In our previous post, we discussed tax planning opportunities while in training. These opportunities were focused around capitalizing on your (temporarily) low tax bracket and being strategic about your tax filing status if you are going for Public Service Loan Forgiveness. In this post, part two of a three-part series, we transition to the next phase of a physician’s career – the post-training period. This phase brings both new challenges and new possibilities when it comes to tax planning. Here are some things to consider as you try to minimize your lifetime tax bill.
Phase 2 – Attending Physician
Upon completion of residency or fellowship, you finally receive that big jump in income that you have been waiting for. And while it means more money available to spend and save, it also means a significantly higher tax bill than what you faced while in training. During this phase of your career, you will likely be at or near the highest tax bracket of your lifetime. Therefore, the focus shifts from taking advantage of future tax benefits (like making Roth contributions as a resident or fellow) to minimizing your current tax bill and deferring taxes to the future (e.g. retirement) when you will likely be in a lower tax bracket than you are now.
Consider Switching From Roth to Traditional Retirement Contributions
The biggest thing you will want to consider is switching your retirement contributions from Roth contributions to traditional contributions. As we mentioned previously, Roth contributions are made with after-tax money (you pay taxes now but don’t pay them in the future), while traditional contributions are made with pre-tax money (you receive a tax benefit now but then have to pay taxes when the money is withdrawn in the future). As a general rule of thumb, if your tax rate is going to be higher in the future, then Roth contributions make financial sense, while if your tax rate is going to be lower in the future, traditional contributions are more optimal.
The More Money You Save, the More Taxes You Save
Ideally, as an attending you will make the maximum contribution to your qualified retirement accounts, like 403bs and 401ks. Some employers offer additional options, like a 457b plan, that allow you to save even more money on a pre-tax basis. To illustrate the tax benefit of contributing to these retirement accounts, here is an example. If you are a married physician with a household income of $250,000 and are filing taxes jointly, your marginal tax rate is 24%. Therefore, if you are eligible to contribute to both a 403b and a 457b plan, and you make the maximum contribution ($19,000 in 2019 if under age 50) to each, you will save over $9,000 on your tax bill this year. When it comes to pre-tax qualified retirement accounts, the more money you save, the more taxes you save.
Consider Contributing to a Health Savings Account
A Health Savings Account (HSA) is an account that provides tax benefits when you save money for qualified medical expenses. It’s the only account with a triple tax advantage. Contributions are tax-deductible, the account grows tax-free, and the money can be withdrawn tax-free if used for qualified medical expenses. While not everyone is eligible to contribute to an HSA (you must have a high deductible health insurance plan), if you are, this provides another way (in addition to your qualified retirement accounts) to save taxes by making pre-tax contributions. And while HSAs are meant to be used for medical expenses, after the age of 65 the penalty for non-medical use is waived and you just have to pay taxes when you withdraw the money, making the HSA like another retirement account.
Additional Opportunities for Business Owners and Independent Contractors
If you are a business owner or have independent contractor income from locums/moonlighting work, you could potentially have even more opportunities to save taxes. If you do independent contractor work, it might make sense to open an individual 401k or a SEP IRA, which would allow you to contribute additional pre-tax money to your retirement savings. If you are a small business owner, a cash balance plan can provide the potential to save several hundred thousand dollars annually (this type of plan makes more sense as you get closer to retirement). If your work situation is different than the traditional employee setup, know that you might have additional tax planning opportunities.
Don’t Forget the Backdoor Roth IRA
As an attending physician, your income is likely too high to make traditional Roth IRA contributions. However, you can still make these contributions in an indirect way through a backdoor Roth IRA. While this requires some additional work, it provides another opportunity to save to a tax-advantaged account, after you have exhausted your pre-tax contribution limits. If you are going to do a backdoor Roth IRA, be sure to follow the correct steps and understand all the rules.
While tax planning in phase one of your career (training) is primarily about taking advantage of your temporarily low tax rate by making after-tax retirement plan contributions, when your income jumps (and your tax rate rises) in phase two of your career, the focus shifts to saving taxes now by making pre-tax contributions. By maximizing your tax planning opportunities in phases one and two, you’ll set yourself up well for phase three, where you’ll have significant potential to minimize taxes by being strategic about the way you withdraw from your investment accounts.
Disclaimer: We are not licensed tax professionals and the content of this post does not constitute the issuance of tax advice. Please consult with a licensed tax professional to understand what is best for your personal situation.
About MD Wealth Management: We are an Ann Arbor financial planner that specializes in providing financial planning for physicians and retirees. We are CERTIFIED FINANCIAL PLANNER™ professionals and fiduciary financial advisors who operate on a fee-only basis, which means we do not sell financial products or collect commissions. As an Ann Arbor financial advisor, we enjoy working with clients both locally and remotely.