Q&A

These magic words help physicians avoid big tax surprises in April

QUESTION:

"I just got my tax bill and it was a whopper. My tax guy asked me to write a check for about $30,000, which was a total surprise and a shocker since he asked me to write another big check late last year. I had to scramble to come up with the cash, and I don't want this to happen ever again. What I don't get is how this could have happened. When I wrote that last check, he said I would be okay. Did he drop the ball, or what?"

ANSWER:

I get this question almost every tax season, usually from physicians in their first or second year of private practice. The largest surprise tax bill I have seen was $150,000! Ouch.

Like the prison warden in the 1967 film classic Cool Hand Luke once said, "What we've got here is a failure to communicate."

As a financial planner for physicians, I know what you want is to have all your taxes paid by year end—before you file your taxes—so you can know how much of the money in your checking account is yours to spend, share, and save.

What your tax preparer  THINKS you want is to avoid paying a penalty for underpayment, and to hang onto your erstwhile tax money for as long as you can.

So when you told your tax guru, "I want to make sure I'm on track with my taxes," what he or she heard was, "Keep me out of trouble with the feds," not "I don't want to owe in April."

There are two things you need to know about taxes and tax people, things they didn't teach you in med school:

  1. Most tax people are genetically pre-programmed to help you pay the least amount of tax possible, as late as possible. It's baked into them from the time they’re born into the tax practice.
  2. The Infernal Revenue Service wants you to pretty much pay-as-you-go, throughout the year, either by having money withheld from your paycheck, or by paying quarterly estimated taxes if you're self-employed.

When your tax guru did your planning, they probably helped you make a "protective" estimated tax payment equal to either 110% of last year's tax liability or at least 90% of whatever they thing you might owe for this year. This protects you from a penalty but it doesn't protect you from a surprise tax bill. (For more on this subject, consult IRS Publication 505.)

To avoid a big surprise this time next year, you need to say something different to your tax nerd when you chat with them in the second half of the year. Instead of saying, "help me plan my taxes," say this:

I want you to help me pay ALL of this year's tax liability before the end of this year. To the best of your ability, I want you to help me pay 100% of my taxes as I go. I understand that by doing this I will be making a small tax-free loan to the government... I don't care. I want to sleep well, knowing that I'm all paid up. I want to know that the money in my savings account is really, really mine, not the fed's. In fact, I would like to pay MORE than I will actually owe. Can you set me up so that I overpay my tax bill by about $1000 this year, so I get a refund next year?

Your tax person may give you a slight scowl (since this goes against their instinct) but that scowl will be far smaller than the grimace you wore this year when you paid your taxes. Don’t worry about it. This is your tax bill, and they work for you. Be polite but firm, and ask them to make it happen.

This way, you'll know how much money you have left in your accounts to spend, share or save. And you'll sleep soundly knowing the jack-booted thugs are not going to kick down your family's door on April 16.

Financial Planner for Physicians Q&A | Where to put college savings for the grandkids?

Question:

"My dad passed away recently. He left some money for my mom (who is in an assisted living center) and she wants to put away some money for college for my two kids and her other grandchildren. She’s thinking about $12,000 per grandchild (up to two children per family).

In this situation, what is the best way to handle the money? I don’t have a lot of experience in investing, and I was just considering CD's or something like that but I thought I’d ask you first.

So, what do you think?”

Answer:

Your mom's well-being is the most important issue here, so I am going to assume that she has all the money she will ever need to pay for her cost of living and care for the rest of her life, and that whatever money she would give away is absolutely unneeded. If that's not the case, stop right here and look into her financial plan. Otherwise, here are some thoughts.

College Financial Planning for Physicians with Young Children

There are two things you need to think about when doing the financial planning for college:

  1.  Time Horizon: I assume your kids are young (since most of the financial planning for physicians we handle is for young physicians with young kids). That means you have a looooooong time before you’ll need to spend the money.
  2. Inflation: College costs have been rising at about 7% per year which is more than twice the inflation rate for other goods. At the same time, rates on certificates of deposit are near all-time lows, and pay even less than the inflation rate.

While the certificates of deposit (CD’s) are “safe,” you run the risk that your college fund won’t keep up with the cost of college, so they’re not a good match for the college goal.

To help your college fund keep up with the rising cost of college, you’ll need to invest it.

Financial Planner for Physicians: Section 529’s A Perfect Fit

As a financial planner for physicians, I’ve seen situations like this before and I believe a Section 529 College Savings Plan is a perfect fit.

  1. Estate Tax Benefits: Section 529 college savings plans allow grandparents to make a gift to a child which can be used for qualified higher education expenses (QHEE). It's a "completed gift" so that the money leaves the gift-giver's estate (your mom's estate).
  2. Parental Controls: At the same time, you as a parent, retain control of the money. Your child cannot reach the money, so they won’t be using it to buy a bright red sports car.
  3. Right Amount: The amount of money your mom wants to give is slightly less than the annual gift tax exclusion amount of $13,000 for 2012.

