Practice and Personal Planning: Tactics That Reduce Taxes and Protect Assets

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At the practice level

1. Qualified retirement plans (QRPs) and IRAs

QRPs include defined contribution plans, like 401(k)s or 403(b)s, and defined benefit plans, such as cash balance plans, which we have previously covered in this column. From a tax point of view, these tools all provide a current tax deduction against a dermatologist’s income, making them extremely attractive for tax planning. These tax deductions can vary from the $20,000 range for 401(k)s to $200,000 or more for certain types of defined benefit plans.

In terms of asset protection, these plans often have the highest level of creditor protection under state law. Of course, there are variations throughout the 50 states, and some states provide the highest level of protection only for a limited dollar amount. Nonetheless, for most states, this protection is at an unlimited dollar level. Be sure to check with an asset protection expert on the protections in your state.

IRAs are technically not QRPs, although they perform similarly in many financial and tax respects. A Simplified Employee Pension (SEP) IRA can provide the same tax deduction level as certain QRPs, whereas a Roth IRA has a different tax treatment but is also beneficial. A Roth acts more like a nonqualified plan in that there is no deduction for contributions, but the assets grow tax-free and come out tax-free (see our discussion below). We have found that most physicians participate in some type of QRP or SEP IRA during their working years.

2. Nonqualified plans

Nonqualified plans are used by working dermatologists much less frequently than QRPs, and this is unfortunate. For tax purposes, as referenced above, nonqualified plans work like Roth IRAs: You get no deduction for the contribution, but the funds grow tax-free in the plan and can come out tax-free at retirement. Most dermatologists, when asked, would like to put more into a Roth IRA–type vehicle yet ignore the tool that could achieve this objective—the nonqualified plan.

Nonqualified plans often fund into a permanent life insurance vehicle. Thus, the level of asset protection is dictated by state rules regarding permanent (also called cash value) life insurance policies. See more details under tool No. 4.

The other benefit of a nonqualified plan is that it is quite flexible. Unlike a QRP, the nonqualified plan does not need to be offered to any employees. It can be completely discriminatory. In this way, a practice can sponsor a nonqualified plan just for the physicians, partners, or just a few doctors who want to participate. We have seen physicians set up a nonqualified plan for side hustles like locum work or moonlighting. If you have further questions about this, please do not hesitate to contact the author.

Whether a dermatologist owns their practice, is employed by a group with a path to partnership, or is an employee of a large institution, 2 wealth planning goals are likely reducing taxes and shielding assets from potential liability. These goals are common among physicians, irrespective of their practice environment. In this article, we will examine 2 tools that can provide tax and asset protection benefits at the practice level and 2 that can do so in personal planning. Some dermatologists may be able to take advantage of all 4, whereas all should be able to take advantage of at least 2.

On the personal level

1. The primary residence

Many doctors already own a primary home or will in the future. Regarding asset protection, nearly every state protects some or all of a home’s equity from lawsuits and creditor claims. As mentioned above, state laws do vary significantly here, ranging from no protection to protection of an unlimited amount of home equity. Be sure to check with an asset protection expert to better understand how your state’s homestead law protects home equity.

The tax benefits of homeownership are consistent in all states and include the ability to write off mortgage interest (with limitations), as well as a $500,000 capital gain exclusion for a married couple on the sale of a home ($250,000 for single filers). In addition, local property taxes on a primary home can be deductible against your federal income tax, although that deduction has become more limited in recent years.

2. Permanent life insurance

As mentioned above, permanent, or cash value, life insurance is shielded from creditors under state law. Once again, these exemptions vary significantly throughout the 50 states.

From a tax point of view, the benefits are also consistent throughout the US because they emanate from the federal tax code. These include the ability for the cash value inside such policies to grow tax-free and, if managed properly, be accessed tax-free. Death benefits paid to beneficiaries are also generally income tax–free under Section 101 of the code.

Further, the Internal Revenue Service allows for the tax-free exchange of these types of policies, using what is known as a like-kind exchange. You may have read about such tax-free exchanges regarding real estate, but life insurance is another asset class favored with this tax benefit. This technique can be beneficial, as one could move cash value from one policy to another over time with no taxation. This might be appealing if costs come down, new policies are more attractive, or new features of competing policies are more aligned with your planning. As just one example, one of the authors has like-kind exchanged his cash value policies 3 times over the last 23 years, moving from what he perceived as good policies to great policies and reducing costs.

Conclusion

Asset protection and tax planning are 2 leading wealth planning goals for many dermatologists. In this article, we have described 2 tools that can achieve both goals at the practice level and 2 that can do so in one’s personal planning.

David B. Mandell, JD, MBA, is an attorney and author of more than a dozen books for doctors. He is a partner in the wealth management firm OJM Group (www.ojmgroup.com).

Carole C. Foos, CPA, is a partner and tax consultant. They can be reached at 877-656-4362 or mandell@ojmgroup.com.

Disclosures

OJM Group, LLC (“OJM”) is an SEC-registered investment adviser with its principal place of business in Ohio. SEC registration does not constitute an endorsement of OJM by the SEC, nor does it indicate that OJM has attained a particular level of skill or ability. OJM and its representatives are in compliance with the current notice filing and registration requirements imposed upon registered investment advisers by those states in which OJM maintains clients. OJM may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration requirements. For information about OJM, please contact us at (877) 656-4362.

This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized legal or tax advice or a recommendation of any particular security or strategy. Investment involves risk and possible loss of principal capital. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes frequently. Accordingly, the information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein.