By Scott Tschappat
Diving into the complexities of retirement taxes can be daunting—especially for dedicated professionals like physicians with tight schedules. Yet, with early and proactive planning before calling it quits, you can position yourself to substantially reduce your overall tax liabilities and bolster your retirement funds.
In this article, we walk you through 10 pivotal tax strategies tailored for physicians on the payroll. It’s important to note that not every tactic will align with your unique financial and lifestyle needs, so you don’t necessarily need to implement all 10.
Further, some of these financial actions should be considered annually, while others simply need to be done once and then monitored after that. Either way, they all should be considered with a focus on what makes sense with your situation, thereby enabling you to strategically navigate your retirement without any unexpected tax surprises.
1. Understanding Different Tax Types
All income isn’t created equal when it comes to taxation, especially in retirement. Take, for instance, your salary. It is subject to ordinary income tax. On the other hand, your Social Security benefits may not be taxed at all, depending on your other income streams in that specific year. Or it could be taxed up to 85% of your benefit amount.
Moreover, while withdrawals from tax-deferred retirement accounts get hit with ordinary income tax, taking out funds from Roth IRAs and HSAs remains tax-free, given you’ve followed the applicable rules.
As you approach retirement, it’s crucial to understand that not all income sources are considered equal in the eyes of the taxman. The nature of your income’s taxation significantly influences your net income during your golden years.
2. Optimizing Retirement Contributions
Prioritizing contributions to tax-favorable retirement accounts such as 401(k)s, 403(b)s, and IRAs while you’re still in the workforce can be a smart move. Not only does it provide an avenue to reduce your present taxable income, but it also paves the way for a more comfortable nest egg. While the exact sum and the choice of account depend upon your current income and how much you need to comfortably retire, overlooking the opportunity to maximize these contributions when possible might be a missed opportunity.
3. Plan for Tax Diversification
Much like the principle of spreading your investments, diversifying the types of investment accounts you hold is equally critical. The trio of account types (taxable, tax-deferred, and tax-free) each come with their distinct contribution and taxation guidelines. By judiciously allocating funds across these three categories, you gain greater leeway in choosing distribution timings and amounts, potentially decreasing the ultimate amount you pay in taxes on those distributions.
4. Consider Roth Conversions
A Roth conversion involves moving some of your pre-tax retirement balance into a Roth account, which is considered an after-tax contribution. The amount you transition is counted as that year’s income, but subsequent withdrawals come without taxes, so long as you follow the rules correctly.
If we think there is the potential for tax rate increases down the road, a Roth conversion today effectively “locks in” your assets at the current tax rate, thus shielding them from future increases. Additionally, the absence of required minimum distributions (RMDs) with Roth IRAs keeps you in control, free from mandatory withdrawal requirements set by the government.
5. Navigate Your Withdrawal Strategy
As we’ve mentioned before, distributions from different accounts carry distinct tax implications. Given this, a thorough examination of your other income streams and both current and future goals is essential before initiating withdrawals. Further, there isn’t a one-size-fits-all solution to making these types of distributions. Depending on your goals and individual circumstances, you might have different withdrawal strategies for different years in retirement. In one year, tapping into a tax-deferred account might make the most sense, while the following year it might be better to take distributions from a tax-free account (like a Roth IRA).
6. Utilize the Triple Advantage of Health Savings Accounts (HSAs)
HSAs come packed with a threefold tax advantage: First, your contributions enjoy tax deductions; second, the funds within the account can grow without tax implications; and third, when you withdraw for eligible medical expenses, it’s entirely tax-free. Leveraging HSAs can be a great tool for increasing your retirement savings, particularly if you anticipate medical bills in retirement.
7. Leveraging Charitable Contributions
For those with philanthropic goals, there are avenues to support cherished causes while simultaneously benefiting from tax reductions. By contributing generously, you can choose to itemize these donations in your tax return (rather than opting for the standard deduction), effectively lowering your taxable income.
Furthermore, upon reaching the age of 70.5, you can channel a qualified charitable distribution from your pre-tax accounts directly to your chosen charity. Not only does this exclude the contribution from your taxable income, but it also fulfills your required minimum distribution. Given the complexity of this approach, though, it’s typically best to engage with a trustworthy financial professional to make sure it’s done correctly.
8. Evaluate Tax-Loss Harvesting Opportunities
For those with taxable accounts, tax-loss harvesting is a strategy worth considering. If you hold an investment that’s currently valued at a lower price than what you bought it for, selling that asset can be advantageous. This can either offset other capital gains from the same year or reduce your taxable income, up to an annual limit of $3,000. This strategy is also best considered with the help of a professional.
9. Relocate to a Tax-Favorable State
If you’re already thinking of moving to a new state for retirement, make sure to evaluate the tax treatment your new potential state has for retirees. Some states might have lower (or no) state income tax; others won’t tax Social Security; and others might have favorable treatment toward pension income. While other factors should take precedence (e.g., your happiness, family and friends, the weather), you also shouldn’t be shocked at the tax treatment of your new state.
10. Implement Your Estate Plan
Proactive estate planning can be instrumental in minimizing looming estate and inheritance taxes and avoiding the pain of your estate going through probate. To do that, verify that the titles, beneficiaries on your accounts, and the specifics of your trust and will are in order. That allows you to rest assured that your assets will find their way to your loved ones in a timely manner with as little hassle and fees as possible.
Charting Your Retirement: Embark on Your Tax Strategy Today
Physicians devote countless hours toward bettering the well-being of others; now it’s time to focus on the well-being of your retirement plan. Through these tax-smart techniques, you can craft a plan designed to keep a larger share of the fruits of your labor long after you’ve retired. If you’re seeking tailored guidance to map out the optimal strategies for you and your loved ones, we’re here to assist.
At Acute WealthCare, our goal is to help physicians take care of themselves after giving so much to others. If you would like to see how we can help you reach your retirement goals while doing everything we can to reduce your tax bill, schedule a 15-minute introductory phone call for us to get started.
Scott Tschappat is a wealth advisor at Acute WealthCare, an independent, fee-based comprehensive financial services firm with over 20 years of experience. Scott is committed to helping his physician and healthcare worker clients create a financial plan that brings them comfort and dignity. Scott learned the importance of proper financial management and making a plan for the unexpected at a young age when his father passed away suddenly and he watched his mother use the life insurance money wisely to take care of their needs, both present and future. He strives to steward his clients’ money well, as if it were his own mother’s, and help them every step on the journey to their financial future.Scott lives in Highlands Ranch, CO, with his wife, Bridget, a school counselor at All Souls Catholic School, and their two daughters, Sarah and Emily. He loves sports and has been lucky enough to coach both of his daughters’ basketball teams. In the spring and summer, you can find Scott getting his hands dirty gardening and enjoying live music at Red Rocks or another local venue. To learn more about Scott, connect with him on LinkedIn. You can also register for his latest webinar on What We Do & How We Help.