By Dr. James M. Dahle, WCI Founder
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.
#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.
Paydown Debt
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.
Best 529 Plans for 2021: Reviews, Ratings, & Rankings
#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
One of those places where a high income does you no good at all
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!
Cirque of the Towers in Wind Rivers Range, Wyoming. Shark’s Nose, Wolf’s Head, Pingora Peak, hard to tell the 4th. Warbonnet or one of the Warriors.
Great guess. You’ve got 3 of the four. The last definitely is NOT Warbonnet or one of the Warriors and in fact is hard to realize is a separate peak from Wolf’s Head which sits in front of it in this photo (the lighting shows they’re separate). Actually, now that I look at it again the left side of the photo includes the shoulder of another peak, but I wasn’t counting that one.
WCI:
“Many doctors, such as myself, have little need for a taxable account.”
How can this be true? Where else are you tax-sheltering besides IRA/401k, and 529? I find myself with lots of taxable income leftover and I’m not a “high-income” physician, just a lowly ER doc.
$51K in a 401K, $15K in a DBP, $6450 in an HSA, $11K into backdoor Roth IRAs, ~$10k into a Solo 401K (for the blog) plus 529s. Even without the 529s I’m over $90K a year already, which is more than I need to reach my goals and a pretty good percentage of my income. I keep seeing taxable investments I’m interested in (like real estate) that I don’t take advantage of because it would mean giving up a significant tax break by using these accounts.
I think this will vary by employment situation. Many docs who are employees or work in academia may be limited to 20 or 25k in a 401K depending on employer match. I am lucky to be able to contribute (with match) the full 51k to a 401/403 combination but have no defined benefit plan and am not eligible for an HSA. I can’t (conveniently) use the backdoor Roth because I rolled over a previous 403b into an IRA (which was probably the right decision because of the fees/poor choices in the 403). For me, and I expect a lot like me, a taxable account is necessary to accomodate the savings I need. I do contribute to my kids 529s but that is really distinct from retirement saving
As mentioned by Dr. X., this really varies by employment situation. I think you often make an implicit (and very reasonable) assumption that most high earning physicians are in partners in some sort of private practice. When in that situation, there as so many more options available.
However, if you are a just a W2 employee that makes a lot of money, your tax-avoidance options are severely limited. I am a big believer in lump-sum investing, so everything goes into retirement accounts ASAP. By the end of January my 403b (I can only put in 17K and employer puts in about 12K more), backdoor Roths, and HSA are fully funded for the whole year.
At that point, my only options are a taxable account or some sort of whole life product. There is nothing else that I’m aware of. If you’ve got any ideas, I’d love to hear them.
Dr. X and AR-
Yes, it can be common for someone to have a decent income and poor retirement account options, especially if they’re an employee. This will probably become more common as the years go by and more people become employees. Although I find that many docs and even advisors aren’t even aware of some of the accounts they could be using (like defined benefit plans, HSAs, backdoor Roth IRAs etc).
I don’t understand why Dr. X can’t just roll that IRA into his 401K and start doing backdoor Roths. Does your 401K prohibit it?
I am a big believer in a taxable account, and don’t see it as the horrible option that many people do. Sure, tax breaks are nice, and I take advantage where ever possible, but if I could only squirrel away $30K into tax advantaged accounts and needed to save $50K per year toward retirement I wouldn’t think twice about doing it in a taxable account. There are far worse ways to save for retirement than using tax-efficient investments like total market index funds and municipal bonds in a taxable account.
AR- I’m impressed that you can stick over $45K into retirement in a single month. I also try to front load my accounts as much as possible, but I can’t make that much in a month, much less save that much! I do get my 401K full by October or so and fund the Roths and HSA in January usually. My 529s get funded earlier and earlier each year (I’ve just been putting in enough to maximize the state tax break so far.)
I’ve got lots of ideas for investing, you’ll find them all over the site. But if I were you, I’d be lobbying my employer to add a real profit-sharing plan (so you can get a $51K max) and a defined benefit/cash balance plan to start.
I’ve seen the ideas, since I read the site pretty regularly, but, at least for me they all involve a taxable account. Did I miss something? I didn’t state it specifically, but kid’s 529 is done as well.
Employer is an non-profit, so lobbying for profit-sharing is a non-starter.
Any other thoughts?
I’m sure there are 401K/Profit-sharing plans at many companies that are considered “non-profit.”
Have you seen this post:
https://www.whitecoatinvestor.com/retirement-savings-without-a-retirement-account/
My current 401k options are pretty poor: relatively high expenses, mostly managed accounts, etc. I think a taxable account with Vanguard is a better option.
