As doctors approach the end of their careers and move toward the sale of their practices, it's important for them to plan as far in advance as possible. Most doctors limit their planning to how they will spend their newfound time in retirement. Some don't even get that far. While savvy doctors are probably keeping a close eye on their personal finances to ensure they can afford retirement, too many doctors overlook this important detail. However, the question even some of the most prepared sellers overlook is what to do with the cash windfall they'll receive when the practice sells. Generally speaking, a buyer should be able to obtain bank financing for most, if not all, of the proceeds necessary to buy the practice. What the doctor ultimately does with that money can mean the difference between saving and losing tens of thousands of dollars or more.
Jeff Harrell, director of Portfolio Management at McGill Advisors, Inc., routinely addresses this dilemma with retired doctors. The first question they nearly all ask is, "Where should I pull the money from that I need to live off of in retirement?" While individual circumstances vary, most doctors should use the following strategy when making withdrawals from their investment accounts in retirement.
When a doctor retires, one of the last things they must do before retirement begins is roll their company-sponsored retirement plan into an IRA. This prevents any tax from being owed on the withdrawal, which is important because it typically becomes the largest asset the doctor has. Doctors who retire before age 70½ are not required to take withdrawals until they pass this age. This is something doctors can take advantage of by living off the proceeds from the sale of their practices. This money has already been taxed, and therefore withdrawing money from this portion of their portfolio will not result in additional tax ramifications. Using these assets first will significantly drive down their income tax rates. In many cases, doctors who use this strategy will see their taxable income during their early retirement years drop to almost nothing due to their deductions and exemptions. While paying no tax to the government for a couple of years may sound attractive, what if instead doctors took advantage of the low tax rate by paying the government less money now than what they would have to pay the government later? This can be accomplished by doing a ROTH IRA conversion.
When a doctor is in an abnormally low tax bracket, he or she can take advantage of this by converting a portion of his or her IRA to a ROTH IRA. Since all of the money in the IRA will eventually be taxed, paying tax at the lower 10% or 15% whenever possible is something that should always be done. We advise doctors in retirement to have their CPA run year-end projections to see what their taxable income will be. We then advise that they convert the difference between their taxable income and the top end of the 15% tax bracket ($74,900 for joint filers in 2015) to a ROTH IRA. The benefits of this strategy are twofold. First, taxes are paid on the IRA assets at a below average rate. Second, the assets are shifted into an account that will grow tax-free for the rest of the doctor's life.
What's the bottom line? Doctors who follow this strategy every year before they turn 70½ can add tens and even hundreds of thousands of dollars to their long-term investment portfolio in retirement.
Jonathan Martin provides transition planning through Roger K. Hill & Company, Inc., a member of the McGill & Hill Group, LLC and is a member of ADS Transitions. Jeff Harrell provides investment advice through McGill Advisors, Inc., a registered investment advisor and affiliate of McGill & Hill Group, a one-stop resource for tax and business planning, practice transition, legal, retirement plan administration, CPA, and investment management services. For more information, visit www.mcgillhillgroup.com.