physician tax planning

3 Ways to Save Taxes While You Invest | Oncology Practice Management

Physicians pay more than their fair share of taxes, so when it comes to your investments, why would you pay more than you absolutely have to? While it may be too late to save taxes on investments you made last year, itís the perfect time to focus on saving money this year, so we want to share some tax tactics to keep your tax bill for 2016 in check.

1. Slip Contributions in Through the Back Door

If you are a physician who is covered by a retirement plan at work, your accountant may have told you that you do not qualify to contribute to an Individual Retirement Account (IRA). That is simply false. Physicians who have earned income can indeed contribute to an IRA, even if they cannot deduct the contribution from their taxable income.

This may leave you wondering why you should make an effort to contribute if you donít receive any immediate tax benefit. The answer is that your nondeductible contribution puts you in an ideal position to convert your traditional IRA to a Roth IRA, using a strategy known as a ìbackdoor Roth IRA. This lets the balance in your Roth IRA grow tax-deferred indefinitely, with no requirement for mandatory distributions at age 70Ω years, and no taxes due on qualified withdrawals.

To make a backdoor Roth IRA contribution, you need 2 accounts – a traditional IRA (preferably an empty account) and a Roth IRA. To do that, start by contributing the maximum allowed amount to your traditional IRA ($5500 for 2016, or $6500 if you are age 50 years or older). Next, you can instruct your financial institution to convert your traditional IRA balance to a Roth IRA account. The institution will distribute the balance from your traditional IRA and then deposit that amount to your Roth IRA, generating a Form 1099-R that is sent to you in January of the following year.

If you are taking advantage of this strategy, however, you must be careful. It is simple if the entire balance in your traditional IRA hails from nondeductible contributions, and if the account has not gained value. If that is the case, you should owe no taxes on this transaction; however, if you have any other IRA accounts (including SEP-IRAs, SIMPLE IRAs, and/or rollover IRAs) that were funded with pretax dollars, the taxable portion of any conversion made from these accounts will be prorated over all your IRA accounts.

Therefore, to truly benefit from the backdoor Roth IRA and avoid the ìpro-rata rule,î you must either convert your other IRA accounts as well, or you must transfer your IRA contributions that were funded with pretax dollars to an employer-sponsored plan that accepts IRA rollovers, so all that remains are IRA accounts funded with posttax dollars.

2. Put Taxable Income in Its Place

Although veteran investors know that a taxable bond fund generates ordinary income that is fully taxable, for some reason we continue to see physicians, even those who are under the care of financial advisors who should know better, owning taxable bond funds in taxable accounts.

For example, an oncologist earning $700,000 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. Since this couple is in the top marginal income tax bracket (39.6% for federal income), their tax bill for these dividends is approximately $5000, so only $8000 remains in the account after the taxes are paid.

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 $3000 this year, and every year thereafter.

It is easy to understand why this mistake happens. Investors routinely focus on the yield or the income from the securities they buy, while ignoring the after-tax total return that the security generates.

3. Save Your Health Savings Account

While Health Savings Accounts (HSAs) were signed into law more than a decade ago, physicians are just now beginning to take advantage of the sizable tax deduction that contributions to these accounts provide. If your family is covered by a qualifying high-deductible health insurance plan (HDHP), you can contribute $6750 to an HSA this year (or up to $3350 if you are covered individually). If you are a physician in the top marginal tax bracket of 39.6%, this contribution can provide you approximately $2700 in tax-savings income.

Having made your contribution and deducted it from your income, now you are in the right position to do the wrong thing: spend the money. Although many physicians will use their HSA balances to cover out-ofpocket healthcare expenses, a better strategy is to leave the balance in the HSA account for as long as you can. Here, the balance can be invested and allowed to grow tax-deferred until retirement. At that time it can be withdrawn tax-free to cover one of the biggest expenses we will all face in our old ageóthe cost of healthcare.

Conclusion

When you understand the ins and outs of tax-advantaged investing, you can stop paying unnecessary taxes and start putting more money toward your retirement, your kidsí college, and anything else money can buy. In fact, Judge Billings Learned Hand once said, 'Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the Treasury. There is not even a patriotic duty to increase oneís taxes.'

W. Ben Utley, CFP, is the lead advisor with Physician Family Financial Advisors, a fee-only financial planning firm helping doctors throughout the United States to save for college, retirement or other financial goals. He can be reached at 541-463-0899 or by e-mail at ben@physicianfamily.com.

Lawrence B. Keller, CFP, CLU, ChFC, RHU, LUTCF, is the founder of Physician Financial Services, a New Yorkñbased firm specializing in income protection and wealth accumulation strategies for physicians. He can be reached at 516-677-6211 or by e-mail at Lkeller@physicianfinancialservices.com with comments or questions.

This article originally appeared in page 48 of the March 2016 print edition of Oncology Practice Management.

Will a defined benefit pension plan save physicians taxes? | W. Ben Utley CFP® answers in Ophthalmology Business magazine

Will a defined benefit pension plan save physicians taxes? | W. Ben Utley CFP® answers in Ophthalmology Business magazine
Will a defined benefit pension plan save physicians taxes? | W. Ben Utley CFP® answers in Ophthalmology Business magazine

Question:

I’m a 45-year-old eye surgeon and I own my practice. This year I got nailed with a huge tax bill despite the fact that I maxed out my 401k and bought new equipment last year. I took home about $500,000 last year pre-tax. I  have 10 employees who earn about $40,000 on average, and I’m carrying all of them in my profit sharing plan too. In your last column, you said that a defined benefit pension plan might save me taxes. I know there’s no free lunch out there, and I’ve heard these plans are kind of risky. Is it true? If so, what are the risks? Or are they actually a decent deal?

