529 Plans

  • September Financial Resolutions

    As summer fades into the distance, September brings with it a sense of renewal and rejuvenation. For many, it’s a time to refocus on their goals, much like the beginning of the year in January. With the start of school families get back into routines which helps people get organized and set goals.

    While you may have set resolutions in January, the start of the year is a tough time to follow through on them because of post-holiday exhaustion, and the temptation make a big change all at once. September represents a clean slate and offers a unique opportunity to revisit and reevaluate your financial progress.

    Here are seven things you can do this September to give your finances a mid-year boost and set yourself up for success through the rest of the year.

    1. Review Your Financial Goals:

    Begin by revisiting the financial goals you set at the beginning of the year. Take a close look at your short-term and long-term objectives. Are they still relevant? Have your circumstances changed? Use this time to adjust and fine-tune your goals to align better with your current situation and aspirations.

    2. Assess Your Budget:

    A budget is your financial roadmap, and September is an ideal time to check if you’re staying on course. Review your income, expenses, and savings contributions. Are you overspending in certain areas? Are there areas where you can cut back? Make necessary adjustments to ensure you’re saving enough to meet your goals.

    3. Emergency Fund Check:

    One of the cornerstones of financial security is having an emergency fund. September is a great time to assess the state of your emergency fund. Aim to have at least three to six months’ worth of living expenses saved. If your fund falls short, prioritize saving to reach this critical milestone.

    Almost as important as having the right amount saved is the account you are saving in. If your emergency fund is in your checking account consider moving it to a high-yield savings account. Most big bank checking and savings accounts pay very little interest (close to zero percent). Today’s rates on HYSAs are close to 5% and you can transfer your emergency fund with just a few clicks.

    4. Investment Portfolio Review and Rebalance:

    Take a close look at your investment portfolio. How have your investments performed so far this year? Are they in line with your risk tolerance and long-term objectives? Index funds that track the overall stock market and bond market are the best long-term investments for most investors. Are your investments doing what they’re supposed to?

    Rebalance your portfolio if necessary to ensure it remains diversified and aligned with your financial goals. Rebalancing usually means selling some of your investments that have done well and buying more of those that have not. It’s best to rebalance on a set schedule. Choose to rebalance once per quarter, or once per year and set a reminder to stick to it.  

    5. Review Your Retirement Account Contributions:

    If you’re not maxing out your contributions to retirement accounts like a 401k or an IRA, September is a good time to increase your contributions. The maximum you can contribute to your 401k/403b for 2023 is $22,500, or $30,000 if you’re 50 or older. The max for your traditional or Roth IRA is $6,500, or $7,500 if you’re 50 or older.

    Increasing your contribution by just 1% each year can really add up. If you’ve received a bonus or a pay raise during the year and your paycheck has increased consider making an even bigger contribution.

    Along with your retirement accounts don’t forget about your HSA. These can also be used as stealth retirement accounts, and maxing out the contributions is a great idea. The contribution limits for HSAs in 2023 are $3,850 for singles and $7,750 for families.

    6. Backdoor Roth IRA Contribution

    If you make too much to contribute to a Roth IRA, consider making a backdoor Roth IRA contribution. The income phaseout for Roth contributions starts at $138k for single filers and $218k for MFJ. Most bonuses and raises are paid by September, so at this point you should have a good sense of your income for the year.

    Unlike the direct contribution to your Roth IRA, you only have until December 31st to make a backdoor Roth IRA contribution. Direct contributions to traditional or Roth IRAs are allowed all the way up to tax-day the next year.

    7. Tax Planning:

    It’s never too early to start thinking about taxes, and there are many decisions you can make in September to put yourself in a more favorable position.

    Now is a good time to review your federal income tax withholding. Withhold too little and you could have a hefty tax bill due next year as well as possible fines for underpayment. Withhold too much and you’re essentially providing Uncle Sam with an interest free loan. Don’t worry, it’s easy to adjust your withholding by filing a new W4 form with your HR department.

    Consider making additional 529 plan contributions. In most states contributions to a 529 plan have to be done before year end, while some states allow you to contribute until tax-day the next year. Many 529 plans offer state tax deductions and the investments grow tax-free.

