Is Your Wealth Plan Built for Flexibility? Part I

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When most physicians build their financial plans (or "wealth plans"), too often they have ignored the most important factor in a sophisticated long-term plan: flexibility.

When most physicians build their financial plans (or “wealth plans”), too often they have ignored the most important factor in a sophisticated long-term plan: flexibility.

Much of life doesn’t work out exactly how one plans, so it would seem obvious that flexibility should be fundamental to a wealth plan. In the financial arena, many factors that make the difference between hitting your financial goals and not are beyond your control.

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In this two-part article, we will examine the important factors for which your wealth plan must provide flexibility

This is likely the most “top of mind” for physicians. With the federal government cutting reimbursements, private insurers following and inflation still causing overhead costs to rise, this is not surprising. Add to this the increasing numbers of doctors who are becoming employees — where the income will be dictated by a hospital or health system — and this clearly becomes the most important factor where flexibility is required. The plain facts are that most doctors cannot accurately predict their income in future years right now, so flexibility has to be part of the plan.

How do you incorporate income/cash flow flexibility into a wealth plan? Two important factors are to live below your means and make saving each month, quarter and year a priority now. These two elements can combine to position you well to weather any temporary or even long-term hits to income/cash flow.

Another important tactic here is to implement savings vehicles that allow for uneven funding/investments. As an example, in the qualified retirement plan (QRP) arena, this might mean using defined contribution plans that allow flexibility in contributions each year — as opposed to a defined benefit plan which can require a certain level of funding or cause underfunding penalties. Even more relevant would be to utilize “hybrid” or fringe benefit plans that may allow much higher contributions than defined contribution plans when income is high but can actually be skipped entirely in years where income wanes.

Another example here would be in the asset class of permanent life insurance — one that has the benefit of tax-deferred growth and top asset protection in many states. Here, funding flexibility would favor a “universal life” type policy — where, as above, funding is flexible year-to-year — over a “whole life” type policy, where funding must occur each year.

The second planning element that one should build flexibility around is taxes. As of the beginning of 2012, we are at the third lowest federal income tax regime (measured by the highest bracket) since the income tax was implemented nearly 100 years ago and the very lowest capital gains tax rates since the 1940s, when that tax was enacted.

Changes in income/cash flowChanges in tax ratesThe charts below show the top marginal federal income tax rate and federal capital gains tax rate in effect for each decade. These charts do not show state income or capital gains rates.

Examining these charts, it seems quite apparent that we could see tax rates rise. If they even return to mean rates of the 20th century, we will experience a sharp increase in tax rates. Thus, it makes sense to build in flexibility for this possibility.

At OJM Group, we approach this through a process of “tax diversification.” While most firms focus only on asset class diversification in the context of investing, we believe it is crucial to layer on top of this focus a concentration to diversify a client’s wealth to tax rate exposure.

As an example, we might look at a client’s QRP assets as those that are subject to future income tax increases — since, to get access to QRP funds; you have to pay ordinary income taxes. Further, most personally-owned assets are subject to future capital gains tax increases — from securities to real estate to closely held business interests to commodities or artwork. As capital gains tax rates increase, the value of these assets decline — at least in terms of how they might assist you in retirement.

Applying a “diversification” approach, we find that most physicians are inadequately invested in asset classes or structures that are immune to future income or capital gains tax increases. Whether these options are in the form of cash value life insurance, tax-free municipal bonds, ROTH IRAs or others, they should be part of every doctor’s wealth plan.

Bottom line: you need to have flexibility against the possibility that tax rates increase, especially if those increases are significant.

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Because risk and uncertainty are so prevalent over the long term, flexibility is a crucial element of a conservative, yet creative, wealth plan. In this article, we looked at two key elements around which any plan should build flexibility — changes in income and in tax rates. In part two of the article, we will examine three additional elements: changes in the “market,” liability and health.

arket changes, liability, health

David Mandell, JD, MBA, is an attorney, author of five books for doctors, and principal of the financial consulting firm OJM Group. Jason M. O’Dell, MS, CWM is also an author of multiple books for physicians and a principal of OJM Group. They can be reached at (877) 656-4362. You can also call for a free (plus $5 S&H) copy of For Doctors Only: A Guide to Working Less and Building More, please call (877) 656-4362.Disclosure:OJM Group, LLC. (“OJM”) is an SEC registered investment adviser with its principal place of business in the State of Ohio. 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 pertaining to the registration status of OJM, please contact OJM or refer to the Investment Adviser Public Disclosure website.For additional information about OJM, including fees and services, send for our disclosure brochure as set forth on Form ADV using the contact information herein. Please read the disclosure statement carefully before you invest or send money.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. 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 information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein.