Doctor’s Digest®

Bridging the gap…between the business of medicine and the practice of medicine.

Why You Should Consider Switching to Roth IRAs Now

Physicians may want to consider converting their traditional IRAs to Roth IRAs this year to avoid a 3.8% surtax on investment income that takes effect in 2013. That hike is part of the new health insurance legislation, which contains higher taxes for upper-income taxpayers—those withincome over $200,000, or over $250,000 for couples filing joint tax returns. Converting your IRA now offers these advantages:

• With a 2010 Roth IRA conversion, you can pay tax at 2010 tax rates, which are lower than expected future income tax rates. After five years and after age 59 1/2, all Roth IRA distributions will be tax-free.
• A 2010 Roth IRA conversion lets you avoid taking taxable distributions from a traditional IRA in the future.
• You can pay the tax on your 2010 Roth IRA conversion from non-IRA funds. This may reduce your taxable portfolio and thus reduce the taxable investment income that will be subject to the 3.8% tax.

“By using non-IRA assets to pay the tax on a Roth IRA conversion, you essentially are moving taxable dollars into a tax-free account with many investment options,” says Marty James, who heads Martin James Investment & Tax Management, LLC, an accounting and investment advisory firm in Mooresville, Indiana.

Following through: Find out more about the 3.8% surtax at http://tax.cchgroup.com/Legislation/Final-Healthcare-Reform-03-10.pdf?pacp-attached=1&pacp-SITESERVER=ID=70e413ad5980c54f9283357f3dd6c50c, p. 4.

Better Deals on PLUS Loans

Medical school students—and their parents—may be able to have easier access to lower federal student loan interest rates because of a change passed as part of the new health insurance legislation. Previously, most colleges and universities participated in the Federal Family Education Loan (FFEL) program, in which federally guaranteed loans came from private lenders. Fewer schools participated in the Direct Loan program, in which the money came straight from Uncle Sam.

But as of July 1, 2010, all federal education loans will come through the Direct Loan program. That may be good news for parents and graduate students who use federal Parent Loans for Undergraduate Students (PLUS) loans for higher education, now called Parent PLUS Loans and Graduate PLUS Loans.

“Parents and graduate students who were formerly borrowing through the FFEL program will now have access to a lower interest rate,” says Deborah Fox, who heads Fox College Funding in San Diego. “Due to a glitch in prior law, FFEL originated PLUS loans had an 8.5% maximum interest rate while the Direct Loan version charged 7.9%.” Starting in July, all new PLUS loans will have the lower 7.9% fixed interest rate.

She notes that because the lending standards of FFEL lenders are tighter than those of the government, PLUS loans may be easier to get than they were in the past once all-government lending begins in July.

Following through: Go to www.fastweb.com/financial-aid/articles/2177-how-will-the-student-loan-bill-affect-students to read how the new legislation will affect student loans.

Greater Tax Deductions for Medical Equipment

You can deduct up to $250,000 spent on equipment for your practice this year, thanks to the Hiring Incentives to Restore Employment Act of 2010. The new law raised this year’s cap from $134,000 for first-year deductions.

“A company—including a medical practice—can take a first-year write-off for up to $250,000 of business equipment, with a phase-out for capital expenditures exceeding $800,000,” says Ed Mendlowitz, partner in the CPA firm WithumSmith+Brown, New Brunswick, New Jersey.

That means that if you buy $900,000 of equipment in 2010, you will be over the $800,000 threshold by $100,000. Thus, your first-year write-off will be cut by $100,000 from the maximum $250,000 down to $150,000. If you buy $900,000 worth of equipment and you take a first-year deduction of $150,000 under section 179 of the tax law, the other $750,000 worth of equipment will be deducted under multi-year depreciation tables.

Following through: See www.section179.org/section_179_faqs.html, for frequently asked questions and answers on section 179.

Take a Longer Look at Short Sales

Whether you’re in the market for a larger residence, a vacation home, or investment property,this is a great time to be a buyer. Prices are down sharply from the peak of a few years ago.

Often you can get a great deal with a “shortsale.” A short sale takes place when the purchase price deal won’t cover the existing mortgage debt. For example, if you bought a house for $400,000 in 2006, with a $380,000 mortgage, and you can sell the house now for only $300,000, this transaction would result in a loss of some $80,000 for the lender.

“Shortsales need the lender’s approval,” says Bob Fornatto, a senior mortgage consultant at Wintrust Mortgage, Downers Grove, Illinois. “If there’s a second mortgage, the holder of that loan also must agree. So short sales don’t always go through.”