That’s possible, but it needs to be a REALLY crappy 401K and you need to stay there for quite some time and there needs to be no employer match before you’re better off passing up a 401K for a taxable account.
Yeah, I read retirement savings without a retirement account. It’s good advice, but it is either stuff I’m doing, can’t do SEP-IRA, or don’t really want to do (i.e., real estate investing).
I remember when I started at my current job I was very surprised that they didn’t have a 457 plan.
I guess I’ll look in to lobbying for better options, but quite honestly I doubt it will work. Our organization has thousands of employees. Effective lobbying in such an environment is difficult.
Sounds like you may be stuck with a taxable account. Remember that there are worse ways to save for retirement, so you might not want to look too hard for an alternative. I’d like to see a better way, and I wrote about it here:
https://www.whitecoatinvestor.com/10-reforms-that-would-improve-our-retirement-system/
How do you get 11K into a backdoor Roth IRA? I thought the limit was $5500. Are you including your spouses?
AR- some non-profit employers have deferred compensation plans (457 plans) that are tax-advantaged – could ask for this if one isn’t available to you. Obviously, not the same as 401/403’s in that if you leave your job, the plan will require you to make withdrawals regardless of age over a certain period of time (and you can’t roll it over to a 401/403/IRA). Still, you get tax-deferred growth with same 17.5k/yr max if you plan on working for the same employer long-term…
I’ve seen some that have a 403B ($17.5K), 457 ($17.5K) and a 401(A) plan also. One issue with being an employee is it is much harder to change what’s offered when you arrive at the job.
Although I live in Utah, I only have one spouse. 🙂 And yes, I’m including her backdoor Roth IRA too.
I lol’d
Clicked here from a previous link. Interesting to see your comments in 2013. Not that long ago you weren’t in real estate or even taxable accounts.
Made a lot less money back then.
I do not see any advantage in a Roth conversion at high income when you expect to be in a lower tax bracket in the future as compared to now. Here is my example:
Assumptions for these calculations.
1) Calculations are done at 25%, 28%, 33% and 39.6% tax brackets
2) When we invest in a Roth, the taxes we pay to maximize our Roth are instead placed in a tradition IRA. for example if I put in $5500 in a Roth IRA I would first need to pay taxes at my top tax bracket. That would be $3,605.96 at the 39.6 percent tax bracket, $2,708.96 at the 33% tax bracket, $2,138.89 at 28%, and finally $1,833.33 at 25%
3) The money we would pay in taxes in a Roth we would instead invest the whole sum in a traditional IRA. The investments would be as follows in the different tax brackets
39.6% – $9,105.96
33% – $8,208.96
28% – $7,638.89
25% – $7,333.33
4) Both investments grow at 7% tax free
5) both investments grow for 20 years prior to withdrawal.
6) We assume our effective tax in withdrawal is lower when we retire. We assume 20% for these calculation.
7) The value of each account after 20 years growth
Tax Bracket Roth 401K 401K after 20% tax payment on withdrawal
39.6% $240,150.81 $397,600.68 $318,080.54
33.0% $240,150.81 $358,434.04 $286,747.23
28.0% $240,150.81 $333,542.79 $266,834.23
25.0% $240,150.81 $320,201.08 $256,160.86
As we can see a Roth is leaving money on the table as long as we expect to have a lower income and pay less in taxes in 20 years compared to today, unless of coarse I am missing something.
Alex-
The reason a very high income person might do Roth conversions now is that they may NOT be in a lower tax bracket later. If you’re expecting $1 Million a year in income in retirement, most of that is going to be taxed at the top tax bracket. So you get more after-tax money into a tax-protected account by putting in Roth contributions or doing Roth conversions. For the typical doctor ($150-500K per year income, less in retirement), this probably isn’t a good idea because they’ll be withdrawing at a lower effective tax rate than the marginal tax rate at which they contributed.
In your example, you’re not choosing between $5500 in a Roth IRA and $5500 in a traditional IRA. You can’t deduct a traditional IRA and you can’t contribute directly to a Roth IRA. You’re choosing between holding a non-deductible traditional IRA and converting that non-deductible traditional IRA. That choice is a no-brainer.
Hope that helps.
The above post poorly formated by table. Here it is again more clearly.