    If your income for the year has been less than normal, perhaps due to switching jobs or taking time off consider making a Roth IRA conversion. Converting funds from a traditional IRA to a Roth IRA means paying taxes on the conversion now, but prevents you having to pay taxes on withdrawals later. A year with a lower income and lower tax rate is a good opportunity not to be wasted.

    Wrap Up

    September is indeed a month of fresh beginnings, and it’s a perfect time to revisit your financial resolutions, assess your progress, and make necessary adjustments. By taking these proactive steps, you can set yourself up for financial success in the months and years ahead. Remember that financial planning is an ongoing process, and staying proactive will help you achieve your goals and build a secure financial future.

  • How to Lower Your Taxes as a Physician

    As a physician you spend so many years in training and fellowships that it feels like you’re never going to earn the “big bucks”. When you finally do start making that attending pay it can feel awesome until you realize you’re paying Uncle Sam in taxes about as much as you used to earn as a resident.

    Today’s article is about highlighting the steps you can take to minimize your tax bill and keep more of what you earn. And if you take these steps you’ll pay less in taxes today and for the rest of your career.

    Key Points

    • Maximize your retirement contributions – 401k/403b/457b etc. You’re probably already contributing to these accounts, but make sure you are making the maximum contribution to really juice their impact on reducing your tax bill.
    • Don’t forget about your other tax advantaged accounts. Utilize 529 plans, HSA accounts, and backdoor Roth IRA contributions for added savings.
    • Make smart decisions in your taxable brokerage account. Tax-loss harvesting, optimal asset location, and donating stock to a Donor Advised Fund can all help minimize your taxable income.
    • Investigate Real Estate investing and whether it’s a good fit for you. Investing in Real Estate can provide a way to build additional wealth while reducing your tax bill as long as you meet a few requirements.

    Max Out Your Retirement Contributions

    It can be hard to contribute to your retirement accounts while you’re still in training, but once you finish with Residency and Fellowships it’s time to boost those contributions into high gear.

    One great side effect of increasing your contributions and reducing your taxable income is that it will also lower your required monthly loan payments if you’re on an Income Driven Repayment plan. Great news for those pursuing PSLF!

    The maximum you can contribute to a 401k, 403b, or 457b plan for 2023 is $22,500.

    * One note for those of you over 50, you can also make what’s called a “catch-up contribution” of an additional $7,500 per year. This can be extremely helpful for physicians who got a late start on their retirement contributions due to working in a specialty with a long training timeline.*

    401k and 403b plans are basically interchangeable, and if you have access to both, the total contributions between the two can’t be more than your $22,500 limit. But 457b plans are counted in a different bucket. This means you can make the max contribution to both your 401k/403b and your 457b. That’s $45,000 you can sock away and reduce your taxable income.

    457b plans are also great accounts to use to turbocharge your efforts to achieve early retirement. If you want to learn more you can read this post all about 457b plans and how to maximize their effectiveness.

    Some employers, like Ohio State University, also offer physicians and staff access to a defined benefit plan (pension) in addition to the other retirement accounts. Your contribution to these plans is usually set at a percentage of salary that you can’t adjust, but is another chunk of money that you are contributing to reduce your taxes today.

    How Tax Brackets Work

    A quick diversion on how tax brackets work and why it’s so beneficial to reduce your taxable income, especially for those in the highest tax brackets.

    In the U.S. we have a progressive income tax system where the tax rate you pay gets progressively higher the more you make. A common mistake that people make is thinking that when they earn enough to get into the next tax bracket, let’s say moving from the 12% to the 22% bracket, that they pay 22% in tax on their entire income.

    That’s not the case, a single filer would pay 10% of their income up to $11,000, they would pay 12% on only the income between $11,001 and $44,725, and 22% on any income between $44,726 and $95,375.

    For example, here are the tax numbers for someone earning $80,000

    While someone earning $80,000 is in the 22% tax bracket their average tax rate over their entire income is only 16.%.

    The higher your income the more benefit you get from making contributions to retirement accounts. For someone in the 32% tax bracket, every dollar contributed to a pre-tax retirement account today saves 32 cents in taxes, grows tax free, and is withdrawn in retirement, likely at a much lower tax rate.