Shortsales may be easier to close now because of federal government initiatives such as the Home Affordable Foreclosure Alternatives (HAFA) program, introduced in April 2010, which encourages short sales. This program provides cash incentives to gain approvals from lenders. Under HAFA, mortgage holders must inform homeowners of the lowest price they will accept, then respond to a homeowner’s offer within 10 days.

Following through: HAFA’s main provisions are spelled out at www.realtor.org/government_affairs/short_sales_hafa.

How to Pay an Advisor

In these tumultuous economic times,you may want a professional’s advice on how to manage your money. You’ll pay for that advice, but different advisors have different compensation arrangements.

Commissions. Perhaps the most familiar way to pay for investment advice is to buy a stock or fund that a broker recommends and pay a sales commission. This arrangement may work well if you invest infrequently and hold onto the securities you buy for years, thus minimizing the commissions you pay.

Assets under management. Increasingly,investment advisors are calling themselves “fee-based” or “fee-only.” Typically, you’ll pay a fee around 1% a year for the assets in your portfolio. With a $400,000 portfolio, for example, you might pay the advisor about $4,000 a year no matter how much trading you do, so this arrangement may be suitable if you tend to change your holdings frequently to take tax losses or rebalance your asset allocation. “Some investors like the idea that the advisor’s compensation will go up only if their portfolio value increases,” says Philip Palaveev, president of Fusion Advisor Network, Seattle. “They like being Ôon the sameside of the table’ with their advisor.”

Flat fees.Some fee-oriented advisors will quote you a fixed rate for their annual services. You’ll know what your outlays will be, and you may receive financial planning advice in addition to investment management.

Following through: Go to www.resourcem.com/dev/documents/rmiller_article_5.pdf for a review of the pros and cons of various compensation arrangements.

Be Flexible With Portfolio Withdrawals

If you have a flexible retirement fund withdrawal strategy, you maybe able to withdraw more than the 4% that is typically recommended.

For example, under a traditional scenario you would withdraw $20,000 from a $500,000 portfolio in the first year. In subsequent years, you’d increase your withdrawal amount by the rate of inflation to maintain your spending power. If you withdraw $20,000 in year one and inflation is 3%, you’d withdraw $20,600 in year two. Going by historic results, your portfolio has a high probability of lasting 30 years or longer.

However, this assumes a worst-case scenario. If your retirement years occur when financial markets are better than a worst case, you’ll have withdrawn less than you could have afforded and lost out on spendable cash.

“We suggest clients start with a 5.5% rate if they’re willing to forgo automatic annual inflationary increases,” says Jonathan Guyton, principal, Cornerstone Wealth Advisors, a financial planning firm in Edina, Minnesota.

With an initial 5.5% withdrawal, you’d take $27,500 from a $500,000 portfolio in the first year. However, if you start at 5.5%, you should be willing to freeze withdrawals or even reduce the withdrawal amount when markets plunge and the size of your portfolio shrinks. Conversely, you can increase withdrawals by more than the inflation rate if your portfolio grows sharply.

Following through: At http://spwfe.fpanet.org:10005,you can read the breakthrough article that introduced the 4% rule.

How to Get Higher Yields on Your Cash Reserves

If you do a little research, you can get better yields for your cash than money market funds and many bank accounts, which pay astonishingly low interest rates these days. Here are three examples from Rich Chambers, founding partner, Investor’s Capital Management LLC, Menlo Park, Calif.

• Schwab Bank’s High-Yield Checking Account. The current yield here is 0.75%. Mr. Chambers says he uses this account and recommends it to his clients not only for the yield but for other advantages, which include easy access to your money and no fees. This account is covered by federal deposit insurance of up to $250,000 per depositor per bank.
• Emigrant Bank’s DollarSavingsDirect.com. The current yield here is 1.5%. This account, which is available online, can be electronically linked to your checking account. You can keep money at DollarSavingsDirect.com, earning the relatively high yield, and transfer funds to your checking account as needed. This account also is covered by federal deposit insurance of up to $250,000 per depositor per bank.
• Ford Interest Advantage. The current yield here is 2.32% to 2.63% depending on the account balance. Mr. Chambers uses this account for some of his own money but not for clients’ cash because of the higher risk: This account is not covered by federal deposit insurance.

Following through: To keep up with high-yielding online savings accounts, go to www.savingsaccounts.com/.

Coping with Disappointing Life Insurance Values

How to Get Higher Yields on Your Cash Reserves The news is grim for those who either bought variable life insurance in the late 1990s and invested in stocks within those policies, or bought universal life and whole life policies hoping that cash values would grow at substantial rates to match bond yields.

