If you're an employee and have already maxed out a 401K ($17.5K), a back-door Roth IRA ($5.5K), and an HSA ($3250). What other options do you have to save for retirement?
The amount of “space” in available retirement accounts rarely lines up exactly with what an investor would like to save for retirement. Some people have far more of that space available than money to invest, while others have plenty of money without enough space! There are so many different options, there's no reason one has to stop saving for retirement if they wish to save more in any given year. Let's consider each of them one by one.
Spousal Retirement Accounts
If you're married, you can save money in your spouse's retirement accounts. Remember that money is fungible and a dollar doesn't care if it was made by you or your husband. There's no reason you can't take all your savings from your income and have most or all of your spouse's paycheck go into his 401K. If you have a stay-at-home spouse, or one with very little earnings, you can do a backdoor Roth IRA for your spouse with your own income, creating another $5500 in retirement “space” each year. Being married also allows you to put $6450 into a Stealth IRA (i.e. HSA) instead of just $3250.
Paying Down Debt
Many of us, especially in our thirties, carry around a large amount of debt, some of which may be at a relatively high-interest rate. If you have maxed out your retirement accounts and have debt at 6-7% or even more, it's a no-brainer to use your additional income to pay that down. It's the equivalent of purchasing an investment with a guaranteed 6-7% return. Even paying down a 3-4% mortgage may be an attractive option for additional savings for some people.
Lobby Employer for Additional Retirement Accounts
Self-employed physicians can use a Solo 401K or SEP-IRA with a $51K limit. Many partnerships have 401K/Profit-sharing plans in place with the same limit. These physicians may also have a defined benefit plan allowing them to save another $10-50K. While an employed doctor can't just walk out and open these types of accounts on her own, she can lobby her employer to add them to the mix. You may find your employer is more than willing to change the retirement options available, but just doesn't happen to understand his options and how important this is to his employees.
Catch-Up Contributions
Once you hit age 50, you can actually contribute more to your retirement accounts. The 401K employee contribution limit goes up from $17.5K to $23K. Profit-sharing plans go from $51K to $56.5K. Your personal and spousal Backdoor Roth IRA contribution limits also go up from $5.5K to $6.5K and even the Stealth IRA limit goes up by $1000 to $4250 (single) or $7450 (married). If you have a 403B and a 457 as many academic docs do, the limit for each of them goes up from $17.5K to $23K, providing another $11K in retirement savings space.
Annuities
While I'm generally not a big fan of annuities due to their additional costs and the fact that they turn income that would be taxed at a lower capital gains tax rate into income taxed at your higher regular rate, there are situations when they can make sense, especially if costs are very low, the asset classes invested in are particularly tax-inefficient like bonds, REITS, or high-turnover stock funds, and if you hold it for a very long time. They may also provide some additional, state-specific, asset protection benefits. However, in exchange for some tax benefits and possibly some asset protection benefits, you give up many of the unique benefits and flexibility of investing in a taxable account.
Cash-Value Life Insurance
I'm also not a big fan of cash-value life insurance, whether it be whole life, universal life, or variable universal life. It is often marketed to high-income people as an additional retirement account and has been discussed in the blog ad nauseum. Returns tend to be low and you must hold the policy for the rest of your life to get any kind of reasonable return. Withdrawals must be taken as “loans” from the policy, on which you must pay interest until your death (or pay back the loan.) You must also be insurable at a reasonable rate, so it really isn't an option for those with relatively poor health or dangerous hobbies. A life insurance policy may provide you some estate planning and asset protection benefits depending on your individual situation and state of residence. Some people may also highly value the permanent death benefit a cash-value life insurance policy is designed for. There are a few steps you can take to make a life insurance policy work out a little better as an investment, but as a general rule, the lack of flexibility and low returns make these an inferior option. You certainly shouldn't be buying one if you haven't maxed out all of more traditional retirement accounts.
Real Estate Investing
Investing in real estate allows you to take advantage of relatively safe leverage (when compared to buying stocks on margin) and many significant tax advantages such as depreciation, the ability to write off travel to the location of the property, 1031 exchanges, and the step-up in basis at death. Downsides include huge transaction costs and the fact that, in many ways, real estate investing is a second job, something most physicians don't need. Certainly, many physicians and other investors have had great success with real estate investing.
Accounts For Your Kids
Some doctors prefer putting extra money toward 529 accounts for their children or into their children's UGMA accounts. While this does have the benefit of lowering your tax bill, it really isn't a great place for your retirement savings due to restrictions on these accounts. Money taken out of a 529 and not spent on education is taxed at your regular marginal rate with an additional 20% penalty. Money put into a UGMA account can only be spent for the child's benefit. Besides, when the child turns 18-21, he can blow the money on dope and strippers and there's nothing you can do about it.
Taxable Investing Account
The much-maligned taxable investing account isn't nearly as bad as most physicians, and certainly most annuity and life insurance salesmen, think they are. Sure, it is exposed to your creditors, but the truth is that few of us will ever have to deal with a judgment that isn't covered by our malpractice or umbrella policies. Retirement accounts, annuities, and life insurance aren't really protected from the judgment most commonly faced by doctors, a divorce settlement, anyway. It is also taxed as it grows, unlike many of the other accounts listed above. However, it has many advantages that the other accounts do not. First, it is immensely flexible. You can invest in pretty much anything and you don't have to deal with age 59 1/2 related restrictions. Second, you can get a step-up in basis at death, passing money to your heirs' income tax-free. Third, you can get significant tax benefits during your life by donating shares to charity or tax-loss-harvesting. Fourth, you can minimize taxable income by choosing tax-efficient investments such as total market stock index funds and municipal bonds. If not completely tax-free or at least deferred, income will generally only be taxed at the lower capital gains and dividend rates rather than your regular marginal tax rate.
As you can see, there are lots of options for retirement investing even after you've maxed out your retirement accounts. As with most things in life, knowledge and creativity are rewarded financially.
What do you think? Which types of accounts do you use for your retirement savings?
great suggestions. Would you reccomend an EE Bond/I-bond ladder as a “DIY annuity” as discussed in the article below as an additional way to save for retirement?
http://www.forbes.com/sites/thebogleheadsview/2013/03/01/build-your-own-annuity/
http://www.bogleheads.org/forum/viewtopic.php?f=10&t=111987
I bonds can be a great investment in a taxable account. Like muni bonds they come with some significant tax advantages and inflation protection. I’m not a huge fan of EE bonds.
For those that are in a private practice or partnership, there is also the option of hiring your children. You need to check with your accountant but I believe the first $4000 or so of income is not subject to the “kiddie tax” because it is earned income.
Not only does this allow you to give money to your children which can be used to save for college in addition to a 529 plan, but it also decreases the amount you have to pay in social security and medicare taxes for your business.
Like mentioned above its not a retirement vehicle, but a much better use of your money than paying taxes on it.
Hiring them is a separate issue from giving them money in my mind. If you want to legitimately hire them, that’s great, but if you just want to give them money and lower your taxes I think an UGMA account makes a lot of sense. If invested in a tax-efficient way, it can be quite large before it starts getting taxed at your rate. I believe the first $900 of income is free and the second $900 is taxed at their rate. It it was all invested in a tax-efficient stock index fund throwing off 2% a year or so, that would be about $100K you could put it in there before income starts getting taxed at your rate. The only issue with an UGMA is that it’s no longer your money. If they want to blow it on drugs and strippers at age 18, there’s nothing you can do about it.
Agree with you on UGMA accounts, don’t like them for the reasons you mentinoed. I look at it this way. If you are in a high tax bracket and you want to pay for you kids college anyway and your business is set up for it, hire your kids.
This offers even more flexibility than a 529 plan as you can do whatever you want with the money whether they go to college or not. You are also not subjecting this money to market risk but still getting the tax benefits.
It would be a good idea to do both, put money in the 529 and hire your kids.
Sure, but it’s also a good idea to fund your 401K, do backdoor Roth IRAs, max out your HSA, pay off your mortgage, build up an emergency fund, replace that old car, take some nice vacations, pay off student loans etc. My problem is I have far more good ideas than money.
The question of building an EE bond ladder is really two questions. Is a bond ladder a good idea and are EE bonds good investments. I like bond ladders but mine are built with corp bonds. You just need to find something you are comfortable using as the safe portion of your account.
Of all these accounts only a taxable one allows Tax Loss Harvesting. TLH is the greatest cure for loss aversion, a dangerous psychological condition.
Taxable accounts can be asset protected somewhat by starting a Limited Partnership or LLC.
The money is taxable accounts can usually be withdrawn at a time of your choosing (no RMD!) and at capital gains or dividend rates. Don’t forget the step up basis on death.
Great discussions here!
I do have a concern about all these backdoor roth IRA encouragements. Several websites i’ve seen have raised concerns about backdoor IRA, especially the legal legitimacy and whether IRS would even view such maneuver as illegal and even force closures of such accounts in the future and maybe even take away the contributions. They talk about ‘step transaction doctrine’ of law whereby a series of maneuvers that is done for one purpose can be viewed as one simple transaction, such that the backdoor Roth IRA contributions can be ultimately viewed legally as you contributing excess contribution directly from your pocket to Roth IRA in one illegal step, prompting IRS to charge excise tax (6%/yr) on every backdoor Roth IRA contribution for all those years of people doing such contributions, etc. Sure, such drastic measures seem unlikely but who knows what can happen when government goes thru dramatic financial and political turmoils in the future ( Cyprus anyone?).
