Non-traditional applicant $$ advice

[anthoncr]

Just a heads-up.

I am a second year MD student passing on a little proven advice regarding financial strategy to pay for school and legally minimize your tax burden.

The idea is to spread out your income earned during your pre-MD years to include the time you are in school. This works exceptionally well if you own a home. This is 100% legal according to my conservative accountant who has done my taxes for the last ten years.

Here's the plan. While you are working and going through the application process MAX OUT YOUR 401k, (currently about $13,000/year). If you are not working and married I think, (check with your tax advisor), your wife can contribute to your IRA, thereby lowering her tax burden. Either way, the idea is to store pre-tax dollars in a retirement fund. Roth IRAs don't count since they are after-tax.

Now, once you start school you can take a distribution from your retirement account. At our school a typical 1098-T is $25,000. This means I can "earn" $25,000 just to get to zero income. It turns out I can take a distribution from my 401k for school and it counts as "earned" income AND I don't pay the 10% penalty. That's $25,000 tax free.

Now the beauty is you still qualify for student loans, since you have zero income, (retirement funds and home values do not affect your student loan eligability).

Disclaimer: I have no vested interest in your financial well-being. I am also not a tax consultant so talk to your advisor before making any decisions about tax burden. I have researched this to the best of my ability and have no reason to believe this is illegal, unethical or just plain wrong.

One other thing: Medical school is even better than I imagined. Please don't get discouraged, medicine needs folks who have had a taste of freedom and nonetheless decided to pursue the caretaking of humanity.

~Tony

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[maxhealth]

Just a heads-up.

Now, once you start school you can take a distribution from your retirement account. At our school a typical 1098-T is $25,000. This means I can "earn" $25,000 just to get to zero income. It turns out I can take a distribution from my 401k for school and it counts as "earned" income AND I don't pay the 10% penalty. That's $25,000 tax free.

~Tony

Tony,

Thanks for the great info. Forgive my financial ignorance, but are you saying that as a med student you can take a distrubution from ALL 401k plans and duck the penalty? Do you still have to pay ~25% income tax on the money or is it TOTALLY tax free? I've been worried about this and didn't realize there was a way around it (obviously haven't talked to a financial planner yet). How do you report the distribution as earned income?? Better yet, who is your tax advisor? Any more info you have would be greatly appreciated. Thanks again.

 

[cfdavid]

Tony,

Wouldn't it be better just to leave your cash in the 401K, letting it earn interest? Then, simply take student loans for all of your financial needs?

Am I missing something?

 

[HunterGatherer]

Tony,

Wouldn't it be better just to leave you cash in the 401K, letting it earn interest? Then, simply take student loans for all of your financial needs?

Am I missing something?

Yeah I thought you should not touch your 401K, not even to buy a house.

 

[anthoncr]

Yeah I thought you should not touch your 401K, not even to buy a house.

The "generic" advice to never touch your 401k funds is in fact, generally, good counsel. Keep in mind that advice is typically reserved for people wo have entered the workforce and plan to stay in it for some time. After five years I left the workforce and started medical school. Remember 401k is all BEFORE tax money. As a student I am in the lowest tax bracket I will ever be in, and given my mortgage payment and tuition costs I have significant write-offs. I chose to take a distribution during school for three key reasons;

1) As an Engineer a significant portion of my income was in the ~30 percentile income tax. "Storing" that money in my 401k for a year or two meant instead of making, say $50,000 in one year of working and $0 the next I essentially earned $25,000 per year. Obviously the graduated system we are subject two in the U.S. results in a much lower overall burden.

2) I wanted to capitalize on the tax benefits of home ownership. I currently pay about $12,000/year in mortgage interest. This means I can "earn" $12,000 a year just to get to "zero" income. Keep in mind the first $15,000 or so you earn after "zero" has a very low tax. Therefore the first $27,000 I earn has an extremely low, if any, legal tax burden.

3) As a physician I will be able to repay my 401k/IRA at a later date and I should be able to nearly maximize it. Additionally, the funds redirected to my 401k at a later date will come directly out of my highest tax bracket.


