One of the underlying themes of this blog is that the vast majority of doctors don't make THAT much money since typical physician incomes range from $200-400K per year. Doctors in this income range are far more similar to their engineer, attorney, accountant, or small business owner friends than they are to investment bankers and Taylor Swift. Estate planning issues are minimal, asset protection needs can generally be met with insurance and retirement accounts, and their retirement and investing needs can generally be met using relatively standard retirement accounts.
There is little need to mix insurance and investing, aside from the potential purchase of a single premium immediate annuity (SPIA) in retirement to provide a base level of income. The main issue the typical doctor needs to address to be successful is to set an appropriate amount of spending (and thus saving), minimize investing costs and taxes, and ensure an adequate insurance plan.
However, for a relatively high-earning family, such as a physician making $500K-2 Million per year, a two-physician couple, or a physician whose spouse is also a high earner, things can get more complicated.
This is a three-post series. In this first post I will address investing and tax considerations, the second post will address disability insurance specifically, and the third post will address non-disability insurance, estate planning, and asset protection issues applicable to these high-earners.
#1 Favor Roth Accounts
The high earner is more likely to favor Roth (after-tax) over traditional (pre-tax) retirement accounts for several reasons.
- Because Roth money is after-tax, you can put more money into the account, which means more money growing in a tax-protected manner and less in a taxable account.
- For estate planning purposes, it is far better to inherit a Roth IRA than a traditional IRA, and, since a high earner ought to have a higher net worth and thus leave more money behind to heirs, better to have it in Roth accounts.
- If you're in the highest bracket now and expect to be in the highest bracket upon withdrawal, there is little “tax-rate arbitrage” that will be happening. For most Americans (and most doctors) they'll be withdrawing money at an effective tax rate far lower than their marginal tax rate at the time they put it into their retirement accounts. That's probably not true for someone making $1 Million a year for several decades. Roth accounts also provide you with a significant hedge against higher future tax rates. There is still value in the tax diversification provided by having some tax-free and some tax-deferred accounts, but the value decreases as your income and assets climb.
#2 Pay a Fair Price for Advice
Most fee-only financial advisors charge based on a percentage of assets under management, with 1% per year being a typical fee (although much lower rates are available). 1% of a $1 Million portfolio works out to $10,000 a year, which while expensive, isn't ridiculous. 1% of a $10 Million portfolio ($100,000) is way too much to pay someone to manage your assets, much less for financial advice. It simply isn't that much harder to manage a large sum than a more moderate sum. If you have a high net worth, you need to negotiate your financial planning and asset management fees very carefully. You should either pay a flat rate as an annualized retainer or the asset management fee percentage should be significantly reduced for additional money being managed. Don't assume that just because 1% of $500K is fair that 1% of $15 Million is also fair.
#3 Learn to Manage a Taxable Investment Account Well
Many doctors have little need for a taxable account. We often have more space available in our retirement and other tax-protected accounts than we have money to save in them. A high-earner, however, will almost surely have some taxable money. This money needs to be invested in a tax-efficient manner. You can do this by minimizing turnover, using specific “tax-managed” or index funds, using municipal bonds (especially for your state) over nominal bonds, tax-loss harvesting, and preferentially placing your least tax-efficient assets into your retirement accounts. If you give money to charity, you should donate appreciated shares from this account, either directly or through a DAF.
#4 Don't Take More Risk Than You Need
Remember when designing your investment plan that you need to consider your need, ability, and desire to take risk. One benefit of a high income (and hopefully net worth) is that you may have much less need to take risk than someone making or having less. If you run the numbers, you may find you can essentially save up all the money you'll need in retirement without taking on significant investment risk. There is great wisdom in not running a risk you don't have to run. Instead of a more typical 60/40 portfolio, you may find you can meet your needs easily with a 25/75 portfolio.
#5 You Still Have to Budget
Just because you make a lot of money, doesn't mean that good financial principles, like a budget, no longer apply. A million-dollar income can be blown just as easily as a $200,000 income. High earners still need to save at least 20% of their income toward retirement. They should still save up to buy large ticket items and avoid carrying balances on credit cards. Their mortgages should still be within the realm of sanity (my general rule is your mortgage shouldn't be more than 2X your gross income and housing should consume no more than 20% of your gross income). Remember that it's all the same game whether you're making $50K a year, $200K a year, or $1 Million a year. The rules don't change, only the number of zeros.
Debt paydown should be a relatively high priority for high earners. Since all your tax-advantaged retirement options are maxed out, and taxable accounts are completely subject to creditors and relatively highly taxed, paying down student loan and mortgage debt can be a great option for extra income. Student loan interest isn't deductible anyway for most doctors, especially high earners. Too much debt/leverage can often spoil even the best financial plans for wealthy people. Strolling through the real estate book section at your local bookstore will reveal that many of the gurus went bankrupt early in their careers. Given your income and assets, there's no reason to run that risk. Pay off your debt. If you wish to invest in real estate, why not purchase the asset outright or pay it off quickly to minimize that risk. And consumer debt? Are you kidding me? You make $800K a year and have a car loan or carry credit card debt? Isn't that embarrassing? If you can save up for and buy a luxury car in a month or two, I see no reason to embarrass yourself in the finance department at the dealership.
#6 Remember the Lowly 529
Few Americans, even doctors, can actually max out available 529 accounts. They're really a tax break for the rich. I have four children, and current law in 2021 allows me to put in $15K per year into each of their accounts. It also allows my wife to put in the same amount. That's $30K per year total. Even better, you can “front-load” with 5 years of contributions upfront. That's $150K per kid for a married couple.
