When building a wealth plan, most retina surgeons judge potential asset classes using traditional investment criteria, with the risk and potential return at the top of the list. However, the tax treatment of those assets should not be far behind. Potential investments that offer significant tax benefits often become even more attractive.

If you’re interested in investing with tax benefits, you may want to take advantage of two commonplace assets that have enjoyed advantageous tax treatment under our tax code for decades: real estate and permanent life insurance. In this article, we discuss these two asset classes and their unique tax benefits.

TAX SIMILARITIES

In our book Wealth Planning for the Modern Physician, we discuss the similarities between real estate and permanent life insurance from a tax perspective. While the United States tax code changes somewhat regularly, both asset classes have enjoyed superior tax treatment for decades.

An owner of real estate can deduct interest payments on home mortgages (within limits) and write off depreciation on business real estate. Other tax benefits include the following:

  • A deduction for local property taxes against federal income taxes (this was limited by the last tax code change and may revert to more generous rules under a Biden tax act).
  • A capital gains exemption of up to $500,000 on the sale of a primary home (for a married couple filing jointly).

Permanent—also called cash value—life insurance is a contract with a life insurance company to provide death benefit protection throughout your entire life, as opposed to term insurance that just provides coverage for a specified number of years. Unlike term policies that do not have any asset value, permanent policies build up a “cash value” that grows in a variety of investment types, depending on the product. Tax-wise, these cash values grow tax deferred; with proper management, owners can access the accumulated cash value tax free during retirement. In addition, policy death benefits generally are paid to beneficiaries free of income tax, and policyholders who are focused on estate planning can even structure the death benefits to be paid free of estate tax, within certain types of trusts.

Further, both asset classes offer a powerful tax benefit that few others provide: the ability to move from one piece of real estate or life insurance policy to another using a tax-free like-kind exchange. These exchanges are controlled by tax code sections 1031 and 1035, respectively. Under code section 1031, owners of an appreciated piece of real estate can sell it and not pay tax on the gains, so long as they follow the tax rules and purchase another qualifying piece of real estate in an allotted time. Similarly, under code section 1035, owners of permanent life policies with accumulated gains in cash value can exchange their existing policy for a new policy without incurring taxes on those gains.

INVESTMENT SIMILARITIES

From an investment and asset class perspective, these two assets are relatively long term. While some professional real estate developers or property flippers might succeed in the short term, most real estate buyers should think longer term when buying a primary residence, rental, or other property. Because of the real estate business cycle and the previously mentioned tax benefits, thinking long term is often savvier. The same is true for permanent life insurance, where a long-term investment approach allows time for the tax benefits to outweigh the upfront costs.

A KNOWN INVESTMENT

Most ophthalmologists already use real estate as a significant part of their balance sheet. This is not surprising, as many doctors own a house, and it is often one of their most valuable assets. Some also own second homes, rental properties, and even undeveloped land. Further, many medical practices purchase real estate, rather than renting office space for their practices.

In fact, we have found that it is typical for physicians to have a significant portion of their net worth tied up in real estate, especially when including the value of their home. Many take full advantage of the valuable real estate tax benefits, including interest deductions, property tax write-offs, depreciation benefits, and like-kind exchanges. In this sense, many retina specialists may not need to reconsider real estate as much as they should reassess permanent life insurance as an asset class.

Despite their interest in building tax-favored wealth for retirement, relatively few physicians take advantage of the significant tax benefits offered by cash value life insurance. This is unfortunate, as the tax-free growth of and access to this asset class fits well within a long-term tax diversification strategy for most high-net-worth investors.

CASE STUDY: THE POWER OF CASH VALUE INSURANCE

Let’s look at an example of how a cash value life policy can work as a tax-favored accumulation vehicle, even without the new law’s potential effect. Owen is a 45-year-old ophthalmologist in good health who wants to invest in either a taxable investment account or a cash value life insurance policy for his retirement. Keeping rates of return equal at 6% annually, Owen wants to see what relative advantages the life policy will produce due to its favorable tax treatment.

Let’s assume Owen invests $25,000 per year for 10 years before retirement and then withdraws funds from ages 65 to 84. Let’s also assume Owen’s tax rate on investments is 29.4% (80% from long-term gains and dividends, 20% from short-term gains, plus 6% from state tax).

With these assumptions, if Owen invests in mutual funds on a taxable basis, he will be able to withdraw $27,103 per year after taxes. If he invests in cash value life insurance, he can withdraw $46,416 per year (no taxes on policy withdrawals of basis and loans) and will still have more than $200,000 of life insurance death benefit protection at age 90. This is a substantial difference (assuming the same 6% rate of return) based primarily on the tax treatment of the cash value policy.

FIND A PARTNER

Real estate and cash value life insurance are two everyday asset classes that can be leveraged to optimize your tax and wealth planning. A professional advisor can help retina specialists evaluate these asset classes to see how they fit within their wealth planning.

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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, or as a recommendation of any particular security or strategy. 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.