One important tip: If you go with a Section 529 college savings plan, make the contribution directly from your mom's account to the plan by check. If you forget to do this (and you make the parents the payee), you’ll lose some of the estate tax benefit. Check with your tax advisor for all the details about how to make this move.

How do I financially plan for a sabbatical?

If you've been in practice and "in production" for ten years or more and you haven't taken a sabbatical, you might want to add one to your long range plans. Today's reader question can help you get started.

Question:

My husband and I want to take a sabbatical, to show our sons parts of the world they've never seen, and to visit friends overseas. Since he's self-employed, we're not sure what all we need to do to get ready to go. What do you suggest?

Answer:

From the standpoint of financial planning, you can think of your sabbatical like a very long vacation with one excetion that I'll get to shortly.

First, set a date, or at least pick a month and year. Next, think about how long you'll be gone, in weeks. Then, decide where you're going.

Next you can budget for the four basic expenses including:

  • Travel expense (air, ship, ground transport, car rental
  • Room: hotels or other lodging, including gifts to people who host you
  • Food & dining
  • Entertainment: things that make the sabbatical fun and interesting for everyone in your family

To estimate the cost, you can use sites like TripAdvisor or information provided by your travel agent.

For self-employed doctors, a sabbatical may come with one exceptional expense: the cost of lost earnings and office overhead during your absence. While you won't pay this "expense" directly, it will show up sooner or later in the form of reduced receivables that ultimately reduce your take home pay. This means you'll need to set aside money to cover your cost of living once you return from your trip. For example, if you live on $10,000 per month (after tax) and you're planning a 10-week sabbatical, you should set aside at least $25,000 to cover lost earnings, and maybe more if you have substantial overhead.

Don't put your vacation at risk. Money that you intend to use in the next five years, including your Vacation Fund and your Sabbatical Fund, belongs some place safe like a bank or credit union checking or high-yield savings account.

Trash or treasure? How to keep your financial records organized without losing your mind

If your New Year's resolution is to "get organized" then today's post can help you start 2012 off right...

Here's a great question:

"What paperwork do I have to keep and for how long?  I have soooo many bank statements, old paid bills, investment statements etc! Thanks- [Busy Mom/Doctor Who Shall Remain Nameless]"

 Answer:

Ugh... I know you hate dealing with paperwork, and that's why I've devised a simple scheme to help you decide what's trash and what's treasure.

But first, you'll need two things: a big box and a magic marker.

 The Simple Three-Step Process

  1. Label your box: On the side of your box, write the words "2012 Financial Records". Let your kids draw on the box just to add some fun and get them involved.
  2. Put stuff in your box: As you receive "financial stuff" throughout the year, stick it all in that box... willy nilly, disorganized, in the original envelope if you dare. Got bank statements? Stick 'em in the box. Investment report? Stuff 'em in the folder. Paid bills? Ditto.
  3. Repeat: At year's end, right after you finish singing "Auld Lang Syne" (what does that mean anyway?), put that box some place safe... and be done with it.

When 2013 begins, get a new box and repeat the three steps. If you have financial stuff from previous years, you can drop each year's worth of stuff into its own box.

 Is it really that simple?

Yes, it is. Here are the benefits:

  • Always have everything.
  • Never lose anything.
  • No need to sort/tag/taxidermy anything.

If you need something, It will take you less time and energy to dig through your box than it takes to neatly organize all that stuff. Chances are good that you won't look back into the box at all.

Still not convinced?

If you're a recovering perfectionist like me, then you might want to check out these articles that tell you precisely what's trash and what's treasure. Warning: these articles tell you to  save almost everything"¦

What do you think about this post? Trash? Or treasure? Let me know...

 

 

 

 

A Spooky Spiel About Card-Wielding Doctor Zombies

You've got credit. But do you need those cards? Some physicians aren't certain.

Question:

"My husband and I have a total of five credit cards between the two of us, all with zero balances. Does it make any sense to keep this many accounts open?  I want to cut down to maybe two for simplicity's sake, but am wondering if there is some value in keeping those accounts open, even if we aren't using them?  Is it true that having more credit cards helps our credit score? How many credit cards should we carry?"

Answer:

There is only one reason to keep so many credit cards accounts open: you don't have an Emergency Fund. And if you do have an Emergency Fund, there's no reason to carry more than one card per person.

But why stop there? Why not go all they way to zero?

You can't.

You're a credit card zombie and mad scientists are controlling your thoughts. Here are two tactics keeping you in their grasp"¦

Thought Control Tactic #1: Make doctors hope for rewards.

A five percent discount on restaurants. Saving fifteen cents a gallon of gas. Taking a "free" plane ride. Sounds alluring, doesn't it?

