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Flexibility in financial planning can help to meet long-term goals


We have consulted with thousands of doctors in all specialties during our combined 35+ years in practice. From this experience, we have become intimately familiar with how most physicians build their financial plans (what we call “wealth plans”). Too often, they have ignored the most important factor in a sophisticated long-term plan - flexibility.

We have consulted with thousands of doctors in all specialties during our combined 35+ years in practice. From this experience, we have become intimately familiar with how most physicians build their financial plans (what we call “wealth plans”). Too often, they have ignored the most important factor in a sophisticated long-term plan - flexibility.

Because so much of life doesn’t work out exactly how one plans, it would seem obvious that flexibility should be fundamental to a wealth plan. This is especially so in the financial arena, since many factors that may make the difference between hitting your financial goals or not are beyond your control.

In this article, we will examine the important factors for which your wealth plan must provide flexibility.

1. Changes in income/cash flow
This is likely top of mind for most physicians. With the federal government cutting reimbursements, private insurers following, and inflation still causing overhead costs to rise, this is not surprising. Add to this the increasing numbers of doctors who are becoming employed - where income will be dictated by a hospital or a health system - and this clearly becomes the most important factor where flexibility is required. The plain facts are most doctors cannot accurately predict their income in future years right now, so flexibility has to be part of the plan.

How do you incorporate income/cash flow flexibility into a wealth plan? Two important factors are to live below your means and make it a priority now to save each month, quarter and year. These two elements can position you to weather any temporary or even long-term hits to income/cash flow.

Another important tactic here is to implement savings vehicles that allow for uneven funding/investments. As an example, in the qualified retirement plan (QRP) arena, this might mean using defined contribution plans that allow flexibility in contributions each year, as opposed to a defined benefit plan which can require a certain level of funding or cause underfunding penalties. Even more relevant would be to utilize “hybrid,” or fringe benefit, plans that may allow much higher contributions than defined contribution plans when income is high, but can actually be skipped entirely in years where income wanes.

Another example here would be in the asset class of permanent life insurance - one that has the benefit of tax-deferred growth and top asset protection in many states. Here, funding flexibility would favor a “universal life” type policy - one where, as above, funding is flexible year-to-year - over a “whole life” type policy, where funding must occur each year.

2. Changes in tax rates
Right behind the No. 1 factor of cash flow/income, the No. 2 planning element that one should build flexibility around is taxes. As of the beginning of 2012, we are at the third lowest federal income tax regime (measure by the highest bracket) since the income tax was implemented nearly 100 years ago, and the very lowest capital gains tax rates since the 1940s when that tax was enacted. See the charts below, which show the top marginal federal income tax rate and federal capital gains tax rate in effect for each decade on the “0 year” (i.e., 1920, 1930, 1940, 1950, etc.). These charts do not show state income or capital gains rates.

*Source: Citizens for Tax Justice, May 2004 **Scheduled

*Source: Citizens for Tax Justice, May 2004 **Scheduled

Examining these charts, it seems quite apparent that we could see tax rates rise. If they even return to mean rates of the 20th century, we will experience a sharp increase in tax rates. Thus, it makes sense to build in flexibility for this possibility.

In our firm, we approach this through a process of “tax diversification.” While most firms focus only on asset class diversification in the context of investing, we believe it is crucial to layer on top of this focus a concentration to diversify a client’s wealth to tax rate exposure.

As an example, we might look at a client’s QRP assets as those that are subject to future income tax increases - since, to get access to QRP funds, you have to pay ordinary income taxes. Further, most personally owned assets are subject to future capital gains tax increases, from securities to real estate to closely held business interests to commodities or artwork. As capital gains tax rates increase, the value of these assets decline, at least in terms of how they might assist you in retirement.

Applying a “diversification” approach, we find that most physicians are inadequately invested in asset classes or structures that are immune to future income or capital gains tax increases. Whether these options are in the form of cash value life insurance, tax-free municipal bonds, ROTH IRAs or others, they should be part of every doctor’s wealth plan. Bottom line: you need to have flexibility against the possibility that tax rates increase, especially if those increases are significant.

3. Changes in the “market”
The reason we put the word “market” in quotes is because we mean more than a small sample of the stock market in the United States, such as the Dow 30 or even the S&P 500 indices. What we are trying to get at here is the concept that there is volatility in all of the securities, commodities, real estate and other asset marketplaces in the United States and all over the world. Values go up and they go down in all asset classes. This might be obvious, but a Nobel Prize was developed around the concept of constructing portfolios that minimize this risk and maximize returns. This is the concept of “diversification,” or “asset allocation.”

Most savvy doctor investors understand that portfolio diversification is a key consideration to reducing some of the risk of loss in a portfolio. In historically volatile markets, mitigation of loss is not a luxury - it is a necessity. Though most savvy investors who thought they were “adequately diversified” also lost almost half of their portfolio value in 2008 and 2009, there is an explanation. Most investors were diversified “within” the stock market with holdings in various sectors. What these investors suffered was “market risk.” As the entire market came crashing down, so did all investors within the market. Wealth plan flexibility requires better planning.

What many experienced investors don’t understand is that diversification need not be limited to securities like traditional stock and bond investments or bank deposits. Proper diversification, especially in a highly volatile market like the one we are experiencing today, must also be across investment classes and not just within a class (such as securities or real estate). A balance of domestic and foreign securities, real estate, small businesses, commodities and other alternative investments would prove to be much less risky than holding the majority of your investments in real estate and securities (which is what most physicians do).

For many doctors, a popular investment strategy is to take advantage of different investment programs that are not traded on a public exchange like the New York Stock Exchange. Non-traded real estate investment trusts, leasing funds and oil and gas drilling programs are a few examples. As with any investment, there are pros and cons for each type of offering.