    If you are in the 32% tax bracket, maxing out your 403b and 457b will save you $14,400 in taxes ($45,000 x 32% = $14,400).

    Max out your HSA

    If you’re healthy and don’t expect too many healthcare expenses, then selecting a high-deductible health plan with an HSA is a great choice. HSAs are another account where you can contribute pre-tax dollars and reduce your taxable income. The contribution limits are $3,850 for an individual and $7,750 for a family.

    HSAs can also serve as a “stealth” retirement account. Most HSAs allow you to invest the money in your account similar to a 401k or brokerage account. If you don’t use or need your funds for health expenses when you reach age 65 you can withdraw them for any use without penalty. In essence they become another IRA, since contributions are pre-tax you will pay tax on your withdrawals if you don’t use the funds for healthcare expenses.

    To learn more about HSAs and how to maximize their triple tax advantage check out this blog post here!

    Maximize 529 Plan State Tax Deduction

    529 plan accounts are great tool for saving for your children’s college expenses, but some also come with some nice tax advantages as well. Most states that have a state income tax provide a state income tax deduction for contributing to a 529 plan.

    The tax benefits vary greatly from state to state. For example:

    • States without an income tax offer no state tax deductions
    • Ohio offers a $4,000 deduction per beneficiary, meaning if you have 4 children and contribute $4,000 to each child’s 529 in a given year you can deduct $16,000 from your income for state taxes
    • Idaho offers a $12k deduction for MFJ (Married Filing Jointly), $6k for single filers regardless of the number of beneficiaries
    • Indiana has one of the best perks – a 20% tax credit, instead of a tax deduction, up to a total of $1,500 for a married couple, $750 for a single filer

    Depending on your state and the size of your family you can make a decent dent in your state income taxes.

    Invest Smartly in Your Taxable Brokerage Account

    You may read the word “taxable” and think that you should stay away, but these are your standard brokerage investment account and the word taxable is mainly used to differentiate them from your pre-tax or Roth accounts.

    While you don’t get a tax deduction for contributing to your taxable account, there are many benefits from investing in a taxable account.

    • No contribution limits – unlike 401ks, IRAs, or HSAs you can contribute as much as you want.
    • No withdrawal penalties – you don’t have to wait until age 59 ½ to access your money, or use it for a specific purpose like an HSA or 529 plan.
    • Flexibility – along with the above points, you can invest in whatever you want within a taxable account. Not just the options that your 403b plan provider has available.
    • Capital gains tax rates – Rather than paying income tax on your withdrawals like in a retirement account, you only pay taxes on your gains, and at the much more favorable long-term capital gains rates (own your holdings for at least 1 year + 1 day).

    As long as you own your holdings for at least 1 year + 1 day before selling you will be taxed at the long-term capital gains rates rather than the federal income tax rates.

    Tax-Loss Harvesting

    For holdings that have lost value you can take advantage of tax-loss harvesting, where you use the losses in parts of your portfolio to offset gains in other parts of your portfolio. When using this strategy be mindful of the wash-sale rule. You can’t purchase the same thing you just sold within 30 days or else you face a penalty.

    But even if you don’t have any gains in your portfolio to offset this is still beneficial because you can use your loss to offset up to $3,000 per year in ordinary income, which is usually taxed at a much higher rate than the long-term capital gains rate.

    Optimize for Asset Location

    A way to improve the tax efficiency of your taxable brokerage account is to own assets that will appreciate, rather than provide dividends or interest payments. A share of stock that appreciates in value can later be sold and the gain can be taxed at capital gains rates. While a bond or dividend stock will produce interest or dividend payments that are taxed at income tax rates.

    Optimizing for asset location is more art than science, because there will be times when you don’t want your entire taxable account to consist of risky assets like stocks, but it’s a good thing to keep in mind when you start investing in a taxable account.

    A champagne problem to have in your taxable account is a stock or fund that’s experienced a massive gain, and will still incur a hefty tax bill, even at long-term capital gains rates. Think Apple stock that you bought in 2010 for $10 per share that’s now worth $200 per share.

    For cases like this a donor advised fund (DAF) can really come in handy.

