How Should You Allocate Savings?

If you live a reasonably balanced lifestyle, you will, at some point in your lives, find yourselves debt free, 529s funded and accumulating cash. As physicians, particularly in dual-doctor households, you can accomplish this 10 years or so out of training if you focus on making good financial decisions and limit your extravagances.

Until you reach this point, you are most likely doing everything possible to lower your tax bill and throw everything left at loans and future education. When you reach this milestone, however, I think it’s a good idea to step back and ask if it’s a good idea to retire with a $3M pre-tax 401k and only a few hundred thousand dollars in other types of accounts, such as Roth’s and brokerage (or, taxable) accounts.

When we first began focusing our business on financial planning solely for physician households, those first few “Initial Foundation Plans” (IFPs) we completed were eye-opening. Our first couple was a dual physician household with no children. Their IFP showed lifetime savings of over $100M at death. Surely, we thought, there was an error. But as subsequent plans and a careful examination of our calculations has shown, these projections are not unusual.

This led to an uh-oh experience: RMD (Required Minimum Distribution) calculations. Conventional wisdom has long held that most people will be in lower tax brackets in retirement than they will during their careers. However, we were projecting that physicians with normal career spans (~25 – 30 years) who were optimal savers and took advantage of all work retirement options were going to owe significant income taxes on IRA distributions in retirement. This was due to their high savings rates along with the long-term compound growth of their retirement accounts.

As a result, we developed a strategy for high-income professionals to allocate savings in such a way as to focus not simply on current tax savings, but also on tax reduction in retirement. At retirement, we began recommending a targeted savings allocation by tax streams. We set a goal of dividing total savings equally among pre-tax, Roth, and brokerage accounts.

  • Pre-tax accounts include tax deductible employer retirement accounts, IRAs, and pensions.
  • Roth accounts include the Roth portion of employer retirement accounts, Roth IRAs, and Health Savings Accounts (HSA’s)
  • Brokerage accounts include all taxable investments, real estate, shares of partnerships and corporations, and cash.

I’ll freely admit that we did not arrive at the 3-way division by scientific determination, but because I believe having control over tax brackets is preferential to being held hostage to high fully taxable RMDs.

When we initially discuss our recommended allocation with clients, the first question is always, “How do we build up the Roth allocation in our portfolios?” This typically takes long-term planning coupled with an eye for watching for Roth conversion opportunities. I’ll cover ways to maximize Roth opportunities in my next DD.

How to Grow Your Roth IRA

7 thoughts on “How Should You Allocate Savings?

  1. This is of high interest to me. I plan to retire early and start doing a ROTH conversion system in place hopefully transferring all my 401k/IRAs into a ROTH IRA and avoiding RMDs.

    Like

  2. Then I think you’ll like next month’s post on how to get money into Roth IRAs. I think many high-income professionals believe they are stuck with high RMDs in retirement and that there are going to be a lot of desperate docs in the years leading up to age 70-1/2. It ain’t gonna be pretty!

    Like

    1. Do you have a calculator to determine the amount to convert and it’s impact on taxes and medicare premium? If yes, please include it in your next month’s post or provide a service to a client! Thank you.

      Like

  3. Hi, Raj, Our planning software calculates it and we include various scenarios in the projections. We’re demo-ing another program that focuses only on retirement withdrawal strategies and Roth conversion timing, which I’m pretty excited about. So, yes, we provide that service to clients. I would like to provide a simple formula to the public but there are too many moving parts (ex: increase in Medicare premiums) to make that possible.

    Like

  4. May I ask – how much do you charge for Roth conversion analysis? or call for an initial phone conversation to get a better understanding of my situations before quote the chargers. Thank you.

    Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s