Given recent market conditions, many physician investors have been attracted to non-traded programs because they offer a certain level of stability. Most of these programs are sold to investors at a flat price, for example, $10 per share, during the offering period. An advantage to these programs is that their performance is not correlated with any particular market or index, making them an additional form of diversification. Holding non-correlated offerings can help reduce the “volatility rollercoaster” of a traditional portfolio. They should be an additional allocation in your portfolio, not a substitute for proper allocation.

It is important to note that one of the advantages of a non-traded offering is also a disadvantage. There is typically no market for shares of these programs. As an investor, you are expected to hang onto the security for the life of the investment, which can be as long as four to 10 years. This can make your investment relatively illiquid. In addition, these programs are not without risk. You could invest in an oil and gas drilling program that finds no oil. Sure you will get a deduction, but you may not get much of the initial money back. Like any other investment class, some offerings are more aggressive than others, and none make any guarantee about future performance. The bottom line: true wealth plan flexibility dictates a true diversification plan that may or may not involve alternative asset classes or non-traded assets.

Another option many physicians overlook to their detriment is a cash value life insurance policy where their policy’s investment performance is tied to a market index (such as the S&P 500), but where the insurance company provides a guaranteed minimum return. The guarantee, of course, is only as strong as the insurance company itself, which is why using a very strong company with a 100-plus year track record is crucial. The benefit of such a policy is that you can use it to truly participate in the years of positive returns of the index and have protection against the years of negative returns. While we will author another article specifically on this asset class (contact us if you would like it emailed to you), suffice it to say, this is a significantly underutilized asset by physicians today.

4. Changes in liability
As one of the authors spent more than a decade as an attorney specializing in asset protection planning for physicians, this area is important to him. What one must realize is that any planning designed to shield wealth from a lawsuit claimant, creditor or even soon-to-be ex-spouse is typically not effective if implemented after you have notice of a threat. Simply put, you have to put asset protection planning in place before there is a problem.

The challenge, of course, is that clients want to maintain ownership of the asset, control of the asset and access to the asset (or some combination of all three) at times where there is no liability threat lurking. Fortunately, with comprehensive asset protection planning, utilizing exempt assets, legal tools, insurances and proper ownership forms, the client’s goals here can typically be accomplished.

Thus, you can build flexibility into your planning by using tools that shield wealth if or when you have liability threats, but that also allow you ownership, control and/or access to that wealth when “the coast is clear.”

In fact, if such planning can be combined with corporate structure and tax planning at a medical practice, we often can find ways to provide asset protection that, in effect, “pays” the doctor handsomely each year - as the tax savings gained from such planning can far outweigh its costs. If this is achievable (which it is), you might ask, “Why doesn’t every doctor engage in this type of planning?” We agree that it is a question worth asking.

5. Changes in health
As physicians, you know the element of health is the most important of any. At one extreme, being in good health is a blessing and can allow you be more productive to create more wealth and allow you to share it, enjoy it and even give it away. On the other extreme, poor health can keep you from practicing medicine, earning a living and even lead to premature death, which can have a devastating economic impact to the family, on top of the emotional difficulty that comes with it. For these reasons, it is crucial that a conservative wealth plan build flexibility around changes in health.

The first way to build flexibility here is to secure the proper insurances to shield your ability to earn income as a doctor. There are two important insurances to examine: One that provides you a regular income stream if you become disabled and one that provides your heirs financial protection in case you die. We are describing, of course, disability insurance and life insurance.

Certainly, if you are concerned only about your own ability to meet your financial goals and have no financial dependents, than disability insurance may be the only coverage on which to focus. The data tell us all that the likelihood that we will incur a significant long-term disability is much higher than dying prematurely. Nonetheless, in our experience, most physicians are significantly underinsured for disability. As such, they are risking all of their financial goals on their ability to avoid disability. This is not a risk we counsel our clients to take.

We have also found that many doctors remain underinsured because they believe they cannot get more than $10,000 or $15,000 monthly coverage, even though their income is well above these limits. As the disability insurance market for physicians has loosened in just the last few years, if you are still underinsured and believe you cannot qualify for more protection, please contact us.

As for life insurance, there are many different types of products, from term to cash value to whole life to private placement. While it is beyond the scope of this article to detail any of these in depth, the point here is to be sure that whatever product you use, you have adequate coverage given your income, debt, assets, family situation, tax rate, state of residency and goals. As you can imagine, this is very much a case-by-case analysis.

Because risk and uncertainty are so prevalent over the long term, flexibility is a crucial element of a conservative, yet creative, wealth plan. In this article, we looked at five key elements around which any plan should build flexibility.

About the authors: David Mandell, J.D., M.B.A., is an attorney, author of five books for doctors, and principal of the financial consulting firm OJM Group. Jason M. O’Dell, M.S., C.W.M., is also an author of multiple books for physicians and a principal of OJM Group. They can be reached at 877-656-4362.

SPECIAL OFFER: For a free (plus $5 S&H) copy of For Doctors Only: A Guide to Working Less and Building More, please call 877-656-4362.

Disclosures: OJM Group, LLC. (“OJM”) is an SEC registered investment adviser with its principal place of business in the State of Ohio. OJM and its representatives are in compliance with the current notice filing and registration requirements imposed upon registered investment advisers by those states in which OJM maintains clients. OJM may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. For information pertaining to the registration status of OJM, please contact OJM or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov).

For additional information about OJM, including fees and services, send for our disclosure brochure as set forth on Form ADV using the contact information herein. Please read the disclosure statement carefully before you invest or send money. 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.

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