Personal Finance Primer

Retirement Accounts

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Retirement accounts are a cornerstone of your financial plan in many ways. Not only do you set aside money for retirement, this is tax advantaged money that (assuming you don’t do the Roth option) reduces your taxable income for the year. Retirement accounts also carry the benefits of asset protection, as many retirement accounts are ERISA protected, which means they can't be seized by creditors. 

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Most physicians start off saving for retirement much later than others, given the length of training and the inability to maximize retirement account contributions (or even contribute) with their resident and fellow salaries.  Therefore, as soon as you’re able, most physicians should try and maximize their retirement contributions, especially if there is an employer match (that is free money!). 

 

Signing up to have these automatically withdrawn from your paychecks in regular increment is a good idea, as it ensures a set amount of money is going towards securing your financial future and removes the urge to cut into that budget for discretionary spending. 

Sometimes, physicians are tempted to dip into that money for things like investing in real estate.  As a general rule, we’d advise against that, as it could leave you in a very vulnerable position if the investments go bad. 

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Every physician’s situation is different, and your definition of what retirement means and what it looks like can make a huge difference in your savings goal. Some people fear “over saving” for retirement at the expense of enjoying their lifestyle now.  While ideally you would be able to do both, if you are in this position, figuring out how much you think you’ll need for retirement and then back calculating your needs for retirement contributions may be helpful.

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How much do I need to retire?

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The more expensive your lifestyle, the more money you will need to maintain it once your primary source of income is gone. This is where income diversification can be a huge help. There are, however, general guidelines people tend to use as benchmarks when figuring out how much they need to feel financially stable and able to retire.

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The rule of 4% comes from looking at historical growth rates across a balanced asset portfolio and historical inflation.  The idea is that you can withdraw 4% from your invested assets annually without touching the principle balance, so ideally 4% of your retirement number reflects your projected annual expenditures. This ensures that, on average, you will have enough to live off of. By leaving the principle amount largely untouched, you have it to dip into for emergencies such as unexpected home repairs or long-term care requirements towards the end of you or your spouse’s life.

 

For example, if you have $3 million in assets when you’re ready to retire (careful counting your house here; remember, you have to have somewhere to live), you could withdraw $120,000 a year and live comfortably knowing you will be covered in retirement through death. If you have other income generation through real estate or side gigs you still plan to work during retirement, then you don’t need as much saved up as you will still have income generating outside of withdrawals during your retirement years.

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Traditional versus Roth

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Traditional accounts

Traditional accounts are typically pre-tax investing (although you can do an after-tax traditional IRA to roll into a backdoor Roth IRA). This means the money goes in before you pay taxes on it, which lowers your taxable income and thus your taxes owed. This can be a useful strategy when you are getting close to hitting an increase in your marginal tax rate (learn more here).

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You will be taxed when you take the money out, but the theory is that you will be in a lower tax bracket during retirement. Additionally, while that money is making money and creating dividends and gains, you won’t be taxed on it until you remove the money from the account.  This eliminates the tax drag that you can see in your taxable accounts, as more money is making money. Just note, you will have to pay taxes on all the growth as well.

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There are required minimum distributions (RMDs) on this money when you reach the IRS defined retirement age (this can change year to year but is generally in your 70s).

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Roth accounts

Roth accounts are post-tax investing. This means the money goes in after you’ve paid taxes on it. The benefit to a Roth account is all growth in the account is tax free. You don’t pay taxes when you take money out. Roths also typically have the advantage of not carrying required minimum distributions (RMDs).

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Some Roth investments accounts, such as the Roth IRA, have income cap limits imposed on them by the IRS.

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Roth accounts can be a great tax-shelter account for high growth investments, as all the growth over the decades is tax free. The longer you leave investments in a Roth, the higher potential advantage they have.

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Traditional vs Roth

Choosing between traditional and Roth can be a complicated decision for physicians that may accumulate significant wealth over the course of their careers.  While most people will be in a lower tax bracket in retirement, this isn’t always the case. Because you don’t have a crystal ball to know what your tax rates will be during retirement, it’s impossible to say with certainty when it’s better to be taxed. 

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In general, if you have a low earning year, you may want to take advantage of the Roth option as you will be in a lower tax bracket. Since the entire growth of a Roth is tax free, time in the market also factors into your decision. The younger you are (Roth can be a great investment strategy in your 20s through 30s), the more years your money has to compound in earnings tax free.  When in doubt, many elect to split the money between a Roth and a traditional. 

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Employer Sponsored Plans (401k, 403b, and 457s)

 

Employer match

At a minimum, you should always take advantage of your employer match for retirement accounts as this is free money. Another way to look at it is regardless of the fluctuations in your portfolio’s returns, it is a guaranteed return on your employee contribution. Very few investment products offer that type of guaranteed return.