    Donor Advised Fund

    This is a really handy account that can help you out tax-wise in a number of ways while also helping you meet your charitable giving goals. A DAF is an account that you can donate stocks to and then the DAF can sell the stocks and give the proceeds to the charities you designate.

    In the case of our Apple stock above, you receive the charitable tax deduction for the full value of the stock donated to the DAF, and neither you nor the DAF owe taxes on the gain, win-win!

    Why would you go through this process rather than donating the stock directly to the charity? One reason is that some charities can’t receive stocks, and in most cases would much rather just get cash. Another is you can make the donation to the DAF and dole out the proceeds over as much time and to as many different charities as you like.

    DAFs are also a great tool if you regularly give to charity but your total deductions aren’t enough for you to itemize (i.e. you still end up using the standard deduction when you file your taxes: $13,850 single, $27,700 MFJ).

    With a DAF you can make a larger contribution in one year, in order to itemize your deductions, and then make contributions to your chosen charities from the DAF for multiple years.

    Backdoor Roth IRA

    While it technically won’t save you taxes this year, contributing to a backdoor Roth IRA will save you from paying taxes on those contributions ever again. If you’re not familiar with it, a backdoor Roth IRA is a two-step process to contribute to your Roth IRA even if you make too much income to qualify. The income limits to contribute to a Roth IRA for 2023 are $153k for single filers and $228k for MFJ.

    To perform a backdoor Roth IRA, you contribute after-tax dollars (i.e., you don’t deduct them from your income) to a traditional IRA, and then do a Roth conversion on that contribution. Voila! Your after-tax traditional IRA contribution is now a Roth contribution. Since the funds are now in a Roth account they will grow tax-free, withdrawals will be tax-free, and you won’t have to worry about RMDs!

    You do need to make sure you don’t have an existing balance in your IRA before conducting a backdoor Roth or you’ll run afoul of the pro-rata rule, where you will end up owing taxes on part of your contributions, which is the opposite of what we want here.

    Real Estate

    The last item in this article is probably one that most physicians have heard about or thought about investigating. With good reason. Investing in Real Estate is a great way to diversify your investment portfolio while also potentially lowering your tax bill, but there are some hoops you’ll need to jump through.

    First off, real estate investing isn’t for everyone. For every story of a low-maintenance property and perfect tenants, you’ll hear one about midnight water heater leaks and busted pipes. This article is focused on ways to lower your tax bill and real estate investing is certainly an attractive option, but do your homework before jumping in to becoming a landlord.

    One of the biggest advantages for real estate from a tax perspective is that you can own a property that provides real world cash flow, while showing an on-paper loss due to depreciation and other factors. The challenge for physicians is capturing that on-paper loss and deducting it against your earned income. The IRS says you can’t deduct your passive real estate losses against your income if your earned income is above $150k. However, you can get around this rule in one of two ways.

    Real Estate Professional Status (REPS)

    The first way to be able to deduct your real estate losses is by obtaining Real Estate Professional Status. To do this you need to spend over 750 hours per year in real estate and not spend more than 750 hours per year doing another job, like being a doctor.

    The easiest way to accomplish this in a physician household is if one non-working spouse manages the real estate duties, so this is not a possibility for everyone. You need to be careful with this and take detailed records of your involvement in managing your properties. You don’t want to run afoul of the IRS on this one.

    Short-Term Rental Loophole

    With the Short-Term Rental (STR) Loophole, you don’t need to obtain REPS to be able to deduct your real estate losses. There are a few criteria you still need to meet, but they are much easier than obtaining REPS and don’t preclude you from also working a full-time job.

    There are several different criteria you can meet to qualify, but I’ll mention two here. If you own a short-term rental where renter stays are less than seven days, and your participation was greater than 100 hours and equal to that of any other individual, then you would potentially meet the STR loophole and be able to deduct your losses against your income!

    Wrap Up

    As you can see there are many strategies that you can use to reduce the amount of taxes you pay as a physician. And many of these tips only require you to maximize your use of accounts that you already contribute to.

    My hope is that after reading this article you can take few steps today to reduce your tax bill for this year and for the rest of your career going forward.

