The final quarter of a year serves as an opportune time to consider your overall financial picture and what strategies you might employ in the new year. Medical professionals tend to have a complex financial picture, but one that can benefit them immensely with the right tools. One such tool is a sound investment strategy which takes all options into account.
When you think of retirement savings or long-term investing, you might think of the traditional 401(k) and Roth IRA. While these are certainly popular options, they have their limitations.
Doctors who want to lower their taxable income and create a long-term return should also consider additional options. Many of these plans can lower taxable income, offer tax-free distributions, or both. In fact, your patients use a couple of them all the time. If you aren’t utilizing them, it might be time to consider one or more for next year.
1. Consider a Flexible Spending Account (FSA)
Also known as a flexible spending arrangement, these plans allow one to contribute regular earnings to the account and later use these funds to pay for health and/or health-related costs.
These contributions are exempt from payroll and income taxes, thus lowering taxable income significantly. The distributions, however, must be used for health-related costs, and have a relatively low contribution limit.1
2. Open a Health Savings Account (HSA)
Similar to the FSA, a Health Savings Account enables you to put away pre-tax money toward qualified medical expenses.2 They are a more long-term strategy than the FSA because the money in the account is allowed to carry forward into future years. There is no tax on contributions, earnings, or qualified distributions of the HSA, but if one contributes over the yearly limit ($3,650 for a single filer and $7,300 for a family as of 2022), there is a tax on additional contributions.
Because everyone has health-related expenses at some point, this is a fantastic place for people to put savings in order to lower their taxable income while preparing for health expenses. It is also a method to lower taxable income during retirement years, when health expenses tend to increase.
3. Think About Investing in a 529 Plan
A 529 plan is a tax-advantaged long-term savings plan for a beneficiary. In order to gain tax-free distributions, the beneficiary must spend the distributions on education or education-related expenses.3 Certain states have a tax benefit for contributions to a 529 plan, meaning the taxpayer can lower their state income taxes by contributing. This, however, does not lower their federal income tax.
The 529 plan has been recently expanded to include K-12 expenses as well as apprenticeships, expanding the options that the beneficiary has if they want to withdraw the money tax-free. The disadvantage is that the benefactor cannot make decisions for the beneficiary regarding how and when the money is spent once the beneficiary becomes an adult. Additionally, certain states have rules regarding where the plan’s funds must be spent in order to unlock the tax benefits.
4. Determine Whether to Invest in Annuities
Lastly, annuities are an additional vehicle for long-term investing that plays a helpful role for some doctors in their long-term wealth-building strategies.
Annuities can be helpful for high-income earners, like doctors, who are already maxing out their tax-advantaged retirement accounts such as 401(k)s. Annuities come in variable and fixed forms, each with its own subtypes, rules, and advantages. Fixed annuities typically have more stable, slow growth, while variable annuities have more risk but potential for earnings. In both cases, the earnings are tax-deferred.
Annuities often have complex rules and carry fees, so they may be best saved for when a taxpayer is already maxing out other options and should be evaluated alongside a qualified wealth manager or investment advisor so you can make the best decision possible for your future.
Regardless of your financial situation, these strategies work best when paired with a Certified Public Accountant (CPA), wealth manager, or financial advisor. These professionals will understand the strategies listed here, as well as the specific rules for your specific situation.
Sources Cited
- https://www.irs.gov/pub/irs-pdf/p15b.pdf
- https://www.healthcare.gov/glossary/health-savings-account-hsa/
- https://www.sec.gov/reportspubs/investor-publications/investorpubsintro529htm.html
