As we write this, one of our physician clients is in a Dallas hospital waiting for a lung transplant. As a pulmonologist, he has treated hundreds of patients with lung conditions, and was on the front lines in treating COVID-19 patients before contracting the novel coronavirus himself. Now, not only is he fighting for his own life, but he has to deal with such critical issues as the continuity of his medical practice and his family’s long-term financial well-being.
Unlike many physicians, our client had the foresight to do some financial planning. He had an estate plan, an up-to-date will and trust, and a retirement savings account that can be tapped for extraordinary medical bills. These and other measures have provided his family with some financial peace of mind and allowed them to focus on his health issues.
Most physicians realize that financial planning is an important aspect of providing a secure future for themselves and their families. But they are often daunted by the complexities of planning, the intricacies of tax and legal issues, and the pressures of managing a successful practice — which can be a prescription for financial disaster. Below, we offer solutions for some of the most common financial planning mistakes physicians make.
Paying Too Much in Taxes
Because most physicians fall into a higher tax bracket, their tax liabilities can be very high. Contributing to a retirement plan is an important way to mitigate high taxes, while also building up assets for a secure future.
While each business situation is unique, the importance of contributing to some type of retirement plan to maximize tax savings cannot be ignored. Assuming a 40% tax bracket, every $10,000 an individual invests in a retirement account will produce a tax savings of about $4,000. For example, investing in a defined benefit plan, a 52-year-old self-employed physician could put away about $193,000 in tax deductible funds. Again assuming that 40% tax bracket, this would mean a tax savings of about $77,000 a year, or about $773,000 over a 10-year period.
No Cost Segregation of Real Estate
If a physician owns a business property, he or she will be paying taxes on rental income collected from the building. Cost segregation, which is the process of separating personal property assets from personal assets for tax reporting purposes, can be a viable way to cut down on those costs. This process enables the physician to accelerate depreciation from 39 years to as few as 5 to 7 years, generating significant tax savings in both active and passive income.
Lack of Asset Protection
For physicians, asset protection can be particularly important. The medical field can be a high-risk profession in terms of professional liability. In the event of a lawsuit, one way for self-employed physicians to protect their business is by utilizing a so-called Nevada Asset Protection Trust. This irrevocable trust allows the grantor to also be a permissible beneficiary, and two years after the grantor contributes a portion of their assets to the trust, those contributed assets should be protected from the grantor’s creditors.
No Estate Planning
While sparing no amount of care for their patients, many physicians neglect to look after their families in the event of their own failing health. No responsible financial plan is complete without estate planning to provide for the financial security of those left behind.
We estimate that the majority of our physician clients come to us without a proper, up-to-date estate plan in place. Particularly at this time, when physicians are on the front lines of a pandemic, the importance of an up-to-date will and a revocable trust, as well as having a power of attorney and healthcare proxy in place, cannot be understated.
Not Using a Fiduciary Financial Advisor
Many physicians will be the first to admit that they suffer from poor financial literacy. This lack of financial acumen can be addressed by employing the advice of a financial professional, but choosing an advisor takes some effort.
It is best to work with a financial advisor that is a fiduciary and has a legal obligation to work in their clients’ best interest at all times. Per PBS Frontline, only 15% of financial professionals in the U.S. meet the fiduciary standard, so it benefits physicians to research the person or firm with whom they’re considering working.
No Umbrella Policy
While physicians always ensure they have malpractice insurance in place, there are limits on the amounts insurance will cover.
An umbrella insurance policy can help bridge that gap, as it can be held in excess of other specified policies to pay out additional amounts not covered under the primary insurance (up to the limit of the umbrella policy). It can also be primary insurance for losses that are not covered under other policies. An umbrella policy is often not expensive and can be obtained through a regular insurance company.
Not Saving for Children’s Tuition
The costs of college tuition have been continually on the rise, and the best way to save money to help children with those costs is to begin saving money early. A 529 plan is an investment vehicle specifically designed to encourage education saving. Withdrawals from the plan are tax-free as long as the funds are used for education expenses, which include K-12 public, private, and religious school tuition.
Spending More, Saving Less
In addition to expenses for insurance, real estate, and education, many physicians face the social “cost” of maintaining a visibly affluent lifestyle. According to a 2019 report, 34% of physicians do not budget for personal expenses. Such expenses can cut into savings, which would be more beneficial in the long run.
Without sacrificing a comfortable life, physicians and their families will benefit from concentrating on planning for their financial future and avoiding the competitive focus of needing to keep up with others’ purchases for social status.
Trying to Time the Market
Physicians, like many other investors, may be tempted to “play the market,” constantly buying and selling along with market trends. Of the physicians who reported making bad investments, 30% said this was due to investing in stocks or companies that “turned out badly.”
This behavior is especially prevalent in times of high market volatility, such as we are experiencing now. But, day trading is not the best practice for overall asset growth. Due to the nature of the market, it is impossible to predict the best trading times. Looking back over the last 20 years, the S&P 500 annualized return was 10.05% a year.
If an investor is out of the market for the best 10 trading days of those 20 years, the return rate would drop to 1.87% a year, according to Bloomberg as of last March. The best days can come at any time, even in times of seeming economic instability, and if investors are not consistently invested, they will not benefit.
Not Involving a Spouse
While many physicians choose not to “trouble” their spouse or domestic partner with financial matters, this makes it much more difficult when there is an unexpected disability or death. Without knowledge of what financial accounts and insurance policies exist, as well as how estate planning strategies have been implemented, the person left behind is at a disadvantage and has additional worries at an already difficult time.
Keeping a spouse/partner involved throughout all the planning also lends another pair of eyes and someone with whom to discuss choices for another opinion. In the case of our pulmonologist client noted earlier, one of our first recommendations was to give his wife power of attorney, so she could execute important decisions involving his medical practice.
Selling a Practice Without a Goodwill Valuation
When a physician sells the assets of his or her practice upon retirement, it is important to consider a separate sale of the retiring physician’s personal goodwill associated with the practice. This encompasses the physician’s reputation and relationship with patients and may be deemed an asset of the corporation when transferred along with the sale.
This sale can create long-term capital gains taxable at up to 23.8%, rather than being treated as ordinary income to the corporation, which is taxable at up to 35% plus an additional tax of up to 23.8% on the remaining balance of the purchase price distributed by the buyer to the seller.
In this example, the seller will be left with approximately 76 cents rather than 49 cents for every dollar of value for goodwill after federal income tax. Structuring the transaction as a sale of personal goodwill, instead of a non-competition payment to the retiring physician, can also result in a lower tax rate.
Physicians are expert at helping patients through critical medical decisions — but they need to exercise similar care in making their own financial decisions. Given the highly specific needs of each physician and family, and the complexities of taxes and regulations, it is often best to work with a financial advisor who has expertise in working with medical professionals.
The resulting financial plan will be the best medicine for a secure financial future.
Note: it is important to coordinate with your tax or legal advisor regarding your specific situation.
Syed Nishat holds a bachelor’s degree in business administration from the University of Nevada Reno; Aadil Zaman holds a bachelor’s degree in economics and management from the University of London and an MBA in finance from the State University of New York at Buffalo. Both writers are partners in the Wall Street Alliance Group.