Given the tax bracket most doctors are in, reducing their tax burden is a key factor in their investment success and long-term retirement plan. At this time of year, many doctors may not have maximized all of their retirement tax-deferred options. Here is a summary of different options to consider.
Traditional 401(k) plans
Tax deductions. Contributions to a Traditional 401(k) are tax-deductible, reducing an individual’s taxable income for the year in which contributions are made.
Tax-deferred growth. Earnings within the account grow tax-deferred until withdrawal, allowing for compound growth.
Employer matching. Many employers offer matching contributions, effectively increasing the amount individuals save for retirement.
Required minimum distributions (RMDs). Individuals must begin taking withdrawals from their Traditional 401(k) at age 72, which can affect tax liability.
Early withdrawal penalties. Withdrawing funds before age 59½ typically results in a 10 percent penalty and income tax on the withdrawn amount.
Roth 401(k) plans
Tax-free withdrawals. Qualified withdrawals from a Roth 401(k) are tax-free, providing tax-free income in retirement.
No RMDs. Roth 401(k)s do not have RMDs during the account holder’s lifetime, allowing for continued tax-free growth.
No immediate tax deduction. Contributions to Roth 401(k)s are made with after-tax dollars, so they do not provide an immediate tax deduction.
Employer match taxed. Employer matching contributions are tax-deferred, meaning individuals will pay taxes upon withdrawal.
Tax deductions. Contributions to a Traditional IRA can be tax-deductible, lowering an individual’s taxable income.
Tax-deferred growth. Similar to Traditional 401(k)s, earnings within a Traditional IRA grow tax-deferred.
RMDs. Starting at age 72, Traditional IRA owners must take RMDs, potentially increasing their taxable income.
Early withdrawal penalties. Withdrawing funds before age 59½ incurs a 10 percent penalty and income tax.
Tax-free withdrawals. Qualified withdrawals from a Roth IRA are tax-free, providing tax-free income in retirement.
No RMDs. Roth IRAs do not have RMDs during the account holder’s lifetime, allowing for continued tax-free growth.
No immediate tax deduction. Contributions to Roth IRAs are made with after-tax dollars and do not provide an immediate tax deduction.
Income limitations. High-earning individuals may be ineligible to contribute to Roth IRAs.
Simplified Employee Pension (SEP) IRAs
Higher contribution limits. SEP IRAs allow for higher annual contributions, making them ideal for self-employed individuals and small business owners.
Tax deductions. Contributions are tax-deductible, lowering taxable income.
Employer contributions only. Contributions are made by the employer, not the employee. Thus, they are generally unavailable for non-self-employed individuals.
No catch-up contributions. SEP IRAs do not offer catch-up contributions for older individuals.
Solo 401(k) plans
High contribution limits. Solo 401(k)s permit higher contributions compared to Traditional or Roth IRAs.
Tax deductions. Contributions are tax-deductible, reducing taxable income.
Self-employed requirement. As the name suggests, Solo 401(k) plans are designed for self-employed individuals and business owners with no full-time employees, excluding their spouses.
Complex administration. Managing a Solo 401(k) may require additional administrative efforts compared to other retirement accounts.
Tax-deferred retirement accounts provide doctors with valuable tools for saving for retirement while benefiting from tax advantages. The right choice depends on a doctor’s financial situation, goals, and time horizon. Traditional accounts offer immediate tax deductions, while Roth accounts provide tax-free withdrawals. The specific benefits and limitations of each account type should guide the decision-making process.
Amarish Dave is a board-certified neurologist with over 20 years of experience in both neurology and active stock investing. In addition to his medical career, he holds a background in business from the University of Michigan and has successfully passed the SIE exam administered by FINRA. Dr. Dave is founder, FiscalhealthMD.com, a website dedicated to educating doctors at all stages of their careers, ranging from residents to retirement, about financial planning.