Doctors Betrayed by Traditional Financial Strategies (Part 2 of 2)

By David B. Mandell JD, MBA of OJM GROUP.

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

1. Not using a corporation (or using the wrong type of corporation).
2. Owning assets your name, spouse's name, or jointly with spouse.
3. Wasting time and money on traditional qualified retirement plans. 

If you missed part one of this article, please click here to read it.

Part 2 of our article will focus more 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 will offer you some helpful hints to avoid these pitfalls.

Risk #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%, you can think of a tax-deductible purchase as being -  as expensive for you because the government will allow you to deduct this purchase. You must realize that nearly 50% of Americans do not pay any federal income tax (Source: IRS). In 2009, Exxon boasted $45 billion of profit to its shareholders - with $0 of US income taxes paid.  You can either look to advisors who can help you legally reduce any unnecessary taxes or you can let the system 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% 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.  If you are a C corporation, you may receive a tax deduction for 100% of the premiums and can pay all of the premiums over a 10-year period to take advantage of the deductions during your prime earning years (when the deductions are most valuable.).

By paying premiums over a short period of time, you will ensure that you will not have unexpected expenses for this insurance once in retirement. 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% tax-free.

There are also non-traditional benefit plans that also allow physicians to make contributions of $100,000 or more per year, discriminate to only include the doctors or key employees, and access the funds before age 59 1/2 without penalty.  These plans can be set up to be very important pieces of a family's estate plan without sacrificing tax deductions or control of the assets by the doctor.  For further information on these plans that are beyond the scope of this article, please contact the authors at (877) 656-4362 or Mandell@ojmgroup.com.

Mistake #5 Wasting Money on Taxes and Term Insurance Premiums.
A famous financial advisor with her own TV show is one of many advisors to 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% 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 47% of my investment income 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, it doesn't. 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.

In our firm, we have advisors with MBAs in finance, CPAs, CFPs®, and other financially-savvy experts. To spare you the pain of a long mathematical proof, let us offer the following simplified analysis.

• Mutual funds growing at 8% (taxable) are worth 5%-6% (after taxes) to high income taxpayers like you and worth 7% 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 family, but be seen as worthless to Average American families who have no real financial threat 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 8% per year.

• The individual who invests in mutual funds on a taxable basis will be able to withdraw $36,940 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 $47,080 per year (no taxes on policy withdrawals of basis and loans) and has $511,833 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 OFFER:  For a free (plus $10 S&H) copy of For Doctors Only: A Guide to Working Less and Building More, please call (877) 656-4362.

David Mandell, JD, MBA is an attorney, lecturer, and author of five books for physicians.  R. Paul Wilson, CRPC® is a consultant with 10+ years working with physicians.  They are a part of the team at the financial consulting firm OJM Group and can be reached at 877-656-4362.