When you read the fine print, you'll see a bunch of do-this-to-get-that language. You may even begin to get a scary feeling in your gut, like someone's trying to control you. I'm not talking about the agreement the guys from H.R. asked you to sign when you went to work for the hospital. I'm talking about your credit card rules disclosure.

It reads like a recipe for a devious mind control experiment, and you might even begin to believe there's an evil corporation out there whose mad scientists have concocted a scheme to rob you of your financial freedom. In fact, you'd be right on the money. Credit card companies actually employ mad scientists. They're called industrial psychologists, and they're the ones who programmed you to seek rewards.

The problem here is that you're so tuned into their trickery that you don't believe me.

Right now, you're telling yourself, "I'm not a big spender. I'm very careful with my money, and I pay off my cards every month. I spend $7,000 per month, not counting my mortgage, and that earns me $840 a year in rewards. I'm way ahead of them."

Not so fast. Can you show me that check from the card company? You know, the one that reads...

Pay to the order of Dr. Credit Zombie: Eight-Hundred and Forty Dollars

Can't find your check? I didn't think so. You're spellbound.

You're not saving one percent of what you spend. Nope. You're not "saving" anything at all"¦ you're spending. And you're not spending one percent more, or five percent more, or twenty-five percent more. On certain purchases, you're spending twice as much as you would if you used cash.

Still don't believe me? I'm not making this stuff up. It came from this study from the M.I.T. Sloan School of Management. Spooky stuff, yes indeed.

Thought Control Tactic #2: Make doctors fear their credit scores.

Are you afraid that cancelling your credit cards will kill your credit score? Of course you are.

The truth is that bringing the guillotine to bear on your credit cards may slightly reduce your credit score, but not kill it altogether. According to the folks at FICO.com, the "Types of Credit Used" category accounts for only ten percent of your credit score. This means your car loans, mortgage, student loans and other borrowing counts in that category too. So more than ninety percent of your score is determined by other factors. For example, paying your bills on time accounts for thirty-five percent of your score, so it's way more important to use credit wisely than it is to have credit cards.

A zombie-like focus on credit score loses sight of the big picture question, "Can you get a loan if you need one?"

You're a physician family, right? You know that bankers will fall all over themselves to lend you money. I've seen young doctors of average creditworthiness get mid-sized six figure loans for doing little more than signing their namesno collateral required. So yes, you can get credit. And your credit score is only a small piece of the decision-making process that bankers use.

Do doctors really need so much credit?

You know the holidays are right around the corner and you'll be buying gifts. You know you're going to take a vacation some place nice. And you know that the car you'll be driving five or ten years from now is not the same one you're driving today. You also know that some day, before you die, you'll have to pay for those things one way or another, so forget about borrowing to buy them. Start saving now, and pay for them with cash.

"Wait a minute," you say. "what about my mortgage? If I need to refinance, I'll need credit for that won't I?"

Yes, you'll need credit. But having cash in the bank, zero balances on most loans, plus equity in your home and a six figure income is more than enough to convince lenders that you're worth the risk. If you can't get a mortgage, nobody can.

An Experiment Gone Horribly Wrong

Here in the United States, it's like we're on the set of Night of the Living Dead. We live with a culture of credit that has turned citizens into consumers, and consumers into credit zombies. I believe we have lost our ability to entertain the thought of first saving money, then spending that money on the things we want and need. No other mindset can explain how a surgeon with a decade of O.R. time under her belt and more than $100,000 in the bank believes she needs to take out a loan to buy a car. And no other thought explains how our country came to be so deeply indebted. The culture of credit is nothing more than a mindset, and you have the power to dispel the curse.

Lucky Seven Steps to Break the Curse of the Credit Card

  1. Get a debit card. Start using it to buy things "with cash" so you won't be using funny money anymore. You can see the impact of your purchase decisions immediately by logging into your bank account, and you'll have tighter control over spending. Learn how to protect your debit card.
  2. Take your cards out of your wallet and stop using them.
  3. Pay off your card debt, if you have a balance.
  4. Build an Emergency Fund. Set aside three to six months worth of living expenses some place safe and leave it there so that you can feel good about not havingor not usingcredit cards.
  5. Get your free credit report at www.annualcreditreport.com, (not freecreditreport.com, which will try to sell you something). Use it to identify all the cards in your name, including the ones you haven't seen in years.
  6. Cancel every credit card account except one. Keep your oldest card account open since it helps preserve the length of your credit history.
  7. Cross your fingers. If you're lucky, the one remaining card issuer will send you a letter a few years from now explaining their decision to cancel the card due to inactivity. I got one of those letters last year. It was awesome.

And now... a brief commercial from Physician Family Financial Advisors"¦

Two five pound bags of candy corn from Costco bought with a debit card... fourteen dollars.

Zany zombie costume kit bought over the internet with a debit card... seventy-three dollars.

Looking like a zombie but feeling like a financially secure physician family... priceless.

In life, there are some things money can't buy. And for everything else, there's a debit card.

Wishing you and your family my best for a safe and happy Halloween.