  • BACK TO SCHOOL WITH THE 529 PLAN

    The summer is over and the kids are back in school. While this is a happy time for parents, it can also cause some anxiety by reminding you that life after grade school is fast approaching. Depending on how old your kids are you may be helping them with their A B C’s, in the thick of college planning, or still looking forward to elementary school when you can finish paying for daycare.

    When thinking about their children’s future after high school most parents’ minds quickly turn to the thought of college and how to pay for it. One of the defining features of gen X and millennials entering the workforce has been the presence of student loan debt. If you plan for your kids to go to college, you may be wondering if there is a way to help them reduce or even eliminate the need for loans to obtain their degree.

    College tuition expenses have outpaced inflation over the past 20 years. A year of tuition and fees at a public school, a public school for out-of-state students, or at a private school will run you $9,528, $21,632, or $34,699 respectively. These figures only account for tuition and don’t include the cost of room & board. Even if the price rise slows and only keeps pace with inflation, that can be a hefty chunk of change 5, 10 or 18 years down the road. By starting saving as early as you can, the power of compounding can help grow your college savings and make the eventual bill a bit easier to swallow.

    Types of education savings plans

    529 Plan: The most popular type of account when it comes to saving for college are 529 plans. The 529 plan is most popular and tends to be the best choice for most people because of a few attributes: tax free growth and withdrawal for qualified use, state income tax deductions for certain states, and higher contribution limits than other plans.

    There are other types of accounts available where you can save for your child or dependent if you have problems with the restrictions on the 529 plan.

    Coverdell Education Savings Accounts (ESA): These allow you to invest in almost any type of security vs the 529 plan’s more limited menu of funds. A downside is that the contribution limit is capped at $2,000 annually and balances must be withdrawn by the time the beneficiary reaches 30. A former benefit was the ability to use funds in the ESA for elementary and primary school as well as higher education. This benefit is lessened by the changes included in the Tax Cuts and Jobs Act of 2017 which gave the same options to holders of 529 plans.

    The Uniform Gift to Minors Account (UGMA) and Uniform Transfer to Minors Account (UTMA): These are a good option for those that are unsure if their children will be attending college. These accounts don’t benefit from the favorable tax treatment that the 529 plan does, but withdrawals are taxed at the typically much lower tax bracket of the child. These are also counted as assets when calculating student aid while 529 plan values are not, which can negatively affect financial aid availability.

     529 plan benefits

    The attributes that make a 529 plan great are the tax advantages: deductions on contributions, tax free growth, and tax-free withdrawals. 34 states allow you to take a deduction on your state income taxes for at least some of your contributions, and no matter where you reside your contributions grow tax free and withdrawals aren’t taxed as long as they are used for covered expenses. So even if you live in a state such as Washington, which doesn’t have a state income tax, you can still benefit from the tax-free growth.

    Because the 529 plans are administered by the states, they can vary in subtle ways but most are pretty similar. The two state 529 plans I am most familiar with are Idaho’s and Ohio’s and offer a good example of the different ways states can structure their plans. Both States offer a tax deduction for contributions, but Idaho offers $6,000 individual/$12,000 joint deduction, while Ohio offers a $4,000 deduction for each beneficiary. In Ohio’s plan you may pay a different fee based on the funds you select, in Idaho’s every fund charges the same 0.5% fee.

    Remember that for most States, you must use that State’s plan to qualify for the tax deduction. If you live in a non-state income tax State, or one that doesn’t offer a deduction you can shop around and choose any state plan that offers the funds or fees that you like best.

    Contributions to a 529 plan are considered a gift for tax purposes, so if you contribute over $15,000 to one beneficiary you will have to list the amount over $15,000 as a gift on your federal tax return. However, you can take advantage of “accelerated gifting” by giving a lump sum of 5 years’ worth ($75,000) of gifts at once without incurring gift taxes. Most people do not have the means to make this large of a donation, but if you have relatives who are looking for ways to reduce the value of their estate they can take advantage of this process as well and the $75,000 applies per beneficiary. Anyone can contribute to a beneficiary’s plan, not just their parents.