Tax ——Bracket Roth—–401K———–401K after 20% tax payment on withdrawal
39.6% —-$240,150.81 —-$397,600.68 —-$318,080.54
33.0% —-$240,150.81 —-$358,434.04 —-$286,747.23
28.0% —-$240,150.81 —-$333,542.79 —-$266,834.23
25.0% —-$240,150.81 —-$320,201.08 —-$256,160.86
412i now know as 412e is almost never a good idea. Its just a different defined benefit plan using inferior investments. You will just pay more for the same defined benefit.
http://www.executivebenefitsgroup.com/images/EBGwp4.pdf
Beyond just that removing any insurance from the plan (since you cant roll it into an ira) can be extremely expensive. Don’t let anyone talk you into thinking you can spring it out based on a low cash surrender value.
Thanks for this series! As a member of an eventual dual physician household I am very interested to hear about the different challenges and opportunities that are present for people in that situation.
You’re welcome. After I did the poll I realized there was more need for this series than I thought.
WCI,
Pardon my ignorance, but despite your discussion and several internet searches I still have a difficult understanding of how a backdoor Roth is beneficial. Can you please help me out with an actual cash example. Assuming you already contributed $51K in a Solo 401K, have all your business expense and deductions and still have taxable income in the 39.6 tax bracket. How would I fund this backdoor Roth, I assume my limit is another 17.5K correct? What are the tax implications today and on withdrawal at 59 1/2 years old.
Let’s try one more time.
You make your money. You pay your taxes on it. So let’s say you make $7678. You pay your taxes ($2178.) You then have $5500 in after-tax money. You put it in a non-deductible traditional IRA. You convert the non-deductible traditional IRA to a Roth IRA. That costs you nothing in taxes since you already paid taxes on that money. It grows to $50K in a tax-protected manner over the next 30 years. You pull it out of the Roth IRA, pay no taxes on it, and buy a boat with it. You still have to pay sales taxes on the boat, of course. 🙂
Does that help? Yea, it doesn’t help your taxes now, but it grows tax-free and is withdrawn tax-free, just like any other Roth contribution. I’m not saying do a backdoor Roth instead of contributing your $51K into a Solo 401K, I’m saying do it in addition to it instead of investing in a taxable account.
The limit is $5500 per year for you, and $5500 for a spouse.
I’m a little disappointed that the tax strategies with charitable giving were not mentioned. I’d hope that most ultra high income people have a desire to give back and would be interested in doing it in a tax efficient manner.
For example, appreciation on stocks donated to charity that have been held over a year can give you the full deduction without having to pay tax on the appreciation. I always have a few stocks cooking in the background that I can later contribute to charitable causes in the future.
Aside from charitable remainder trusts, I’m not sure charitable giving issues are any different for a high-income doctor vs a typical-income doctor. Is there some issue there I’m missing?
Nothing especially different other than typical-income doctors don’t usually have the income to have a need for charitable planning. CRUTS, CRATS, CLATS, CLUTS, foundations, etc. Lots of different options for charitable planning.
I see lots of doctors do retirement planning, I see very few do charitable planning. Usually I see doctors sell stocks to write checks to charities they support…it makes me cringe, donate appreciated property. Selling stocks is just handing money to the government.
Hi WCI,
Great blog and thanks for all the posts. Used the site to educate myself and obtain my disability policy.
Any advice/input on Jefferson National – Monument Advisor variable annuity. This was suggested to me by our financial advisor since it has a flat fee of $20 a month. Iam a 43 year old and wonder whether annuities has any role in my portfolio?
Forgive my ignorance. Can a HSA be funded by an employed physician?
Keep up the good work!
An HSA can be funded by an employed physician IF he has a high-deductible health plan.
I am generally NOT a fan of variable annuities. If you really do want a variable annuity, you might consider buying Vanguard’s VA, which has much lower fees than the vast majority of VAs, but still more than their typical mutual funds. For example, the admiral shares REIT fund at Vanguard has an expense ratio of 0.10%, or $100 per year for a $100,000 investment and the REIT VA has an expense ratio of 0.58%, or $580 per year for a $100,000 investment. The difference is $480 per year, or $40 per month. It would be $10 per month difference for a $25,000 investment. Now you have something to compare to. But before you invest in a VA, read this book:
https://www.whitecoatinvestor.com/the-truth-about-buying-annuities-a-review/
and these two posts:
https://www.whitecoatinvestor.com/8-reasons-why-you-should-invest-with-mutual-funds-instead-of-a-variable-annuity/
https://www.whitecoatinvestor.com/what-about-cheap-variable-annuities/
If you do decide to use a VA, the Jefferson National product, advertised as a low-cost option to be used by fee-only planners, isn’t a bad choice:
https://www.jeffnat.com/home/products/monumentadvisor.cfm
It’s nice to see the industry coming out with these types of things. But I still think it’s not a great move for the vast majority due to the fact that although a VA grows in a tax-protected manner, withdrawals are taxed at your higher marginal rate instead of your lower capital gains rate. It really only makes sense for very tax inefficient assets held for a long time.
