Doctors betrayed by traditional financial strategies, part 2

In part 1 of this article, you learned why the following strategies may not make sense for most physicians.

• Not using a corporation (or using the wrong type of corporation).

• Owning assets your name, spouse’s name, or jointly with spouse.

• Making a questionable bet on traditional qualified retirement plans. 

Part 2 focuses 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 offers you some helpful hints to avoid these pitfalls.

Understanding the dynamic of the "Average American"

Mistake #4 – Paying Full Price when the Government Offers to Pay Half. Technically, the government (Internal Revenue Service) is not paying half of anything. However, if they offer you a tax deduction and your combined state, federal and local marginal tax rate is close to 50 percent, you can think of a tax-deductible purchase as being half as expensive for you because the government will allow you to deduct this purchase. You must realize that nearly 50 percent of Americans do not pay any federal income tax. You can either look to advisors 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.

Suggestion – Deduct Long Term Care insurance (LTCi) through your Practice.   Over 60 percent 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. 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 are not both physicians or employees. With your own practice entity, you may receive a tax deduction for 100 percent of the premiums

Unlike traditional retirement plans where contributions that are tax-deductible and benefits are taxable, Long Term Care insurance premiums can be tax-deductible and the benefits are 100 percent tax-free.

Mistake #5 – Using only Term Insurance Premiums.  Some well-known advisors tout, “Buy term insurance and invest the difference.”  This is excellent advice for the “Average American” family who earns $49,000 per year, pays 12 percent 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.

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.  If you have the following characteristics:

• I have no concern over lawsuits against me, my partners, my employees or my family.

• I am not worried about 23% to 37% of my investment gains going to taxes.

• I don’t mind 40%-70% of certain assets in my estate going to taxes when I die.

Does this sound like the typical physician situation? Of course not. 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.

Suggestion – 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. 

 To spare you the pain of a long mathematical proof, let us offer the following analysis.

Mutual funds growing at 7% (taxable) are worth 4%-5% (after taxes) to high income taxpayers like you versus 6% or more to Average Americans.

Investment gains within cash value life insurance policies are tax deferred, and can be accessed tax-free.

For relatively healthy insureds, the annualized cost of all internal expenses within a life insurance policy range from 1% to 1.5%.  

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.

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’s family, but be seen worthless to average American family who has very little risk of a lawsuit.

EXAMPLE: 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 7% per year.

• The individual who invests in mutual funds on a taxable basis will be able to withdraw $29,871 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 $38,699 per year (no taxes on policy withdrawals of basis and loans) and has $525,652 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.  The authors welcome your questions. You can contact them at (877) 656-4362 or through their website www.ojmgroup.com.

SPECIAL OFFERS:  For a free hardcopy ofFor Doctors Only: A Guide to Working Less and Building More, please call 877-656-4362. If you would like a free, shorter Kindle, iBooks or Nook eBook version ofFor Doctors Only, please download our “highlights” edition at www.fordoctorsonlyhighlights.com.

David B. Mandell, JD, MBA, is a former attorney, author of ten books for doctors, including For Doctors Only: A Guide to Working Less & Building More, and principal of the financial planning firm OJM Group www.ojmgroup.com, where H. Michael Lewellen, CFP ® serves as Director of Financial Planning. They can be reached at 877-656-4362 or mandell@ojmgroup.com.

Disclosure:

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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.

CIRCULAR 230 DISCLOSURE: IN COMPLIANCE WITH TREASURY DEPARTMENT REQUIREMENTS, WE INFORM YOU THAT ANY FEDERAL TAX ADVICE CONTAINED IN THIS ARTICLE IS NOT INTENDED, AND CANNOT BE USED, FOR THE PURPOSE OF (A) AVOIDING PENALTIES UNDER THE INTERNAL REVENUE CODE OR (B) PROMOTING, MARKETING OR RECOMMENDING TO ANY OTHER PARTY ANY TRANSACTION OR MATTER SET FORTH HEREIN.