Answer:

Looking at the headlines these days, you might begin to believe that “pension” is actually a four-letter word. Recent data from the Pew Center on the States showed that the country’s 100 largest pension plans are facing a combined shortfall of almost $1 trillion. That means employees in these plans are going to get a nasty surprise when they hit retirement age: way less money than promised.

But when I spoke with a few of the nation’s top “pension geeks” (that’s what they call themselves), I got an entirely different impression, especially about pension plans for small business owners.

“It’s kind of a shame,” said Michael D. Hughes, an employee retirement benefits attorney and pension guru based in St. Petersburg, Fla. “I think a lot of people are missing the boat by overlooking these plans,” he said. Defined benefit plans, particularly the new breed of plans known as “cash balance plans,” are often a slam dunk for high earning professionals, particularly those who already max out their 401(k) and profit sharing plan contributions like you do.

The Employee Retirement Income Security Act (ERISA) calls these “hybrid” plans, said Dan Kravitz, author of Beyond the 401k, and president of his own cash balance plan design firm in Los Angeles. They combine the features found in both defined contribution plans (e.g., 401k) and traditional defined benefit pension plans. As the business owner, you get a tax deduction for making contributions to the plan. As a taxpayer and a physician, your portion of the plan gains asset protection from bankruptcy creditors and can grow tax-deferred since this is a qualified plan under ERISA.

One more feature of cash balance plans makes them a win for your employees, too. Mr. Kravitz, who worked as a teacher before he began doing pension stuff back in 1989, still has an “old school” pension plan from his days as an educator. He said the school district’s plan is so complicated that, “I still have no idea how much money I’m going to get at retirement.” Since this is a benefit for your employees (not just a fat tax shelter for you), it’s nice for them to be able to look at their annual statement, see the cash balance, and know what it’s worth to them. It’s a nice feature if you’re aiming for higher rates of staff retention.

Unlike 401k plans, you as a business owner bear responsibility for the performance of the investments in your plan, and that’s where the risk comes in. By design, the plan assumes a rate of return or “interest crediting rate” that may be pegged to a benchmark (like the yield on the 30-year U.S. Treasury bond) or it may be set arbitrarily, usually at a rate near 4%. If your investments earn less than the interest crediting rate, you as the plan’s sponsor are responsible for making up the difference. That’s the bad news.

The good news is that eye surgeons can contribute way more money to a cash balance plan than they could contribute to a standalone 401k/profit sharing plan. According to Norman Levinrad, a pension actuary with Summit Benefit & Actuarial Services, Eugene, Ore., you might contribute as much as $120,000 more to a cash balance plan than if you had only a 401k plus profit sharing plan alone.

That extra contribution could save you about $48,000 in state and federal taxes, depending on where you practice and pay taxes.

There is one more catch but it’s manageable. The feds wants to make sure that everyone in the plan is treated fairly, so you will be required to include your employees in the plan and make a contribution for them as well. In this case, you’re contributing to their profit sharing plan accounts, so you may have satisfied the contribution requirements already.

So yes, there are some risks but the benefits far outweigh the costs. This is indeed a good deal for someone in a situation like yours.

Mr. Hughes believes now is a good time for physicians to consider setting up a cash balance plan, and he should know. He has been at this game a long time, having started his law practice just one year after ERISA became law, almost 40 years ago. “When you look at the tax and compliance issues surrounding these plans, it’s just about as good as it’s been since the 1980s in terms of what you can do and how you can design these plans.”

Speaking of design, I want you to know you will need a small team to make a cash balance plan a reality in your practice. First, you will need an actuary to calculate how much you can contribute to the plan. Next you will need an attorney to draft the plan documents. Once the plan is in place, you will need a bank, brokerage or mutual fund company to hold or “custody” the plan’s assets. If you’re crazy, you will manage the plan’s investments yourself, but if you’re smart, you’ll hire a registered investment advisor to do it for you. You will need a third party administrator or “record keeper” to keep track of the value of each participant’s balance in the plan. And you will need an accountant to file the plan’s Form 5500 each year, which is a report to the Department of Labor.

Sound overwhelming? Don’t fret. You can acquire each one of these team members independently (like you might if you called Mr. Hughes), or you can get them all in one place (like you might with Mr. Kravitz or Mr. Levinrad), though none of them offer investment management or custody services.

The all-in administrative cost for a cash balance plan might run you as much as $7,000 per year or maybe just a couple thousand more than you already pay for your 401k and profit sharing plan. All three of the pension gurus I interviewed for this column said that they would generate a free proposal to help you determine the costs and benefits of a plan for your practice, as is the custom in their line of work. At the very least, you or your office manager should make an effort to get further details.

Keep an Eye on Your Money

The key to financial security is vigilance. Get curious. Ask questions! Dig for answers … or email your questions to me so I can do the digging for you. If I use your question in “Eye on your money,” I will send you one of my favorite personal finance books to feed your head and a cool “Eye on your money” coffee mug to satisfy your thirst for answers.

Mr. Utley is president and founder of Physician Family Financial Advisors Inc., which delivers fee-only financial planning and independent investment advice to clients coast-to-coast. Contact him at 541-463-0899 or visit www.physicianfamily.com.

This article originally appeared in the July 2013 ezine of Ophthalmology Business, pages 12-13. To download a PDF version, click here.

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.