Keep in mind that each state has a different limit on 529s. Once the 529 hits the limit, you can no longer make contributions. In Utah, that limit is $510K per beneficiary. They don't count contributions to other state 529s, however, and your account can easily grow to more than that. You still don't want to put more in there than you anticipate the kid will spend on education, since earnings not used on education are subject not only to taxes, but also a 10% penalty. If you find that you have, the best option is often to leave the money in the 529 and change the beneficiaries to the grandkids, but there may be some gift tax issues with that.
#7 Don't Worry About the AMT
One nice benefit of being a high-earning doctor is that you no longer have to worry about the Alternative Minimum Tax (AMT). This tax generally affects those with taxable income between $150-415K. If you're making twice that, at least you have one less thing to worry about and plan around. However, since the Tax Cuts and Jobs Act (TCJA) went into effect in 2018, dramatically fewer doctors of any income are affected by it.
#8 Consider Cash Value Life Insurance
Although it pains me to say it, as I'm generally one of the internet's harshest critics of mixing insurance and investing, the higher your income the more sense investing in an appropriately designed cash value (whole life or variable universal life) life insurance policy can make. (For lower-income folks, I think Dave Ramsey is absolutely right when he calls it the “payday loan of the middle class”.)
High earners have maxed out available retirement accounts, are in and expect to stay in the highest tax brackets, have less need for high returns, and are more likely to gain maximal benefit from any estate planning and asset protection features. It's still reasonable to invest in tax-efficient mutual funds or tax-preferred real estate instead of life insurance (especially if your costs of insurance are relatively high), but the difference isn't nearly as vast as it would be on a typical physician income.
Bear in mind that if you choose to invest in a cash value life insurance policy that it should be set up as much as possible as an investment from the beginning. That generally means minimizing the death benefit, overfunding it to the MEC line, minimizing insurance and investing fees and expenses, funding it annually (instead of monthly), having it “paid up” as soon as possible to minimize required future payments, and perhaps most importantly, ensuring only a reasonable percentage of your assets are going into this investment vehicle.
#9 Mo' Money, Mo' Problems
Unfortunately, being a high-earner means there are fewer people around in your situation and that means you'll have many more opportunities to be swindled. This includes being sold cash value life insurance inappropriately, being pushed into a “special” retirement account that probably isn't superior to a taxable account for you, and being offered private investments (real estate funds, private equity funds, hedge funds, surgical centers, radiology centers, etc.) that are either too expensive, or worse, run by scoundrels. Due diligence becomes far more important than if you were just maxing out your profit-sharing plan. The good news is that purchasing background checks on the principals of these funds ($3-4K a piece) becomes a little more reasonable when you're investing large amounts.
Protect Your Assets
Again under the heading of “Mo' Money, Mo' Problems”, as your assets increase avoiding catastrophic loss becomes more and more important compared to the rate of return on your money. An appropriate insurance plan is still key, even for high earners, but asset protection considerations should be taken into account with most financial decisions. These laws are all state-specific, so you should become very familiar with your state's laws. If your state has a favorable homestead law (such as Texas or Florida) you may wish to buy a larger house than you otherwise might, and favor paying down the mortgage to other investments. If your state's homestead law is weak, like mine in Utah, you may wish to place money preferentially into retirement accounts, annuities or cash value insurance to protect it from creditors. For a high-earner with a large amount of assets, the asset protection features of a cash value life insurance policy may outweigh the lower returns and higher costs. You may also want to consider more exotic solutions, such as a portable offshore trust and family limited partnerships.
Purchase Liability Insurance
Liability insurance, including professional malpractice and personal (umbrella), policies should cover any reasonably likely liability. There is great debate whether more coverage makes you a bigger target, but there's no doubt that when you have more to lose you probably ought to have more liability coverage. Most docs should carry an umbrella in the amount of $1-5 Million. High-earning docs should probably err on the high side of that, and perhaps even go up to $10 Million if they can find someone willing to sell it to them. Discuss the pluses and minuses of increasing your malpractice coverage with local attorneys, including both defense and plaintiff's attorneys. In fact, it never hurts to make very good friends with the local ambulance-chasers, as many of them keep a “do-not-sue” list that includes friends and family.
#10 “Special” Retirement Accounts
There are a plethora of retirement/business/asset protection arrangements out there aimed at the high earner. The rules for these can get sticky, and they're not well-known. Many times, they're sold completely inappropriately. For your situation, however, the tax or asset protection benefits may be worth the additional expense and complexity. These accounts include:
- Cash Balance Plans
- Defined Benefit Plans
- 412(i) Plans
- California Private Retirement Plan
- Captive Insurance Companies
- Business Interruption Equity Trust
- Malpractice Insurance Equity Trust
- Equity Disability Trust
- Accounts Receivable Leveraging
- Accounts Receivable Business Continuation (ABC) Plan
- Non-qualified Deferred Compensation (NQDC) Plan
An entire post could be written about each of these, and each scheme cannot be explained here due to space limitations. Prior to instituting any of these plans, I suggest you get multiple opinions and be sure you thoroughly understand what you're purchasing, and what benefits it provides you in comparison to a taxable account, and at what additional cost and risk.
What do you think? Are you a “high-earning” physician? How has that affected your finances? Have you reached for any creative solutions? Comment below!