Because of the recent severe bear markets, stocks have suffered while bond yields have fallen. Therefore, many life insurance policies have disappointing cash values. Unless the policy is bolstered, there may not be enough cash to keep the policy in force as you grow older.

Here’s what you should do now to re-evaluate and bolster your situation:

1. Request an “in-force ledger.” That will show the policy’s current status.
2. If the policy is underfunded, get a schedule of how much you’ll need to pay to catch up.
3. Explore your other options. You can cancel the policy if it’s no longer needed, reduce your coverage, or exchange your old policy for a new one.

“Policies offered now might be better,” says Terry Quinn, an attorney who has an insurance consulting firm in Atlanta. “Some companies are offering stronger guarantees of cash value and insurance benefits.”

Following through: For insights on how to interpret a life insurance policy illustration, go to http://articles.moneycentral.msn.com/Insurance/AvoidRipoffs/AvoidTheInsuranceIllustrationTrap.aspx.

Are Hedge-like Mutual Funds Right for You?

With only a modest investment of a few thousand dollars, you can now invest in hedge-like mutual funds and take advantage of a hedging strategy that has previously been available only to the very wealthy or to institutions, thanks to the introduction of new mutual funds.

Hedging is a strategy that paid off during the recent economic downturn: Results vary; but Morningstar’s Long-Short category posted a loss of 15.4% in 2008, which was much better than regular stock funds, which posted loses a 37.5% average loss for domestic stock funds in 2008.

In 2009, these funds hedge-like mutual funds were up 10.4%, enabling investors to recoup a good portion of their losses from the 2008 bear market.

Although there are many types of these funds, the basic hedging strategy is to go long—and short. Here’s how it works:

• Hedge funds go long. The funds buy certain stocks, bonds, or other assets and hope to make money if prices rise.
• Hedge funds also go short. They enter into transactions structured to make money if specified assets lose value.

Because of this mix, a skilled hedge fund manager can make money in bull or bear markets. Investors may wind up with superior long-term returns and a smoother ride to get there. Unlike regular hedge funds, many—though not all—hedge-like mutual funds offer lower minimum investments and lower fees as well as easier access to your money.

“You might be able to get into these funds with just a few thousand dollars,” says Nadia Papagiannis, editor of Alternative Investments Observer. “You can sell your shares whenever you want, which generally is not the case with hedge funds; and fees are much lower than what you’d pay for hedge funds.”

Following through: Go to http://www.nytimes.com /2010/01/10/business/mutfund/10hedge.html for a detailed look at why 24 hedge-like mutual funds were launched in 2008 and 2009.

When Prepaid Plans Make Sense

If you’re planning for a child’s college education, you may find prepaid tuition plans a good option.

Unlike the 529 college savings plans, which were hit hard by the 2008 bear market and still have not recovered their losses, contributions to the prepaid plans are guaranteed to grow at the same rate as college tuition increases, regardless of how financial markets perform.

The catch? Most of these plans, which are offered in 18 states, are tied to the state’s financial fortunes. In the recession of 2008-09, many states have increased fees for these plans or adopted other measures to make them less attractive.

“A few state plans shift the risk from the plan to the schools, which is better for parents,” says Joe Hurley, a CPA and president of Savingforcollege.com. He cites Massachusetts and Texas as examples of this shift. “In addition, the Independent 529 plan offers the same approach to funding tuition at over 280 private colleges across the country.”

You probably shouldn’t manage all of your college savings through a prepaid 529 plan, because these plans generally will provide benefits only for tuition and only at specific schools. Nevertheless, you may want to put some money there if you think your child is likely to attend a school covered by the plan.

Following through: Go to http://www.savingforcollege.com/college_savings_201/ to find out whether your state has a prepaid plan.

Understanding New Tax Credits for Home Buyers

If you’ve been putting off buying a first home—or even moving at all—new tax credits may make it more attractive to do so. Congress passed a law late last year that expands the previous law’s tax credit options for home buyers. Here’s what’s new:

Higher income limits. The full tax credit is available to single taxpayers with income up to $125,000 or up to $225,000 for married couples filing a joint return. These amounts have been increased from $75,000 and $150,000 in the prior law from early 2009. Partial credits are available if those income levels rise to $145,000 and $245,000, respectively.

Option for certain previous owners. First-time home buyers can get a tax credit up to $8,000. You qualify if you (and your spouse, if you’re married) haven’t owned a home for three years before the purchase. In addition, if you’ve owned and lived in the same home for five consecutive years during the eight years before the purchase, you may qualify for a $6,500 tax credit depending on your income.