Any chance for a part 3 on cash value life insurance?
What hasn’t been covered?
Did you have a specific question about it? I’ve written at least a dozen posts on the site about cash value life insurance. I am generally not a fan but there are a few unique circumstances where it can make sense (especially if you don’t mind having low returns despite holding the investment for decades.)
Whitecoat i thought it was $51k total to 401k inclusive solo 401k. How are you doing both?
It’s $51K per employer. So $51K for my partnership at work and $51K for my completely separate business, The White Coat Investor LLC (except I don’t make enough on the blog to max that one out.)
Hi, This is a question for White Coat Investor or anyone else who wants to jump in! My husband is an ER doc making approximately $450,000 per year and saving about $150,000 per year. Since we fired our investment guy, I’m now the “investment gal”. We recently restructured our investments to Vanguard and are still working on fine-tuning our asset allocation. Tax-planning is something I’m still trying to fully grasp. Here is how we allocate our funds each year:
401k $17,500 our contribution/ $33,500 Employer Match
Spousal Roth IRA $5500
Health Savings Account: $6000 Funded by Employer/ Can we contribute another $450 into this?
So, with the $17,500 401k, $5500 Roth, $450 HSA, we are only at $23,450 or our total savings each year. This leaves $126,500 that needs to be placed in our Vanguard taxable account, I-bonds, and EE-bonds.
My husband also does consulting work on the side and just set up an LLC. What type of tax-advantaged account can he set up and what is the max he could contribute?
I may also start doing consulting/public relations work. Would it be advantageous to set up an LLC in my name and also set up a tax-advantaged account for this business?
Aside from the LLC businesses, are there any other tax-advantaged accounts we are missing?
You can probably contribute some more to the HSA. Check with the HSA provider directly.
You and your husband can do backdoor Roth IRAs- $5500 a piece.
Your husband gets $51K if you include the match (and I don’t see why you wouldn’t.)
If his “consulting work” isn’t emergency medicine, he can probably open a Solo 401K for it. He doesn’t need an LLC necessarily to do that, but he will need a federal employer identification number. If it is EM, you probably can’t.
If you open your own business, you can also do a Solo 401K.
I Bonds and EE Bonds can be useful, but they’re hard to get excited about. You might consider a cash balance/defined benefit plan. I’m not sure I completely understand your husband’s situation. If he is a partner or employee, the group will have to do it for his main job. He could do it for his consulting work, but I doubt he’s making enough there to justify the expenses.
So $51K +$11K + $6450 = $78,450
You could do another $20K into I bonds. That leaves $50K to invest in a taxable mutual fund account, real estate, or somewhere else. You can probably get some of that into Solo 401Ks for your businesses, it depends on how much you make.
Mary,
This is just my option, but I believe with your savings potential it is actually a good idea to have a taxable account. This is money that is much more liquid than those retirement plans and can be used during an emergency or for other investing oppurtunities. I also believe investing some money in precious metals as a hedge (not for growth) may also be a good idea and can technically be sold tax free. The big question is what percent should be in taxable accounts? Looks like fate is deciding for you at 50-70k.
I agree that fate usually decides the taxable percentage. Most people want as little as possible in there since tax breaks are better in the retirement accounts. I’m apparently pretty lucky to be able to save a good amount and not need a taxable account. But if I was trying to put $150K a year toward retirement, about $50K of it would have to go into a taxable account. I view that as superior to any type of annuity or cash value life insurance for me, especially given that I can flush out the capital gains using charitable contributions. Uncle Sam shares my losses, and I pay nothing on the gains. It’s not a bad gig.
I don’t completely understand this concept of donating appreciated stock shares to charity as part of a retirement plan. I’m all for it and I currently give more than my fair share to my favorite charity. I get that you don’t pay capital gains tax on the shares and get to deduct the full value of the shares, but it’s not as if you can use that money for retirement–it goes to the charity. Am I missing something here?
Sorry I probably wasn’t being clear. It does go to charity, and has nothing to do with retirement. I was more saying how diligently a lot of people put into planning for a tax efficient retirement plan, but give no thought to making tax efficient charitable donations.
I have a self-managed portfolio of a few stocks and generally will meet my donation goals and plans with the highest appreciated stocks.
Thanks for the advice, WCI and Alex.
My husband’s main job is as a partner in an emergency medical group. His part-time consulting work is not practicing emergency medicine but is related to review of medical cases – (insurance review work, medical-legal consulting)and consulting for a medical device company.