Lastly-a point was made about not touching it and letting it earn interest. This may work for you, but I prefer a guaranteed savings of several thousand dollars in taxes a year.

And really lastly-your 401k funds are not considered when banks calculate your financial aid eligability. Doing this actually makes you MORE eligable, not less. Your income pre-medical school is lower, and the fact that you put more money into your 401k makes you look "poorer" hence a higher award.

 

[anthoncr]

That is correct, your 1098-T form lists the maximum amount you can withdraw from your 401k without paying ANY penalty, (at our school last years in-state 1098-T was about $25,000). This DOES count as income however, keep in mind the first $15,000 or so you make is at an extremely low rate. Also if you own a home you probably have about $10,000 or so of interest to write off. The result is there is almost no tax burden.

Any tax advisor can help you with this. It is really simple, totally legal, and in my opinion the smart thing to do.

Tony,

Thanks for the great info. Forgive my financial ignorance, but are you saying that as a med student you can take a distrubution from ALL 401k plans and duck the penalty? Do you still have to pay ~25% income tax on the money or is it TOTALLY tax free? I've been worried about this and didn't realize there was a way around it (obviously haven't talked to a financial planner yet). How do you report the distribution as earned income?? Better yet, who is your tax advisor? Any more info you have would be greatly appreciated. Thanks again.

 

[HunterGatherer]

As a student I am in the lowest tax bracket I will ever be in, and given my mortgage payment and tuition costs I have significant write-offs. I chose to take a distribution during school for three key reasons;

What write-offs are you talking about? I know of 2 but will have to figure out which is best when the time comes.

Lastly-a point was made about not touching it and letting it earn interest. This may work for you, but I prefer a guaranteed savings of several thousand dollars in taxes a year.

I'm lost. If you put your money in a 401K and leave it there aren't you doing both?

Aren't IRA accounts your only option if you are self-employed or without a job? I thought 401K accounts could only be had through being employed.

 

[hottie]

If you have roth IRA, this might work well. But, if you have a traditional IRA, you will be paying tax twice on the money you borrowed from your traditional IRA. How? you cannoy tax exempt the money you will use to pay off the amount you borrowed and you pay another tax on the same money when you withdraw it later when you retire.

But if you have a ROTH IRA you will avoid paying the other tax since this is already a taxed money.

The "generic" advice to never touch your 401k funds is in fact, generally, good counsel. Keep in mind that advice is typically reserved for people wo have entered the workforce and plan to stay in it for some time. After five years I left the workforce and started medical school. Remember 401k is all BEFORE tax money. As a student I am in the lowest tax bracket I will ever be in, and given my mortgage payment and tuition costs I have significant write-offs. I chose to take a distribution during school for three key reasons;

1) As an Engineer a significant portion of my income was in the ~30 percentile income tax. "Storing" that money in my 401k for a year or two meant instead of making, say $50,000 in one year of working and $0 the next I essentially earned $25,000 per year. Obviously the graduated system we are subject two in the U.S. results in a much lower overall burden.

2) I wanted to capitalize on the tax benefits of home ownership. I currently pay about $12,000/year in mortgage interest. This means I can "earn" $12,000 a year just to get to "zero" income. Keep in mind the first $15,000 or so you earn after "zero" has a very low tax. Therefore the first $27,000 I earn has an extremely low, if any, legal tax burden.

3) As a physician I will be able to repay my 401k/IRA at a later date and I should be able to nearly maximize it. Additionally, the funds redirected to my 401k at a later date will come directly out of my highest tax bracket.


Lastly-a point was made about not touching it and letting it earn interest. This may work for you, but I prefer a guaranteed savings of several thousand dollars in taxes a year.

And really lastly-your 401k funds are not considered when banks calculate your financial aid eligability. Doing this actually makes you MORE eligable, not less. Your income pre-medical school is lower, and the fact that you put more money into your 401k makes you look "poorer" hence a higher award.

 

[anthoncr]

You are mistaken. An IRA/401k is pre-tax money, contributions are made while you are earning so it comes out of your highest tax bracket.