You have to use the home you buy as a principal residence by April 30 of this year. That moves up to no later than June 30 if a binding contract is in place by April 30. “A qualifying purchase in 2010 can be taken on a 2010 or a 2009 tax return,” says Marty Abo, a CPA in Voorhees, N.J. He notes that homes costing over $800,000 are ineligible for either tax credit.

Following through: Go to www.irs.gov/newsroom/article/0,,id=204671,00.html for complete details on the newest version of this tax credit.

What’s the Right Strategy for You?

While financial professionals usually differentiate between strategic and tactical investing, some say a combination of these approaches would work for some investors.

Although the definitions are not etched in stone, here’s a guide:

Strategic investing usually refers to a long-term approach. You might decide to hold 75% of your portfolio in stocks, for example, and 25% in bonds. You’d keep investing, through good times and bad, and hope for superior returns.

Tactical investing usually indicates an attempt to move in and out of stocks at the right time, to avoid the worst of bear markets. You might sell stocks when the market seems pricey, park the proceeds in cash, then reinvest after stocks have tumbled.

“Investors probably should not be fully invested in tactical methods because they may be late getting in and out of the market,” says Bill Crager, president of Envestnet, a wealth management firm based in Chicago. “However, it may be appropriate to use tactical methods for a portion of the portfolio because these methods may help investors become defensive in falling markets.”

Following through: See www.thestreet.com/story/10612765/the-tactical-investor.html for an overview of tactical investing.

Investing: Physicians’ Best Bet

If you’re leery of stocks and looking for similar returns without the turmoil, put some of your money into bonds.

At first glance, Treasury bonds (T-bonds) seem a wise investment choice. If you had bought intermediate-term T-bonds during 1995-2008, your 7%-a-year return would have beaten stocks’ annualized returns of below 7%, according to Morningstar, Inc., an independent investment research company based in Chicago. Of course, if you bought the wrong stocks or tried to time the market, you may not have made any money at all, making that T-bond yield look even better. In addition, because those bonds had only one down year (they lost about 2% in 1999), investors during that period managed to avoid the stress that often accompanies stock market investments.

However, today T-bonds have relatively low yields—about 2.75% for 5-year bonds and 3.80% for 10-year bonds. Instead, physicians are likely to be better off investing in municipal bonds, which yield around 4% and, importantly, are tax-exempt. Tax rates are widely expected to rise, especially for those with six-figure incomes; and higher tax rates would make tax-exempt interest even more appealing.

Marilyn M. Gunther, a partner at the Center for Financial Planning in Southfield, Mich., currently prefers municipal bonds with maturities no longer than 10 years; longer-term bonds may lose value substantially if interest rates rise.

“It has become difficult to find suitable individual shortterm municipal bonds for clients,” Ms. Gunther says. “So we are using more shorter-term ‘muni’ bond funds.” She advises investors to consider the following before investing:

• Overall length of bonds in the portfolio
• Credit quality of the bonds
• Experience and success of the fund manager

Still wary? Consider this: Municipal bond prices are actually somewhat depressed because investors fear the weak economy will trim states’ and cities’ revenues, perhaps leading to defaults. Once the economy recovers and confidence returns, municipal bond prices may move up, which would boost returns to bond fund investors.

Following through: Keep up with current yields on T-bond and municipal bonds at www.bloomberg.com/markets/rates/index.html.

Taxes: Special Rule Can Help Pay for College

If your son or daughter is in graduate school and 24 years of age or older, he or she may be able to take advantage of a special tax rule (in effect through 2010) that makes income shifting especially attractive.

According to this rule, low-income taxpayers get a 0% tax rate on dividend income and longterm capital gains, explains Tom Ochsenschlager, vice president of taxation at the American Institute of Certified Public Accountants.

In 2009, that 0% rate applies as long as taxable income is no more than $33,950 on an individual return, or $67,900 for a married couple filing jointly. Because tax brackets generally expand each year to keep pace with inflation, those numbers probably will be slightly higher in 2010.

To see how your son or daughter might use the 0% rate, suppose that your 24-year-old daughter is in medical school, has minimal taxable income, and you are helping to pay her bills.

Suppose, too, that you have $52,000 worth of stock in a biotech company that you have been holding for many years. Because you paid $20,000 for those shares, you would incur a $32,000 long-term capital gain if you sold them.

“Instead, you can give $26,000 worth of those shares to your daughterÑand file a gift tax returnÑso she can sell them by yearend,” Mr. Ochsenschlager says. If you’re married and have made no other gifts to your daughter this year, gifts up to $26,000 will be gift-tax free, thanks to an annual gift-tax exclusion.

Your daughter will collect $26,000 from the sale and will owe 0% tax, assuming her taxable income (including the gain amount) remains under $33,950 in 2009. Thus shewill have $26,000 to put toward medical school costs. You can repeat the process in 2010 if that 0% tax bracket is still available.

