive all your paperwork throughout the year, you can put your documents into the box. You don’t even have to organize it neatly; just put it in as you receive it.

  3. At the end of the year, choose a spot where you can store the box. Place it there and then get yourself a new box. Write “Financial Records,” the new year, and repeat the process. After a couple of years go by, you can move older boxes to the attic or basement.

This ensures you keep what you need, you know where it’s at, and you don’t need to continuously sort through it. If you need to fetch documents for your financial planner or tax preparer, you’ll know where to find your box.

5. Choose the Right Credit Cards

Keep your credit in check by using it deliberately. Get 2 credit cards and use one for online purchases. Use the other for in-person transactions, so you always have a useable card if one becomes compromised. Some card issuers will even issue two cards on the same account, making things even easier.

Choose credit cards that offer cash back, not points or miles, like these:

  • Quicksilver® Rewards from CapitalOne: Earn unlimited 1.5% cash-back on every purchase.

  • Discover it® Card: Get 5% cash back in rotating categories (like gas stations, restaurants, and Amazon) that change each quarter, and unlimited 1% cash back on all other purchases.

6. Audit Your Accounts

When’s the last time you tracked down every financial account with your name on it? Make a list of all your bank accounts, credit cards, investment accounts, retirement plans (from past and present employers), and so on.

Consider closing accounts that you don’t use anymore. You could also consolidate accounts, whether it’s putting two savings accounts together or rolling over an old retirement plan into your current account.

Do the same with your service and subscription accounts. Make a list and then ask: do I use these? Do I need them? Close the ones you don’t want or need. More organization means more savings.

7. Refinance and/or Consolidate Student Loans

Refinancing your student debt can save money. It can also provide you with a more manageable financial situation if you consolidate multiple loans into one.

When you refinance, you get a new loan to pay of an old one (or a single new loan to pay off multiple existing debts).

Refinancing and consolidating may make sense if you can originate that new loan with better terms -- and without giving up benefits that came with the old debt, having to put up collateral, or getting co-signer on the new loan.

Use our guide to refinancing medical school debt to help you decide if this should be part of your financial organization process.

Building a solid financial foundation starts when you get financially organized and put your information in consolidated, easy-to-reach places.

Need help getting started? Get subscription-based financial advice to help you organize your financial life and then start taking action toward your goals.

13 Tax Mistakes Doctors Make That Cost Thousands

Tax mistakes are the most common financial mistakes physicians make. Errors, oversights and outright blunders cost thousands in unnecessary income taxes so a little tax planning goes a long way to save money for doctors.

If you want to catch mistakes before they cost you, check out the list below. By the way, the financial mistakes you see here are real: we have seen at least one doctor make every error on this list. (See Assumptions at the end of this article.)

1. Overlooking the Health Savings Account means overpaying taxes

A Health Savings Account (HSA) is a tax-advantaged savings vehicle that lets you make tax-deductible contributions, enjoy tax-deferred growth, and make distributions that are tax-free when used to pay qualified medical expenses. it’s also the best tax break you can get as a physician since it’s a permanent benefit.

Anyone who is covered by a qualifying high deductible health plan (HDHP) can contribute to a Health Savings Account. Many doctors don’t know they have a HDHP option or they don’t understand how HSAs work, so they stay the course with first-dollar coverage and lose the tax benefit.

This mistake costs doctors who are eligible for a family HSA plan $2,228 each year.

2. Spending your HSA makes healthcare less affordable in retirement

Health Savings Accounts are poorly understood by most physicians who often mistake them for FSAs (Flexible Spending Accounts). With the balance in a Flexible Spending Account, you must “use it or lose it” by the end of the year. With HSAs though, “using it” means you lose the power of tax-free compound growth. The smart move here is to invest the HSA balance and let it compound over time.

By making the mistake of spending your HSA each year, you throw away more than $390,000 in tax-free earnings over a 30 year period and that’s money you could have used to cover the cost of healthcare in retirement.

3. Skipping the 529 tax deduction is like skipping college

Section 529 college savings plans are tax-deferred accounts that can be used to pay qualified higher education expenses including college tuition, fees, room, board and the cost of a computer.

While almost every physician has heard about 529 plans, it’s no wonder they tend to skip the accounts altogether. The rules— including how much you can contribute, how much you can deduct, how many accounts you need and whether the deduction is granted to one taxpayer, one return or one account—all vary from state to state. Still, it makes sense to puzzle out the rules, especially in more expensive states where the top tax rate can run to 9%.