You are not "borrowing" from you IRA, you are taking a distribution. A distribution is treated like earned income. The 10% penalty is waived since it is for school. Your income tax on the first 15,000 you make in a year is extremely low, (somewhere around 15%).

Therefore, you are not taxed twice, if fact you are not even taxed once. You are sort of taxed one half, if that. Add the tax benefits of home ownership (if applicable) and you pay no tax.

I won't even go into the reasons of why NOT to use Roth IRA money for this, but it is a mistake.

I would encourage any interested parties to print off my postings and show them to your tax advisor. Please stop telling people how their 401ks/IRAs work unless you actually know what you are talking about. As they say, the only thing worse than no information is bad information.

~Tony

If you have roth IRA, this might work well. But, if you have a traditional IRA, you will be paying tax twice on the money you borrowed from your traditional IRA. How? you cannoy tax exempt the money you will use to pay off the amount you borrowed and you pay another tax on the same money when you withdraw it later when you retire.

But if you have a ROTH IRA you will avoid paying the other tax since this is already a taxed money.

 

[magic_drm]

Another option is to roll some of your IRA or 401k into a Roth IRA while in med school. You basically do what the original poster said but take the money and put it in a Roth IRA rather than paying for expenses. Then of course your Roth IRA isn't taxed when you take distributions later.

The "generic" advice to never touch your 401k funds is in fact, generally, good counsel. Keep in mind that advice is typically reserved for people wo have entered the workforce and plan to stay in it for some time. After five years I left the workforce and started medical school. Remember 401k is all BEFORE tax money. As a student I am in the lowest tax bracket I will ever be in, and given my mortgage payment and tuition costs I have significant write-offs. I chose to take a distribution during school for three key reasons;

1) As an Engineer a significant portion of my income was in the ~30 percentile income tax. "Storing" that money in my 401k for a year or two meant instead of making, say $50,000 in one year of working and $0 the next I essentially earned $25,000 per year. Obviously the graduated system we are subject two in the U.S. results in a much lower overall burden.

2) I wanted to capitalize on the tax benefits of home ownership. I currently pay about $12,000/year in mortgage interest. This means I can "earn" $12,000 a year just to get to "zero" income. Keep in mind the first $15,000 or so you earn after "zero" has a very low tax. Therefore the first $27,000 I earn has an extremely low, if any, legal tax burden.

3) As a physician I will be able to repay my 401k/IRA at a later date and I should be able to nearly maximize it. Additionally, the funds redirected to my 401k at a later date will come directly out of my highest tax bracket.


Lastly-a point was made about not touching it and letting it earn interest. This may work for you, but I prefer a guaranteed savings of several thousand dollars in taxes a year.

And really lastly-your 401k funds are not considered when banks calculate your financial aid eligability. Doing this actually makes you MORE eligable, not less. Your income pre-medical school is lower, and the fact that you put more money into your 401k makes you look "poorer" hence a higher award.

 

[CoverMe]

I've actually thought about doing this... it seems like a good way to actually benefit from having ZERO income while in med school.

Cash out money (max allowed) from 401k, no penalties due to it being in school...

then reinvest the money. As it is then considered taxed (having already been taxed... but actually you dodged that one being in poverty), you can put it somewhere to make money.

The advantage to this is, some day, when you're a doctor and making lots of $$, and you're in an astronomical tax bracket, that money will already be taxed... your having "counted coup" on it back in med school. Of course, you're still responsible for taxes on the interest gained, but depending on the amount you're rolling out of your 401, it may be worth it.

best of luck, everyone!

 

[HunterGatherer]

What confuses me is why do traditional IRAs still exist? It seems as if Roth IRAs are superior in every way. Someone explain this beyond the possibility that the traditional IRA was here first.

Thanks!

 

[CoverMe]

I'm certainly no guru, but different IRA's are set up with different laws. For instance, there is a MAXIMUM contribution allowed per annum with the Roth. Which is why many people max out their Roth's and then put money into other IRA's once they've reached that max.

Best of luck.

 

[hottie]

has someone actually tried this?

I thought you can waive the 10% penalty on IRA but not on 401k.