Remember, income shifting doesn’t work for younger children. In those cases, the “kiddie tax” assesses investment income over $1,900 (in 2009) at the parents’ tax rate. Children who aren’t full-time students will no longer be liable for the kiddie tax once they reach age 19. Other rules apply to youngsters whose earned income provides more than half of their own support.

Following through: For more details on the kiddie tax, go to www.fairmark.com/college/kidtax/kiddietax.htm.

Retirement Planning: New Option for High-income Physicians

If you’ve been earning too much to take advantage of Roth individual retirement accounts (Roth IRAs), you may be able to tap into a special rule that takes effect in 2010.

Roth IRAs allow tax-free withdrawals after you’ve had the account for five years if you’re 591/2 or older. In addition, you never face any required distributions, no matter your age.

But most physicians have been shut out of the option. In 2009, for example, a single taxpayer with modified adjusted gross income (MAGI) over $120,000 wasn’t able to contribute anything to a Roth IRA; married couples with MAGI over $176,000 were also barred. To contribute the maximum $5,000 this year ($6,000 if you’re 50 or older), your MAGI must be under $105,000 on a single tax return or $166,000 on a joint return.

If you want to convert your traditional IRA to a Roth IRA, the hurdles are even higher. You must have MAGI no higher than $100,000 this year, on a single or joint tax return. That $100,000 income limit will be abolished after 2009 so you can have a Roth IRA next year, regardless of your income.

Usually, when you convert a traditional IRA to a Roth IRA, you owe tax on any pretax dollars that you’re converting for the year of the conversion. But for 2010 conversions, you can report half the income on your 2011 return and half on your 2012 return, says Ed Slott, a CPA in Rockville Centre, New York, author of Ed Slott’s IRA Advisor, a monthly newsletter; and host of the PBS special, “Stay Rich Forever and Ever.”

He cautions that the tax bill can be steep. Assuming that Dr. Jones has $400,000 of pretax money in his IRA, if he is in a 35% tax bracket, Dr. Jones will owe a total of $140,000 in tax on a full conversion.

If Dr. Jones prefers to pay less tax, he can do a partial conversion. He might convert $100,000 of his IRA in 2010 and defer the taxable income to 2011 (when he’ll report $50,000) and 2012 (when he’ll report the remaining $50,000). Assuming tax rates remain the same in those years, Dr. Jones will pay a total of $35,000 in tax.

“Many people expect future tax rates to be higher because of all the obligations the federal government has assumed,” Mr. Slott says. “If you convert your traditional IRA to a Roth IRA now, you’ll be able to take tax-free distributions and pass the tax-free account to your beneficiaries, even if tax rates shoot up.”

Following through: For answers to your questions about Roth IRAs, go to Mr. Slott’s Website, www.irahelp.com. Click on “IRA Resources” and “Frequently Asked Questions.”

Real Estate: Time to Buy Investment Property

If you are interested in rental property, now may be the time to buy. Housing prices may be as low as they’re going to get while mortgage rates are reasonable for investors with a good credit record and cash for a down payment.

“To get the best mortgage terms, investors probably will need a credit score of 750 or higher as well as enough cash to put at least 30% down,” says Greg McBride, a senior financial analyst at Bankrate.com, North Palm Beach, Fla.

For the best deals, follow these tips:

• Try to buy from a lender after it has foreclosed on a home. These homes are collectively known as REO (“real estate owned” by a bank or other lender). Because banks generally don’t want to be landlords, they may ask low prices in order to get REO homes off their books.
• Ask the bank to verify that you won’t have to deal with others’ claims such as title liens, delinquent taxes, or homeowners’ association fees that are in arrears.
• Be aware that, because REO property usually is sold “as is,” a house may have hidden flaws. “It’s vital that you hire a reputable home inspector before signing a contract,” Mr. McBride says.
• Insist on working through a realtor who represents one or more lenders. This realtor will have easier access to the bank’s properties and probably will have experience in moving the process along.

The days of property “flipping” for quick profits are gone and best forgotten, but rental real estate is likely to deliver solid returns and tax benefits to investors who can hold the property for four years or longer.

Following through: Find local REO properties owned by Bank of America at www.countrywide.com/purchase/f_reo.asp.

About the Author: Donald Jay Korn is a New York-based financial writer with particular expertise in investments, real estate, financial planning, taxes, and insurance. He has authored seven books on financial topics and is a regular contributor to Financial Planning, Black Enterprise, Investor’s Business Daily, and Consumer Reports Money Advisor.