If he were to set up a solo 401k for the part-time business, how would he do this? Can this simply be done through Vanguard?
Regarding the backdoor Roth, the reason he doesn’t currently have one is that he has a large roll-over IRA from former employers, and he didn’t want to have to pay taxes on that large amount if he were to set up a Roth.
Could you please explain the cash balance/defined benefit plan? I’m not familiar with that. Thanks again!
Yes, he should be able to use a solo 401K for the consulting business. It is easy to open one through Vanguard and I just did so a few months ago. He’ll need an EIN. Keep in mind that Vanguard’s Solo 401k does not accept incoming IRA transfers. You may want to get a solo 401K with a provider who does so you can do backdoor Roths.
Here’s a link to the post on cash balance plans:
https://www.whitecoatinvestor.com/cash-balance-plans-another-retirement-plan-for-professionals/
Thank you again, WCI, for the helpful advice. Just so that I understand this correctly:
– Can my husband roll his existing IRA into a solo 401k through his consulting firm OR to his current employer 401k (with Schwab)? I have never heard that IRAs could be rolled into 401ks. (I thought it was the opposite – that 401ks could be rolled into IRAs.) So does this avoid paying the tax on existing IRAs when opening a Roth or is there no way to avoid paying the tax on all IRAs combined?
– If he has his IRA currently at Vanguard, if could not be rolled into a solo 401k if it is also set up at Vanguard?
Also, would you be able to take my last name off my original post on this thread (I didn’t realize it would show up on the site). Thank you again!
Rollovers into 401Ks depend on the plan rules. If the plan allows it, you can do it. Most plans allow it because the plan managers want more AUM, so his current employer will almost surely allow him to do so. My 401K through Schwab allows IRA rollovers into the account. Yes, it avoids paying the tax on existing IRAs when you do a backdoor Roth. You can convert them all if you like, but you’ll have to pay the tax on that.
The Vanguard Solo/Individual 401K, for whatever reason, doesn’t accept IRA Rollovers. I believe Schwab’s Individual 401K does, however. It seems to say it will on page 3 here:
http://www.schwabcdn.com/public/file/P-619738/I401k_SPD_Bundled_BDL52452-02_Final_124510.pdf
I edited the above post as you requested.
Pretty sure the Max annual contribution to solo 401k is $51,000 regardless of how many different plans you have set up (SEP, 401k, 403b).
I disagree, as does every other reliable source I’ve been able to find. It is $51K per employer. If you have a reliable source saying otherwise, I’d be very interested to see it.
Here’s a post from January about it:
https://www.whitecoatinvestor.com/beating-the-51k-limit-friday-qa-series/
My bad, looks like you are correct. Once again I have learned something new on your blog!. Keep up the good work. Now I need to find a part time job paying $17,500!!
Me too, but I hope the blog will be close this year.
It’s weird how every time my husband or I have a question about something, I come on your blog and you’ve already covered it! For Instance, one of his partners just signed on with the Army National Guard and my husband is thinking of exploring it, too, and you covered this topic just last week!
As I’ve been exploring the solo 401k issue, the question about maximum employee contributions came up yesterday while on the phone with the Vanguard Rep. He said that since my husband already has a 401k through his full time job which is being maxed out at $17,500, that he cannot contribute any more to a solo 401k. The Vanguard rep said that he would be better off with a Sep IRA. Although, my husband is a partner in his group, I’m now very confused after reading your post above about “beating the 51k limit.”
I don’t find it weird at all. Remember I not only practice medicine full-time (so I’m doing exactly what you’re doing) but I also interact constantly with readers via email, comments after posts, and on internet forums. I try to keep my finger on the pulse of what’s going on out there. Without the interaction, the blog wouldn’t stay as relevant to readers.
This isn’t the first time a Vanguard rep has been wrong about something, by the way. As I mentioned to the other reader, if you can find a definitive source (preferably off IRS.gov) I’d be very interested in seeing it. Until then, I’m going to go with the information I found before, which seems pretty definitive to me.
WCI, I meant “weird” in a good way! I really appreciate your wealth of knowledge and the range of topics you cover.
I researched the topic of 401k employee contributions on the IRS.gov website and found something that states: “A business owner who is also employed by a second company and participating in its 401(k) plan should bear in mind that the limits on elective deferrals are by person, not by plan.”
Here’s the link: http://www.irs.gov/Retirement-Plans/One-Participant-401(k)-Plans
What is your take on this? Thanks again!