For self-employed people, going backdoor means converting all SEP-IRA to solo-401k with its attendant nemurous cumbersome inconviniences also to avoid getting taxed for backdoor Roth IRA conversion. Many brokers, like Schwab, don’t allow online transfer of money for solo-401k accounts and now you have to send in checks by mail for every contributions and you have to do extra paperwork for tax time every year, not to mention the headache of converting all SEP-IRA holdings to more primitive 401k accounts which may cost you a little and which also may be subject to extra annual account fees in many brokers.
I’ve contemplated taxable account investing vs backdoor Roth IRA investing for extra retirement savings, and i haven’t been convinced yet to go thru all the troubles. Maybe somebody can enlighten me?
Sounds like you understand the issues very well to me. If tax free forever and significant additional asset protection isn’t worth some hassle to you, go for the taxable account.
As far as the step transaction, I’ve also seen people concerned about the step doctrine. If you’re that worried, wait a few months before your conversion. It’s going to be awfully hard for someone to pin the step doctrine on you if you wait 3 months between steps.
The IRS seems too busy prosecuting the tea party to come after people for a backdoor Roth.
Hope you can answer this for me. I have a 401k/profit sharing account with my private practice which puts away that 52K per year or whatever that number is. I have also been putting money into backdoor IRAs. Is this legitimate, or am I not allowed to use IRAs because of the $52K in the other account.
Yes, I max out a personal and spousal backdoor Roth IRA in addition to a $52K 401K/profit-sharing plan each year and it is completely “legitimate.”
Our 5 partner group do SEP-IRA . I have around 100k in it. I am in the 35% tax bracket. Is it worthwhile doing backdoor Roth every year? Is there any strategy to mitigate the tax burden during the conversion?
You need to do something with that SEP-IRA. It either needs to be rolled into a 401K, or completely converted each year. I’m not sure I’d advocate doing that if you’re in your peak earning years. You may have to forgo the backdoor Roth due to your group’s poor choice of retirement plan. You could always talk the group into switching to a 401K.
You mentioned an HSA could be $6450 if you’re married. I’m assuming that this only applies if your spouse is on the same insurance plan. Is that correct? My wife’s work provides a decent low-deductible health plan, whereas my employer offers a limited high-deductible plan with HSA option. Our monthly premiums end up being less if we each stick to our own employer’s plans.
Remember that the HSA limit of $6450 is for “family” not “married.” If you have a kid on your plan, you may still qualify for $6450.
I am an employee with a group that has a 401k plan that I max out. I also do an independent back door Roth IRA and spousal Roth IRA. I secondarily moonlight as an IC with another group. Just to be sure – I can contribute 25% of my IC income to a SEP-IRA (up to $50k-ish) which will be tax-deferred and taxed after I take it out at my tax rate when I’m over 59.5 yo?
It’s 20% of your NET (net of the employer portion of payroll taxes) that you can contribute to a SEP-IRA. But you SHOULD NOT do that since you’re doing a backdoor Roth IRA. You should use an individual 401(k) so you don’t screw up your pro-rata calculation (line 6 of Form 8606 asks for SEP balances.) Too late for this year, but if you do a SEP-IRA for 2016 (which you can still do) you can open an individual 401(k) for 2017 and (if the i401(k) allows it) roll the SEP-IRA in there to avoid a pro-rata issue for next year.
I haven’t opened the SEP-IRA, so I can do an individual 401(k) instead. In that case, I can contribute pre-tax/tax-deferred $18k + 25% of the rest up to 50k-ish? And do all of this in addition to my current accounts?
*20%
You can’t do it for 2016. Too late. But it’s not too late for SEP-IRA for 2016. If you’re doing it for 2017, do the i401(k).
You only get one $18K employee contribution no matter how many 401(k)s you have.
But yes, in addition.
Love your blog and forums. I have been reading them but getting confused and was hoping for some suggestion. My wife owns a private practice (structured as an LLC with S-corp designation for taxes) with 10 employees (including me) and couple of IC working under it. We both take W2 wages (About $30k for me and about 100K for her which is average in her line of work) with significant amount passed through as distributions . We dont have any retirement accounts at work and only have a tIRA account that we funded $5500 for 2016 . As of now our (with extensions) business tax return filing is due 9/15/17 and personal tax return filing is due in October. We live in a state with out state tax, with 2 little kids, mortgage, practice loan, dividends from a taxable stock acct. Paid off student loan and paying off practice loan (4.65% vs 4% for mortgage) aggressively. We are in 39.6% bracket and paid 30.3% federal tax (Line 63/Line 22) for 2015.