    A new 529 benefit I mentioned above is the ability to withdraw 529 proceeds to pay for elementary or primary school education as well as secondary schooling. While this is a nice benefit for those looking to use a 529 plan to help pay for private school tuition, it arguably hinders the largest benefit of the plan, the tax-free growth that occurs inside the account. By withdrawing the funds early to use to pay for a private elementary school you are robbing the account of the later compounding and growth that would occur.

    The 529 plan sounds like the winner, now what?

    Before diving into starting up a 529 plan for your kids I recommend taking a step back to take stock of your own financial situation first. I give the same advice flight attendants give in their pre-flight safety briefing, put your own oxygen mask on first before helping those around you. Saving for your children’s education is important and it’s something you can do along with saving for your retirement and other goals, but I recommend making sure you are hitting a few benchmarks beforehand.

    • Do you have a safety fund of 3-6 months expenses built up in the case of emergency?
    • Are you contributing enough to your employer’s 401(k) to receive the full match amount?
    • If you have some high interest debt, do you have a plan in place to pay it off before opening a 529 plan for your child?
    • If you have student loans are you on track to pay them off in a reasonable time frame?

    If you can answer yes to these questions and feel comfortable with your savings and investing goals, then forge ahead!

    Ok, I’m ready, what do I do next?

    As I mentioned above, you can’t purchase individual stocks within a 529 plan account. Each State’s plan includes a set of funds to choose from. These range from a conservative option like a savings account to an aggressive option invested in growth stocks. The fund options available to investors is an area where most states are doing a great job. Both Idaho’s and Ohio’s plans are full of the type of funds that I use and recommend: low-cost, passively managed index funds.

    The goal for a passive index funds is to mirror the returns of the index it is benchmarking, such as the S&P 500. I use and recommend passive funds over active funds because studies have shown that active managers can’t reliably outperform the market year in year out, so investors are better off going with the low fee passive fund rather than the more expensive active fund.

    A few things to take in mind when selecting the fund are your risk tolerance and your time horizon (e.g. how long until junior heads to college). If you are lucky enough to get started when your children are very young you can probably afford to take more risk and invest in the aggressive funds more heavily weighted to stocks. Whereas if you only have a few years until college you might want to be more conservative and divide your investments among stock funds, bond funds and savings accounts.

    As always you need to take your own behavior and risk tolerance into account. If you have 15 years until you need to use the money for college then you have time to weather the ups and downs in a stock fund in order to get more growth, but if you know that your stomach can’t stand a 20%-40% drop in the value of your account without panicking then you may want to invest more conservatively. A financial planner can help advise you on the funds you should choose, as well as provide support and guidance when the markets get rocky, as they surely will. Some plans also offer the ability to work with a financial advisor as a service for an additional fee.

    Ohio’s plan has another option that can take some of the guesswork out of selecting which fund to choose: target-date funds. These funds work in the same way as target-date retirement funds. You select a fund based on the year your child will graduate. In the early years the fund will be invested mostly or all in stocks, and as graduation approaches the fund gradually and automatically shifts into a more conservative posture of bonds and cash. This reduces the chances of a large drawdown just as you would need to use the money.

    If you are planning to choose the funds and manage the account on your own, you should have a plan in place to revisit them regularly (quarterly, half yearly, annually), just as you would your other investments. If you are manually managing your funds you will want to adjust the portfolio to lean more conservative (and less likely to go down in value) as your child gets closer to college age. If you invest in target date funds these check-ins should not require much work other than checking on the account balance and that your deposits are still going into the account as they should.

    To sum up, if you are looking to save for your children’s college education:

    • Open a 529 plan for a beneficiary (your kid), probably the one offered by your State so you can take advantage of the income tax deduction.
    • Deposit into the account, or better yet set up a monthly auto-deposit.
    • Decide if you are going to pick the investment funds inside the plan yourself, or work with an advisor to help you.
    • Feel confident about the steps you’ve taken to prepare for your children’s future!

    Bonus Step: If relatives have asked about helping out with your children’s education, then let them know they can contribute to the account as well.If you have more questions about 529 plans or are curious about other education savings options you can reach me at chris@steadyclimbfp.com or by phone or text at 208-996-0375. I look forward to hearing from you!