Young physicians – especially those about to enter residency or still in residency, have a unique tax planning opportunity that’s almost unmatched by any other profession: The opportunity to contribute to a Roth IRA (or Roth 401(k)) while earning an income far, far below their likely income brackets in retirement.
And that’s why the Roth IRA is such a perfect fit for younger doctors – If I were to try to imagine the perfect tax treatment for a retirement plan for residents and other early career physicians, I could not design anything better:
Ideal Retirement Plan for Residents
1. Pay income taxes on current income that you would have to pay anyway.
2. All growth in the account (other than that attributable to borrowed money under UDIT rules, but that’s very unusual), whether from income, dividends or capital appreciation, is free of income tax, and free of capital gains tax, for as long as they are left in the account.
3. Any withdrawals on money left to cook in the account at least five years is tax-free.
4. A 10 percent penalty will normally apply on withdrawals prior to age 59 ½, but there are a number of ‘hardship’ exceptions to this rule that still allow you to access money in your Roth IRA if you really need it (note: While the Roth 401(k) has similar tax advantages, 401(k)s don’t offer the same hardship withdrawal options. So if you have access to both, it’s a good idea to save some money in your Roth IRA, all other things being equal, just in case.)
Why this plan?
Because as a young physician, your earnings in your residency years and generally in your early years as an attending physician are a fraction of what you can reasonably expect your income to be later in your career. If you play your cards right, live on less than you make, create a successful private practice if that is where your heart takes you, purchase a couple of investment properties, bonds and annuities that generate income in retirement, your income bracket will likely be anywhere from 3 to 10 times higher than it is today. And that means your marginal income tax bracket will be much higher, as well. If you are single now, and marry another physician or other high income earner, the effect will be all the more pronounced.
The more money you have stashed away in non-taxable investments – such as Roth IRAs, but also including Roth 401(k)s, cash value life insurance (which also grows tax free and provides a valuable death benefit) and certain municipal bonds that generate tax free income – the better off you will be.
The idea at this point is to pay a relatively low tax rate on a small amount of money now, in order to avoid paying a higher tax rate on a much larger amount of money later.
Why not opt for a tax deductible contribution?
Yes, some of you may have raised your eyebrows at bullet point number 1, above. Of course, you can contribute to a traditional IRA or some other tax deferred retirement vehicle, or make a business investment and take a current tax deduction. But that option is relatively unattractive, for most early career physicians and anyone else who expects to retire in a much higher tax bracket than before.
Set yourself up for success
So protect your future income with disability insurance. Protect your family and loved ones and your future options with life insurance. And run – don’t walk – to take advantage of the Roth IRA while you’re young, while you make a low enough income to qualify for it, and to maximize the number of years of potential tax-free growth.
You’ll be glad you did.
For more information, or to have us help you set up a plan to protect your financial future and accomplish all your goals, call us today at 866-899-7318. Our offices are in Southern California, but we have clients all over the United States.
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