1) Is there anything we can do in terms of retirement accounts for 2016?
2) What is the maximums we can put in various retirement accounts at the personal level or through our business?
Our CPA/book keeper/Taxguy has been charging about $1300 for business and personal tax filings in addition to $4800/year to maintain books hasn’t been very helpful. Appreciate all your input.
1) I don’t think so. You might be able to do SEP-IRAs still, but you’d have to do them for your employees too. Better get professional help if you want to consider that.
2) Depends on the retirement account.
3) Start interviewing other CPAs and ask them to help you with tax strategizing, not just preparing returns and maintaining books.
By the way, that seems like a huge red flag for you guys to be in the 39.6% bracket while only claiming salaries of $130K. I suspect you’ll get audited eventually on that point so I hope you have a very good reason to justify your low salaries.
Regarding SEP-IRA do we have to do it for all the employees that received a W2 in 2016 or only the employees that still work for the company currently. Also I found this requirement for SEP-IRA on Vangaurd. “Generally, employees must be allowed to participate if they’re 21 or older, earn at least $600 annually (limit for both 2016 and 2017), and have worked for the same employer in at least three of the past five years”. We have some that moved on and some that has not been working for the three years mentioned in that quote which excludes bunch of our employees including myself.
Are flat fee financial advisers better for Tax strategizing or CPA’s?
Market average pay is between $90k-$125k in her line of work and she pays the same for her associates as she pays herself based on the amount of hours they work. I help run the practice and may need to increase my pay to reduce the disparity you are talking about. Even if I pay myself $100k the disparity will still be there.
You can exclude some employees from retirement plans but the rules are very specific. It’s an important discussion to have with the professional helping you decide which retirement plan is right for your practice. Not a DIY project.
Tax strategizing is a pretty mushy topic. Someone who likes it and does it a lot is what you want. Tax prep CPAs SHOULD be better at it, but too many of them don’t do it.
Your salaries may be just fine, I don’t know. I’m just making sure you’ve looked at it carefully.
I have a dumb question that I feel like I should know the answer to, but I don’t. I have an “employer” 401K that I set up for myself as sole proprietorship of my practice (I am a 1099 emergency physician). I also set up an “employee” 401K for my wife who is employed in our practice (office manager). These were set up by our financial advisor, who we are separating from. They were set up with an EIN now associated with these accounts. I am in the process of trying to set up new 401Ks for her and myself that I can manage without the assistance of a financial advisor.
Do I use the same EIN that they used to open these accounts? Is this some kind of a violation because we would now have two separate brokerage accounts using the same EIN? Additional confounder: we formed an LLC that we use for payroll for my wife. Do I use the EIN associated with the LLC for the new 401Ks, or the first one?
Many thanks!
I swear I just got this exact question by email, probably from you. Maybe you need to check your spam folder?
At any rate, use the EIN associated with the business when you set up a 401(k). If the business EIN is now different, then you’ll now need to use the new one. Also, it is generally a change in plan rather than a whole new one as far as the paperwork goes. Make sure when you set up the new one that those helping you know there is one already in place for this business.
Is this affected by whether or not we pay ourselves through the LLC? For instance, one can “give oneself a salary” through the LLC, or instead just pay for everything through the normal bank account and file sole proprietorship instead. If the 401k is set up using the EIN associated with the LLC, then does it have to be funded with a business account associated with the LLC? And if this is the case, would I need to re-do all of my 1099 work contracts to be “between the ER/physician staffing group and the LLC”, versus how they currently are, which is “between the ER/physician staffing group and me personally”?
Sorry if these are dumb questions. I am in the VERY early stages of DIY investing, and just eager to get out from under the 1% AUM fee of my current financial overlords.
Many thanks!
It sounds like you need to decide your business structure first.
THEN get a 401(k). You can do a solo 401(k) with either a sole proprietorship or an LLC. Either way, employer contributions should be made from the business bank account. And yes, you should use your EIN when doing “business contracts”.
Your business is an entity separate from you personally. It has its own EIN, its own contracts, its own 401(k), and its own bank account. It could be a sole proprietorship. It could be an LLC. That LLC could be taxed as a sole proprietorship or as an S Corp.
Don’t mix personal stuff and business stuff.
Thank you for the response, and for all that you do for our community.