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November 30, 2015

Protecting your future income

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As advisors to young physicians across the country, we are often asked, "What is the most important thing I should be doing financially in the first years of practice?"

Our answer is simple: You need to build a solid foundation. But the application of this concept is different for each physician.

Building your financial foundation

Foundation building for young physicians depends on where they are in their personal lives (single, married, kids, etc.). Also, ideally it begins before you even leave training because, like most things, establishing the right habits is a key to building a financial foundation.

Most young physicians will see a significant increase in their incomes when they begin their practice. Up to this point, they have typically been living paycheck to paycheck, and a jump in income by five-fold or more can be a bit euphoric. With a "spend now and plan later" attitude, many young physicians will indulge a bit and make large purchases. Often taken too far, they find themselves once again living paycheck to paycheck. The attitude then becomes, "Once I make partner in a few years, I’ll address my financial plan."

Though some splurging is in order, we try to get our young clients to focus on getting into the right habits and shielding what they have already built.

Your greatest asset: Your future income

The most important factor in the building of a foundation is to protect what you have already built. For many young physicians with little savings and large student loans, the question is often, "What have I built? I am in severe debt!" The answer is that they have actually built a significant asset that needs protecting: the value of their future income.

Given the significant investment made to become a practicing physician, it should not be surprising that the value of your future income is also significant.

For example, let’s say an orthopedic surgeon is offered a starting salary of $300,000, including benefits. Assuming this physician plans on practicing for 30 years (and 3.5% inflation), the present value of this annual income is more than $5.5 million - even if that physician never makes more than $300,000 per year, including inflation.

Most people would think an asset this valuable is worth protecting.

What is needed to protect this asset? That depends on who they are protecting it for, if it’s for just themselves or for others dependent on them. For either scenario, physicians need to protect their ability to earn this income in the future. That is why disability income insurance is so critical, and is tool number one for young physicians to implement.

Disability insurance

Disability income insurance conceptually is straightforward: If you become disabled, it will pay you. For young physicians (and on into your 50s), this protection is critical because you have not accumulated the savings to support yourself and your family in case you can’t work as a physician.

When looking at purchasing individual disability income insurance, physicians need to determine what their true need is, not how much they can get. If monthly expenses are $3,000 a month, but an insurance salesman says you can get $5,000 a month, you are over-insuring yourself. Though having more coverage than what’s needed is not always wrong, controlling expenses in order to build the proper foundation is more important.

Physicians will also want to make sure they’re purchasing adequate coverage. The definition of disability should be occupation-specific; thus a physician cannot be forced to go back to work in another field. Residual or partial disability rider is another important part of the contract, which in case the physician suffers a partial disability, they can still work part-time in their occupation. Typically there has to be an income loss of 20 percent or greater. Also, in the event of a long-term disability, having a cost-of-living rider as an inflationary protector is important.

Young physicians should also beware of what is available through an employer. The issue with group insurance is that it covers the masses. This can lead to coverage that is not occupation specific, has short benefit periods, does not have a partial or inflation protection rider, and can be canceled at any time. While that is not the case with all hospitals, generally group insurance is not adequate for a young physician.

Often, there are discounts in place that are connected to hospitals that allow young physicians to purchase individual disability income insurance at a lower rate or with unisex rates. The unisex rate option is the most ideal and has the greatest positive impact on female physicians.

Life insurance

Young physicians with financial dependents - typically children or spouses, but sometimes other family members - need to focus on protecting their future income value not only against disability, but also against death. This is why life insurance is tool number two that we typically recommend.

Much like disability income insurance, you need to first determine what your need is from a death benefit perspective to make sure you are being cost efficient. The way to determine your need is to decide what expenses would need to be covered. For example: mortgage, education funding for children, car loans and other debts and income support for spouse.

Young physicians in a position of purchasing life insurance should probably consider term insurance as their best option.

Term insurance is inexpensive and provides a death benefit for a period of time (10, 20, 30 years). This does not mean term insurance is the only or best type of insurance; it is generally best for a young physician who has a specific need. Permanent life insurance can be a very tax efficient saving vehicle that provides tax-free growth and tax-free distributions, if structured properly, and can provide great asset protection depending on the state of residence. For these reasons, permanent (cash value) insurance is often selected even by young physicians as a wealth accumulation and protection vehicle.

At the outset of their medical career, physicians in training are told "first, do no harm." As advisors to young physicians nationwide who are at the outset of their financial careers, we give similar advice: "First, build your foundation."

David B. Mandell, JD, MBA, is a former attorney and author of 10 books for physicians, including For Doctors Only: A Guide to Working Less & Building More, as well a number of state books. He is a principal of the financial consulting firm OJM Group where H. Michael Lewellen, CFP serves as director of financial planning. They can be reached at (877) 656-4362.



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