401(k) plans are valuable tools for employees at all income levels, but physicians often face limits on how much they can contribute, relative to their earnings. As a result, many doctors need additional strategies to build sufficient retirement savings and maintain their lifestyle after their work career. These strategies generally fall into two categories: tax optimization and layering savings vehicles.
Tax Optimization
Tax-deferred savings during peak earnings years is beneficial, especially for high-income professionals. However, relying too heavily on pre-tax savings can create significant tax liability in retirement. For example, a $3M traditional 401K at retirement can easily carry $1M in future taxes, leaving only $2M for you to enjoy. Diversifying savings across different tax categories can help minimize the total tax paid over your lifetime.
- Roth 401(k): Many employer-sponsored 401(k) plans offer a Roth option. You can defer part of your salary directly to a Roth 401(k), and there is no income cap preventing participation like there is with a Roth IRA. While you will pay ordinary income tax today on those Roth deferrals, the contributions and growth will generally be tax-free upon withdrawal.
- Backdoor and Mega Backdoor Roth: High-income earners who cannot contribute directly to Roth IRAs can consider Backdoor and Mega Backdoor Roth strategies. These involve contributing to a tax-advantage account and then converting those funds into a Roth account. While the converted amount would be subject to ordinary income tax today, those converted dollars and the growth associated with them are generally able to be withdrawn tax-free in the future.
- Health Savings Accounts (HSAs): A highly efficient tool for those participating in a High-Deductible Health Plan. Contributions are tax-deductible, growth is tax-deferred, and withdrawals are tax-free when used for qualified medical expenses. A popular strategy with HSAs is to pay for today’s medical expenses out of pocket while saving receipts, allowing the HSA to grow over time. Individuals can reimburse themselves tax-free in the future for those prior expenses, and the additional compounding that occurred over time can be used to fund retirement or any future qualified medical expenses.
Layering Savings Vehicles
Because 401(k) plans have contribution limits, high-income earners often need additional vehicles to maximize savings. By layering these additional savings vehicles, physicians can substantially increase the amount they set aside annually.
- Non-Qualified Deferred Compensation (NQDC) Plans: These plans, such as 457(b) plan, are employer-sponsored and typically offered to high-income earners. Unlike 401(k) plan, NQDC plans are not subject to the same restrictions that limit contributions for high compensated employees. This allows participants to defer more of their income beyond the standard limits of a qualified plan.
- Defined Benefit (DB) Plans: This is your classic “pension” plan. Instead of focusing on the contributions you make today, these plans aim for a specified benefit in retirement. Contributions are calculated based on the amount needed to reach that benefit goal. This often allows for much higher annual contributions than a 401(k) plan, especially for high-income earners who are behind on retirement savings.
- Taxable Brokerage Accounts: A flexible “catch-all” for additional savings. There are no contribution limits, and they provide access to funds at any time. Your basis (principal/contribution) is not taxed, but the investment growth in the account is taxed at the much lower capital gains rates (20% Capital Gains vs 37% Ordinary Income for the highest tax bracket).
Physicians have access to a wide range of retirement savings strategies, but the optimal mix depends on individual circumstances. Just as in medicine, there is no one-size-fits-all solution. By combining some or all these strategies, doctors can execute a plan that supports long-term financial security and a comfortable retirement.
Contact
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About Ballast
Ballast, an employee-owned financial planning and investment management firm based in Lexington, KY, specializes in providing tailored services to high-income earners, high-net-worth clients, and individuals/businesses with complex financial situations. Our team of fiduciaries proactively anticipates and solves your needs by taking the time to understand your goals, passions, and what truly matters to you and your legacy. Ballast is built for financial security, by financial experts. You work hard every day. Let us take on some of the work for you.
Disclosure
Ballast, Inc. is a registered investment adviser with the SEC. Registration with the SEC does not indicate that the adviser has achieved a particular level of skill or ability, nor is it an endorsement by the SEC. All investment strategies have the potential for profit and loss. Ballast, Inc. is not engaged in the practice of law or accounting. Always consult an attorney or tax professional regarding your specific legal or tax situation. Any specific strategy or market/economic commentary may or may not be appropriate for your individual situation, may not have discussed all material implications of implementing said strategy, and may be reliant on data provided by outside resources. Prior to implementing any strategy or investment decision discussed in a Ballast commentary, please consult with the appropriate professionals to confirm thoroughness of the strategy presented and the appropriateness of said strategy for your individual situation.