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Strategies all Medical Professionals Can Use to Out-Smart the Tax Man
By Rick Kahler MS CFP
® ChFC CCIM
Maybe Warren Buffett, the second richest man on the planet, doesn’t care how much he pays in taxes.
For medical professionals and the rest of us however, what our investments earn after taxes is much more important than what they earn before taxes. Federal and state income taxes, capital gains taxes, and alternative minimum taxes can reduce your investment earnings by up to 50%.
How so?
It doesn’t take much to substantially reduce your nest egg. If Dr. Smith earned an average of 8% and was taxed at 28%, his after-tax rate of return is 5.76%. A $50,000 investment earning 5.76% grows to $87,536 in 10 years. If that same $50,000 investment isn’t subject to taxes, it grows to $107,946. The higher tax bracket he is in, the more important it is for him to seek out ways to lower his tax bill.
Tax Free Growth
One of the best tax maneuvers is to invest your money where it will grow tax-free, meaning you will never pay any taxes on the income or accumulation.
One way to do this is via a Roth IRA or a Roth 401k plan. All earnings compound tax-free and are not subject to tax or penalties when you take them out of the Roth after age 59½. The downside is that your contribution is not deductible from current earnings.
Another tax-free investment is interest from municipal bonds. The higher income bracket a person is in, the more an investment in municipal bonds makes sense.
For a doctor in the 33% tax bracket, a 5% interest rate on a municipal bond is equivalent to a 7.46% rate on a taxable bond. But, for a new practitioner in the 15% tax bracket, it’s only equivalent to a taxable rate of 5.88%. Don’t make the mistake of investing in municipal bonds only because they have tax free income. Be sure the investment makes sense for you.
Tax Deferred Investing
After tax-free investing comes tax-deferred investing. This includes traditional retirement vehicles like IRA’s, 401k’s, 403b’s, pension plans, and annuities. Contributions to these plans are pre-tax, while contributions to annuities are after-tax. The earnings are not taxed until taken out, usually after retirement when you may be in a lower tax bracket.
Retirement Tax Rates
If you anticipate your overall tax rate (the average percentage of income taxes you pay for the year) in retirement to be over 15%, you’ll want to evaluate whether investments that earn most of their returns in the form of long-term capital gains might be better held outside of a tax-deferred account. That’s because withdrawals from tax-deferred accounts generally are taxed at your ordinary income tax rate, which may be higher than your capitals gains tax rate (currently 15%).
Get Advice
Look for advice from accountants and investment advisors who manage investments in ways that can help reduce the taxable distributions. Investment managers can employ a combination of tactics, such as investing in stocks that don’t pay dividends, counterbalancing the sale of stocks with gains against those with losses, tax harvesting, and minimizing portfolio turnover.
As important as minimizing tax is, be careful not to let the tax tail wag the dog. A poor investment doesn’t become a good one just because it’s tax-free.
Records
Finally, keep good records of purchases, sales, and distributions so you can accurately calculate the tax basis of your investments. Not keeping good records could mean paying more tax than you should when you eventually sell.
Assessment
While you can’t control the direction of the economy and markets, you can have a lot of control over where you invest your retirement funds, the taxes you will pay, and the costs. The tax consequences of investment choices matter to the rich. They matter even more to smaller investors; like doctors and nurses.
The Author
Rick Kahler, Certified Financial Planner®, MS, ChFC, CCIM, is the founder and president of Kahler Financial Group in Rapid City, South Dakota. In 2009 his firm was named by Wealth Manager as the largest financial planning firm in a seven-state area. A pioneer in the evolution of integrating financial psychology with traditional financial planning profession, Rick is a co-founder of the five-day intensive Healing Money Issues Workshop offered by Onsite Workshops of Nashville, Tennessee. He is one of only a handful of planners nationwide who partner with professional coaches and financial therapists to deliver financial coaching and therapy to his clients. Learn more at KahlerFinancial.com
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Filed under: Investing, Taxation | Tagged: lowering taxes, Retirement Tax Rates, rick kahler, Tax Deferred Investing, Tax Free Growth, tax records |
The Leading Business Education Network for Doctors, Financial Advisors and Health Industry Consultants 
Senators Support Charitable Deductions
Rick – On October 18th 2011, the Senate Finance Committee held a hearing on charitable deductions. Senate Finance Committee Chair Max Baucus (D-MT) opened the hearing with a statement of support for “rural philanthropy.” He noted that many non-profit organizations in his home state of Montana were particularly focused on assisting those in the midst of “tough economic times.” Sen. Baucus stated, “These partners rely on the benefits of the charitable tax deduction, which is why we must ensure the deduction is fair and effective.”
Baucus continued by stating that 86% of Americans who itemize claim a charitable deduction. However, he also indicated that “only 27% of all Americans” benefit from charitable deductions because most taxpayers do not itemize.
The Ranking Member of the Senate Finance Committee is Sen. Orrin Hatch (R-UT). He strongly supported the charitable deduction and opposed the White House proposal to limit tax savings from charitable gifts. In several budgets and proposed bills, the White House has supported limiting the benefits of deductions for higher-income taxpayers by reducing the tax savings from 35% to the 28% bracket.
Sen. Hatch stated, “As state and local governments grapple with budget deficits and revenue shortfalls, Americans in crisis are turning for help in ever greater numbers to churches, charities, shelters and other social welfare groups. Charitable donations are the lifeblood of charities and the last thing Congress should do is interrupt the blood supply.”
Finally, Sen. Charles Grassley (R-IA) is a former chair of the committee. He agreed with Sen. Hatch and stated that “higher income taxpayers are more sensitive to changes in the tax rules.” Grassley was concerned because “the tax increase resulting from limiting itemized deductions, including the deduction for charitable giving, will result in less money for charity.”
Several witnesses at the hearing also supported philanthropy. Brian A. Gallagher, President and CEO of United Way, stated, “I urge the committee to preserve the charitable deduction for all donors.” He noted that the proposed White House cap could reduce charitable giving from $2.9 billion to $5.6 billion per year. This loss could have a very harmful affect on the ability of non-profits to serve those in need.
Independent sector President Diana Aviv echoed those same concerns. She stated, “A 2010 study by the Center on Philanthropy at Indiana University found that 85% of high net worth households donated to basic needs charities in 2009, compared with 31% of other taxpayers.” Aviv pointed out that charities providing assistance to the needy frequently receive gifts from higher-income donors targeted by the proposed White House reduction tax savings for charitable gifts.
Source: Children’s Home Society of Florida Foundation
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A new tax law that could make grandkids rich
Congress last year enacted temporary changes that allow for a massive estate-tax break through a Roth IRA. As a result, a grandchild could pocket millions, tax-free, over a lifetime.
This is by far the biggest estate-planning break on record, created even as lawmakers debate over which tax giveaways should be killed to help shore up the federal budget. Any thoughts; Rick?
http://money.msn.com/how-to-invest/tax-law-could-make-grandkids-rich-fiscaltimes.aspx
Dr. Raymond
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