Physicians who pay taxes in Colorado, Georgia, Idaho, Iowa, Kansas, Louisiana, Maryland, Michigan, Mississippi, Missouri, Montana, Nebraska, New Mexico, New York, Ohio, Oklahoma, Oregon, Rhode Island, South Carolina, Utah, Virginia, West Virginia, and Wisconsin all get a state tax break. In Oregon, the deduction is worth $455 per year. In New York, it’s worth $882 per family. In a handful of states—Colorado, New Mexico, South Carolina and West Virginia—the deduction is unlimited. Perversely, the state with the highest tax rate offers no deduction at all: thanks California!

 No matter where you live, 529 plan accounts can grow tax-deferred until you withdraw the money to pay for college, tax-free. Assuming a savings fate of $500 per month over 18 years, skipping the 529 plan is a mistake that can cost physicians over $90,000 in tax-free growth: enough to send one child to a state college for four years.

4. Believing you cannot contribute to an IRA leaves assets unprotected

Tax advisors often tell physicians “you cannot deduct an IRA contribution” which doctors mistakenly understand to mean, “there’s no reason to do an IRA.” It’s the first logic error in this two-part tax blunder.

Assuming annual household contributions of $11,000 over 30 years, the “tax arbitrage” opportunity—the way you can leverage your current high tax bracket against the lower tax rates you will see in retirement—is worth more than $168,000 to a physician family. The mistake is compounded by the fact that the alternative vehicle to hold these savings is often a taxable account where income and dividends are taxed every year.

When you combine this mistake with the fact that IRAs receive asset protection from creditors under the Bankruptcy Abuse Prevention Act, it’s easy to see how a well-meaning tax man’s casual comment can steer plenty of docs in the wrong direction. But there’s more to this story.

5. Failing to use a Backdoor Roth IRA makes retirement more taxing

A “backdoor Roth IRA” isn’t really a Roth IRA at all. It’s a Traditional IRA that receives a nondeductible contribution that is converted to a Roth IRA.

The physician family who contributes $11,000 to Traditional IRAs each year for 30 years ($5500 per spouse) and then dutifully converts those contributions to a Roth IRA will owe no income taxes to withdraw the money.

On the other hand, physician families who merely contribute to a Traditional IRA and fail to do the conversion will be forced to begin withdrawing the money at age 70½ and pay more than $90,000 in income taxes.

6. Ignoring Roth rules makes the Backdoor Roth (surprisingly) taxable

The rules surrounding IRA conversions are so complicated that many physicians wind up paying taxes for something intended to save them.

First, physicians need to understand there are two kinds of money in most IRAs: pre-tax money (that comes from 401k rollovers and previously deducted direct IRA contributions) and post-tax money (that comes from direct contributions that were not tax-deductible). You can think of this as “bad money” (pre-tax) and “good money” (after-tax). To effect a successful Roth conversion, you have to separate the good money from the bad (using a 401k rollover) or you will pay taxes on the bad money that is converted.

Second, doctors need to know that “IRA” means all of your Traditional IRAs, no matter where they are held, and your SIMPLE and SEP-IRA balances. The IRS sees all of these accounts as “your IRA” such that when you convert one, you are deemed to have converted a pro rata portion of all your IRAs.

Finally, even if you manage to separate the good money from the bad, you still need to handle your tax return correctly. If you fail to tell your tax specialist that you “converted a Traditional IRA with basis to a Roth IRA” or if someone fouled up Form 8606 of your tax return somewhere along the way, you are very likely to (unknowingly) pay unnecessary taxes which might conservatively be estimated at $3,600 for a physician family with two IRAs.

7. Rocking the wrong Roth makes doctors pay more tax now and less later

Did you know there are three Roths? It’s true. There’s the “front door” Roth IRA that’s right for interns, residents and hardworking but underpaid doctors who can contribute directly to a Roth IRA. Then there’s the backdoor Roth IRA that’s right for docs who cannot directly contribute to a Roth IRA. And finally there’s the Roth 401k that’s right for low earners but disastrous for high earners.

When you contribute to the non-Roth portion of your 401k, you are able to defer taxes into the future, when rates may be lower for you.

But when you contribute directly to a Roth 401k, you are essentially raising your hand to the IRS and saying, “please tax me now.” If you’re a high earner, you’ll pay an extra $6000 in taxes each year by rocking this Roth.

8. Underfunding your 401k is like giving extra money to the tax man

Sometimes it makes sense not to fund your 401k, like when there’s no employer match, when you’ve got a ton of high interest rate student loan debt and when you have zero dollars in your Emergency Fund. But for all but a few physicians, the best bet is to stuff your 401k as full as you can.