That’s an interesting link which seems to directly contradict the previously noted example. They do seem tough to reconcile don’t they. Here’s the wording from the other example:
Example 1: Greg, 46, is employed by an employer with a 401(k) plan and he also works as an independent contractor for an unrelated business. Greg sets up a solo 401(k) plan for his independent contracting business. Greg contributes the maximum amount to his employer’s 401(k) plan for 2012, $17,000. Greg would also like to contribute the maximum amount to his solo 401(k) plan. He is not able to make further elective deferrals to his solo 401(k) plan because he has already contributed his personal maximum, $17,000. He has enough earned income from his business to contribute the overall maximum for the year, $50,000. Greg can make a nonelective contribution of $50,000 to his solo 401(k) plan. This limit is not reduced by the elective deferrals under his employer’s plan because the limit on annual additions applies to each plan separately.
Here’s the key however. You can limited to only $17,500 in elective deferrals into all plans no matter how many employers. Remember your cited statement says “elective deferrals.” So all of my 401K/profit-sharing plan money at work is not an elective deferral. It is simply profit-sharing and is limited by ~ 18-19% of my income through that job. My Solo 401K consists mostly of elective deferrals, at least until I get more than $17.5K into there, at which point I’d be limited by the relatively low income the blog generates.
Hope that helps. I’d be willing to go to audit/Tax Court on this one, but it’s never a bad idea to discuss it with a CPA if you’re particularly concerned.
The final stage of a doctor’s career are going to be approaching retirement. At now creating the foremost of the monetary opportunities out there is probably going to be high on the lists of priorities to ease them into a snug and pleasurable retirement.
WCI, yes, it’s very confusing. We’ll have to discuss this with our CPA. Interesting about the “elective deferrals” vs. 401k/profit sharing at your main job where you area a partner. Is your 401k plan specifically set up as a 401k/profit sharing plan by your emergency group? If that is how it needs to specifically be designated, I do not believe that my husband’s Schwab 401k is set up that way even though he is a partner. His group clearly follows the employee $17,500 and employer contribution limits up to $51,000. Thank you again for your advice and input. I will let you know what our CPA says.
It is set up as a 401K/profit-sharing plan. I don’t think there is a requirement that $17.5K of it has to be an employee contribution (since I’m a partner, not an employee.)
In tax areas that you feel are gray (I don’t think this one is, but you might) I feel it is advantageous to call it in your favor. Your tax return is really just your first offer in a negotiation. There’s a good chance they’ll take your first offer (no audit.) There’s also a good chance that you will end up with a compromise amount. You’re unlikely to come out behind when you compare to just paying as much tax as possible on the gray issue.
Sorry for being dense here, but where does the ~18-19% come into play? Is that of gross or net income? Is this a legal restriction or idiosyncratic?
It comes from the IRS guidelines for how much can go into an account like a SEP-IRA. In IRS Publication 560, on page 6, it says the following:
Contribution Limits
Contributions you make for 2012 to a com
monlaw employee’s SEPIRA cannot exceed
the lesser of 25% of the employee’s compensa
tion or $50,000. Compensation generally does
not include your contributions to the SEP. The
SEP plan document will specify how the em
ployer contribution is determined and how it will
be allocated to participants.
Example.
Your employee, Mary Plant,
earned $21,000 for 2012. The maximum contri
bution you can make to her SEPIRA is $5,250
(25% x $21,000).
Contributions for yourself.
The annual limits
on your contributions to a commonlaw employ
ee’s SEPIRA also apply to contributions you
make to your own SEPIRA. However, special
rules apply when figuring your maximum deduc
tible contribution. See
Deduction Limit for
SelfEmployed Individuals,
later.
If you go through the link, it reads this:
Deduction Limit for
Self-Employed Individuals
If you make contributions for yourself, you need
to make a special computation to figure your
maximum deduction for these contributions.
Compensation is your net earnings from
selfemployment, defined in chapter 1. This def
inition takes into account both the following
items.
The deduction for the deductible part of
your selfemployment tax.
The deduction for contributions on your be
half to the plan.
The deduction for your own contributions
and your net earnings depend on each other.
For this reason, you determine the deduction
for your own contributions indirectly by reducing
the contribution rate called for in your plan.
To
do this, use either the
Rate Table for SelfEm
ployed
or the
Rate Worksheet foSelfEmployed
in chapter 5. Then figure your
maximum deduction by using the
Deduction
Worksheet for SelfEmployed
in chapter 5
If you then go to this worksheet for the self-employed, and run your numbers through it, you’ll quickly discover that you can put about 18-19% of your gross earnings into a SEP-IRA, at least up to the maximum.