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How much to contribute

Most would advocate for maxing out your retirement accounts whenever possible, as this is tax advantaged money. Understand that each employer sponsored retirement plan has its own rules, and you should read the plan documents to take maximum advantage. You should make sure you understand the fees and costs associated with managing your 401k as well as the funds available when deciding how to allocate your investing. Some employer plans vastly limit your investment options and can carry significant fees.

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How contributions work

Contributions to an employer or self-employed 401k or related type retirement plan work differently than with IRAs (discussed below). With IRAs, you are able to make lump sum contributions anytime throughout the year (or before you file your taxes, if the account is opened before the end of the tax year you want to contribute for).

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For employment plans, you cannot write a check or deposit funds directly into your 401k plan (self-employment options can be a little different). Contributions to your employer plan are set up through your employer’s HR department or through the 401k plan website and are pulled from each paycheck in the amount you specify.

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Some plans may allow you to make a lump sum contribution in the form of a transfer or rollover from another employer plan or, in some cases, an IRA, but you cannot lump sum fund your 401k yourself.

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You may have an introductory period before you are able to contribute. Sometimes, this period is a few months. Other times, it’s a year (or more)! Make sure you understand the eligibility rules when accepting a new position.

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Not all employers make matching contributions. When they do, it isn’t always a one-for-one match. For example, they might match 0.5% for every 1% of your contributions, up to a 10% limit or up to $10,000.

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The employer may also put a vesting stipulation on their employer contributions. A certain percentage may vest every six months or year into service. If the employer contributions aren’t all vested, the part that hasn’t vested may be forfeited if you leave their employment.

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Traditional and Roth 

Many 401k, 403b, and 457s now offer a Roth option. While any contributions your employer makes are required to be pre-tax into a traditional account, if your employer offers a Roth option, you can contribute to both the traditional and the Roth in any proportion you choose.

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Roth 401ks can be a great option because, unlike Roth IRAs, the IRS does not impose an income cap. Anyone can invest in a Roth 401k, regardless of their income. Having a balance of Roth and traditional funds in retirement can be a great way to balance withdrawals to keep your income taxes low during retirement.

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Individual Retirement Accounts (IRAs)

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Once you’ve taken the maximum match in your employer sponsored program, you may be looking for other retirement options. IRAs are a great option for investing. The IRS knows this, which is why they limit the amount you can invest in an IRA in any given year. For 2023, the contribution limit is $6,500 per individual under 50, $7,500 for individuals 50 and above.

 

IRAs, unlike taxable accounts you may hold at the same company, are individual accounts. If you are married, both you and your spouse are required to have separate accounts in your own individual names.

 

Roth IRAs

You should absolutely max out your regular Roth IRA while you qualify on an income basis if you can (like when you are a resident or fellow; most attending physicians will not). You are likely in the lowest tax bracket you will ever be in during training, and that money will grow tax free for decades.  If it’s at all possible, put it into your budget.  If you receive a signing bonus during the first half of your last year of training, this is a great place to direct it assuming you don’t need it elsewhere.

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Backdoor Roth IRAs

The backdoor IRA is a tax loophole that legally allows high-income earners to contribute to a Roth IRA once they’ve surpassed the income limit for a regular Roth IRA by contributing to a traditional IRA and then converting to the Roth IRA.

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Learn more about Backdoor Roth IRAs here. It’s important to note that the IRS has a pro-rata rule when calculating the tax bill a backdoor Roth creates if you have a mixed of post-tax and pre-tax funds in the traditional IRA you are converting, so make sure you have a financial advisor help you understand the tax implications before setting up your backdoor Roth IRA. Your financial advisor can also help with any paperwork required, including Form 8606 for the IRS.

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You can also do a spousal backdoor Roth IRA if married filing jointly (totally separate ‘individual’ accounts, two 8606s submitted each year to the IRS).

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The spousal rule also applies to traditional and regular Roth IRAs. A nonworking spouse can open an IRA and contribute as well if their spouse works and has an earned income and they file their taxes jointly.

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See this section for more details on individual retirement accounts and self-employed retirement accounts.

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Healthcare Savings Account (HSA)

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As mentioned above, if you’re generally healthy and have low medical expenses, a high-deductible health plan (HDHP) might be a good way to not only save on insurance premiums, but it offers the advantage of a HSA.

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We love the HSA. Why? HSAs have a feature almost no other investment options offer: they are triple-tax free. You are not taxed when you contribute to it, you aren’t taxed on the growth, and you aren’t taxed when you withdraw the funds.