Even knowing this, many physicians fail to do so. Sometimes there’s a mix up and they fail to enroll. Other times they enroll but fail to contribute enough to get the match. And occasionally the contribution limits change but they have elected a flat-dollar contribution amount that’s never reviewed, resulting in a contribution gap.

To avoid paying an extra $6,000 to $8,000 a year in taxes, check your 401k account every year in September to see if you’re on track to make the maximum contribution by year’s end. If not, you still have time to fix it.

9. Working extra hard to pay extra taxes for self-employed physicians

Moonlighting, doing locums, researching, lecturing, teaching, acting as a contracted medical director and other sideline doctor gigs are a great way to pick up some extra cash—and extra taxes— if you overlook special deductions available only to self-employed physicians.

If you don’t have a 401k at work, you can easily set aside $18,000 in a tax-deferred self-employed retirement plan. Physicians who do have a 401k at work can establish a profit sharing retirement plan for their own business and contribute up to $36,000 in 2017. If you have a whole bunch of self-employment income, you can even establish a defined benefit plan and save even more. But doctors who didn’t know about these opportunities will likely pay somewhere between $2,000 and $9,000 in extra taxes.

10. Blowing up your retirement plan by overlooking the fine print

While this is a less common mistake, the consequences are dire. Small physician practices who lack a skilled business manager—often radiologists and ER docs—sometimes have an “everybody does their own thing” style of retirement plan in which everyone opens a SEP-IRA wherever they like and everyone contributes as much as they like.

In these cases, there is a de facto qualified retirement plan in place for the entire practice but there is no documentation and no one checking to make sure the contributions meet IRS guidelines. Occasionally these groups will hire a W2 employee and exclude them from the plan, which runs afoul of the rules surrounding “affiliated service groups.”

These situations are complex and often require an ERISA attorney and an accountant to straighten out the plan. Those who fail to get with the program run the risk of having their plan “disqualified” which leads to immediate taxation of the entire plan balance plus the payment of penalties, undoing all the tax savings from the plan. It’s impossible to estimate the cost of this mistake but know that the low end is on the order of tens of thousands of dollars.

11. Holding taxable bond funds in a taxable account

Although veteran investors know that a taxable bond fund generates income that causes state and federal income taxes, many physicians—even those under the care of financial advisors who should know better—own taxable bond funds in taxable accounts.

For example, a surgeon owns a joint account with her husband that holds $1.2 million in mutual funds, including $400,000 invested in corporate bonds. Those bonds yield dividends of approximately $13,000 this year. Their tax bill for these dividends is approximately $4,000, so only $9,000 remains of the return they garnered.

Had this couple purchased a tax-exempt bond fund that pays dividends of $11,000, they may owe no taxes. As a result, this couple would have an additional $2,000 this year and years to come.

12. Giving away tax benefits when donating to charity

When you give to charity, you can donate cash or you could donate securities. Since qualified charities are treated as non-profit organizations under the tax code, giving them appreciated securities means physicians not only receive a tax deduction but they avoid paying capital gains tax.

For example, a physician family owns mutual fund shares worth $50,000 for which they paid $30,000. If they donate the shares to charity, the charity can sell the shares to raise $50,000 cash and sidestep the capital gain. However, if that couple makes the mistake of first selling the shares, they will pay unnecessary capital gains tax of $2,000.

13. Just saying “yes” to stupid tax penalties

While many physicians assume the Internal Revenue Service is a bunch of jack-booted thugs intent on making life difficult, the IRS tends to be a little more understanding, particularly in the case of honest first-time mistakes.

If you have failed to file or failed to pay your taxes and it’s your first offense, you can ask for an “abatement” by writing a well-worded letter to the IRS asking them to waive the penalty. We all make mistakes but failure to ask for an abatement means sending good money after bad. Remember, if they say “no,” you are no worse off than if you hadn’t asked at all.

 

The biggest tax mistake physicians make is to think of taxes only at “tax time” when it’s too late to do anything about it. Most doctors file their personal taxes on a calendar year basis which means that you pay on April 15th for everything that happened between January 1 and December 31 of the prior year… after the fact.

To avoid making tax mistakes that cost thousands, start thinking about this year’s tax bill right now, and check in with your financial advisor and your tax specialist throughout the year to see what you can do to pay no more than what you truly owe.

ASSUMPTIONS: Federal marginal income tax rate of 33% (which kicks in at $230K for joint filers), a 20% capital gains tax rate, no state income tax, no Medicare surtax and a hypothetical 7% return. For post-retirement tax calculations, we assume a 25% federal marginal income tax bracket. These are conservative assumptions which means a few physicians will save less by avoiding the mistakes above but many doctors can save much more than what is demonstrated.