The guidelines say it is 25% of your income, but that’s your income not counting the amount put into the SEP-IRA, so it’s really 20%. That is slightly reduced due to the deduction for self-employment tax. I don’t know the exact percentage, but it’s between 18 and 19%.
This is a question about opening a Solo 401(k). I’m very appreciative of this blog for introducing me to this concept, in addition to many other helpful ideas. In brief, I’m a newly-graduated IM doc in a physican-owned primary care practice. I earned some income outside the group this year, primarily as the director of a hospice branch. My hope is to shelter some of those earnings in a Solo 401(k) through Fidelity (whom I chose over Vanguard largely b/c they allow IRA rollovers, which I need to remain eligible for a backdoor Roth). Their small-business specialist warned me on the phone, however, that I may subject my group’s 401(k) plan to the terms of my Solo 401(k), as it may be considered an “affiliated employer” once I become a partner in the group. Does anyone know if this is true? Am I not eligible, then, for a Solo 401(k), even though my income is separate from the work I do as a PCP? My understanding is that the Affiliated Employer law is designed to prevent business owners from profiting from retirement accounts that they don’t offer their employees. I’d appreciate any insight other might have; I’m eager to open this Solo 401(k) but now a little spooked…
Well, your situation is less clear than mine. Business 1 is a physician practice. Business 2 is a blog. Clearly unrelated. For you, however, business 1 is a physician practice and business 2 is a physician practice. That gets a little tricky. It’s a bit of a gray area. However, I’m a big fan of calling the gray areas of the tax code in my favor. Worst that can happen is they audit you, rule against you, you go to Tax court and tax court rules against you, and you have to pay the tax plus penalties and interest. You’re not going to get thrown in jail. I would probably fund the Solo 401K, at least with the employer portion (~ 18% of what you earn doing hospice care.) Whether or not you can do the employee portion is also a bit gray. Remember the limit is $51K per employer for employer contributions, but only $17.5K per employee for the employee contributions, no matter how many jobs you have. Probably worth spending a few bucks with a good CPA.
Thanks, WCI, for your reply. I like your concept of calling gray areas in the taxpayer’s favor. Although I’ll likely run this by a CPA and even try to find the statute myself, I believe that I won’t be violating the intent of the law anyway. The sources of income are independent; one would persist if even if the other ended. They are taxed differently, suggesting that even the IRS recognizes them as distinct. Plus, no matter how generous our practice made the 401(k) for our employees, my hospice income wouldn’t be eligible for it (meaning that I’m not using the Solo route to keep the group’s employees from having access to a retirement plan).
This post and the links in it may help:
https://www.whitecoatinvestor.com/beating-the-51k-limit-friday-qa-series/
You might also discuss it with Mike Piper at Oblivious Investor, who pointed some of this stuff out to me.
That post, and the discussion thereafter, is very helpful. It let me to the IRS statue, which contained examples that clarify that I am not in a “controlled group of corporations.” My 1099 income will be filed as a sole proprietor, which isn’t a corporation. Be that as it may, however, there are enough partners in the practice that no “five or fewer persons” will own more than 50% of each corporation. Ergo, my practice and independent contractor work are not part of a “brother-sister controlled group.” Thanks so much. The Solo 401(k) Adoption Agreement gets sent tomorrow.
Hi WCI,
I wasn’t sure where to post this question exactly, but since I recently negotiated a raise, here we go.
My salary is due to go from 450K to 650K in 2019. Cardiology, large health system, employed (but unlikely to get higher raises).
Ages: Me 42, spouse 36, 2 troublemakers ages 6 and 1.5 living in HCOL metro NYC, no plans to relocate out of area.
Goal: retirement in about 25 years. Would like to have $4 million in today’s money (or about $9.5m in future dollars) for a retirement withdrawal rate of 3.5% producing an income of about 130-150K prior to SS.
Disability, life insurance and wills are in place. I try to follow the BH philosophy.
Total Retirement assets: 795K ( IPS calls for 75/25 stocks/bonds for now then decreasing 70/30 at age 45, it’s around 80/20 but I will rebalance) Taxable account: 440K in taxable (split among Vang Int Tax Exempt, Total Stock and Total International)
His backdoor Roth: 65K in VISVX small cap value
Hers backdoor Roth: 28K in VISVX
403B/457B: 222K in Vanguard Target 2040 (about equal amounts in 403B and 457B, the 2040 was the closest thing to a 3 Fund option, it’s non-governmental 457 and I’m aware of the risks).
old 403B: 40K in Vanguard Total Bond
Assets: primary home, purchased at 950K, have about 540K remaining on mortgage. 15 yr with 10 years left.
Debts: no cc debt, one vehicle purchased in 2015, have 10K left on loan. Mortgage as above.
For the last two years, these are roughly my expenses. Salary as I mentioned was 450K.
150K to taxes (Fed + State + FICA)
170-180K spending (higher last year due to nanny) + 10K for health insur
100K saving
My new role will come with a salary of 650K.
My plan is to do the following:
250K to taxes (based on estimates online)
150-170K spending + 10K for health insur
130-150K saving
That leaves about 100K left over (if my tax calculations are correct).
My plan is to do this with the 100K for the next few years.
15K/ year to age 18 —> 529 plan for child 1 (age 6, current balance 45K)
15K/ year to age 18 —> 529 plan for child 2 (age 1.5, current balance 5k)
10K/ per year for 5 years —-> Emergency Fund (that’s right, I do not have an EF, have a HELOC)
10K/ per year for 4-5 years —-> new car fund
50K/ per year for 5 years —-> planning to save 250K for larger home purchase
Questions:
1. I feel I am a bit behind in retirement savings for someone my age but based on calculations, I think I can reach my number before age 65. Do you guys think my AA is too aggressive for my age? I never went through 2008 so I don’t know what I’ll do if pushed against a wall but I think I will stay the course.
2. We are planning to buy a larger house in the same area in 5 years (cannot move due to family reasons). Most likely, I will have to look in the 2 million range. Our current home was purchased in 2013 with a 15 yr fixed. I have about 400K equity in it now and anticipate in 5 years, to have 700K equity. If we sell for 1.2 million at that time, I would anticipate having 700K equity + 250K cash (see above from annual saving) + extra 150K (appreciation – transaction costs) which comes out to about 1.1 million. That means I would have to take out another mortgage for 1 million. Do you think that is feasible? The property taxes on such a property would be about 20K/ year. My plan would be to take out a fixed 20year loan and try to make larger payments to pay off in 15.
Please review and make any suggestions. Thanks.
1. Would you feel better if I told you were way ahead of the average doc your age as far as income, net worth and retirement assets? Too often we compare up instead of down and don’t realize how fortunate we are. The average doc in his 60s has a net worth of $2.1M. You could be there by 45. I think the AA is reasonable, but neither of us will know for sure until your first big bear market!
2. $2M stretches my guidelines a bit without a big down payment. If you can come up with $800K or so between savings and home equity for a down payment, it could still be reasonable. NYC and the Bay Area often require some stretching. Just realize it’ll have a significant impact elsewhere in your financial life. Your plan sounds just fine, although it’ll require a nest egg of $500K just to pay your property taxes in retirement!
JeanP,
Thank you for the breakdown! Looks like you are currently living off of approximately $15000/month. Any chance you could break that down (Mortgage/Utilities/Maintenance /Nanny/Food/Car/Gas/Clothes/Insurance/Disability/Travel/Insurance/Kids Activitie/Etc)? Seems like you are doing great budgeting! Thank you!
I didn’t follow:
“#7 Don’t Worry About the AMT”
The AMT gets me most every year since it limits the foreign tax credit among other things. It’s probably the single biggest contributor to my US tax liability (even more than the NIIT) and it seems like more of a problem as one’s income rises into seven figures rather than less.
That’s interesting that you have a 7 figure income and are still paying AMT. By that level, the regular top tax bracket usually generates more tax than the AMT top tax bracket. Is there something really interesting about your income/tax situation?
I am an expat and income varies by year but AMT has hit to a greater extent in my best income years. About 15% of my income is now from qualified dividends but I don’t think that is creating the problem. If I understand what is happening on my tax return (and it is a struggle to really figure it out even working with my Enrolled Agent) the AMT is limiting the foreign tax credit. It also of course will hit for stock option exercises but that has not been my issue in recent years. I pay taxes in a mostly higher tax country (higher marginal rate of 55% for earned income but slightly lower rate of 20% for dividend income) than the US so my guess is without the AMT I would only be paying NIIT.
Sounds like a pretty unique income structure to me. Is this on a 7 figure income?
Actually it’s a 9-figure income because it comes in Yen and it varies a lot by year (will be 40% lower this year due to Covid). I realize you still have far too few Expat physicians at WCI so my situation is a little unusual but this link from the Tax Policy Center suggests currently the AMT most often affects the over-$1 million income group (although that wasn’t the case in 2013 when the comment stream started): https://www.taxpolicycenter.org/briefing-book/who-pays-amt
Interesting. Thanks for sharing.