I know, I know, I know… it’s Medicine Mondays, not Finance Fridays. However, like I alluded to on my prior posts: Spousal IRA and Talking to Med Student Me, this is at least circumferentially related to Medicine Mondays, since it is a very small window of opportunity for which utilizing a Roth carries significant advantages.
Stock Photo from: Pexels
So what is a Roth 401k/403b?
I’ve talked a little about the differences between regular 401k/403bs and their Roth versions on my introductory Finance Friday Post of Talking the Talk. Hopefully, you’ve already read it, or you already know enough about 401k/403bs and their Roth versions.
However, the long and short of it is that 401k/403bs are funded pre-tax and their Roth versions are funded post-tax. In my opinion, it doesn’t really make sense to fund a Roth 401k/403b as an attending physician because you will be pre-paying the taxes while you are in you are highest tax bracket. Your tax bracket in retirement should be lower than your tax bracket as an attending physician. Unless you have a ton of money in a nest-egg to withdraw from and/or large inheritance. In that case, your tax issues would be significantly more complex than what I talk about here and outside the scope of this article.
Now, there are some of advocate for funding your retirement post-tax, or funding half pre-tax and half post-tax. There are some nuances to why, but for all intents and purposes, they are predicated on “guesses” to how taxes will change between now and when you retire. Like I’ve said over and over, I am a simple man and I try to keep things as simple as possible.
So, in general, for physicians, it makes sense to fund your 401k/403b with pre-tax dollars, while your Backdoor Roth IRA is post-tax dollars (because you can’t get the tax benefit to do it pre-tax).
Ok, so what about residency then?
Well, for residency, you are in a whole different ball game. As an intern/resident/fellow, you will likely be making less than 25% of your attending salary. Let’s use the round numbers of $50k/year as a resident and $200k/year as an attending.
Incoming very busy picture with the 2016 tax brackets:
(Click to Enlarge) – Source
So from there you can see the marginal tax brackets:
As a single resident, making $50k, you would pay:
$5183.75 + 25% of every dollar over $37650 = 5183.75 + 3087.50 = $8271.50
As a single attending, making $200k, you would pay:
$46278.75 + 33% of every dollar over $190150 = 46278.75 + 3250.50 = $49529.25
I am oversimplifying this because I am not considering 401k/403b or any tax deductions or other complexities.
Ok, bare with me now.
Essentially, as a resident making $50k you pay ~16.5% in taxes (overall – 8271.50/50000)
Essentially, as an attending making $220k you pay ~24.8% in taxes (overall – 49529.25/200000)
This doesn’t include SSN, ACA, etc, this is just straight up income taxes.
In retirement, you will likely have income which is more than that of a resident and less than that of an attending.
For this reason, it makes sense to utilize a Roth 401k/403b as a resident to pre-pay while you are in your lowest income tax bracket.
Sensei, I’m going to be barely staying afloat as a resident as it is, how much will this really help?
I completely understand. Even more so now that you guys can’t defer or forbear your loans and must start paying them during graduate medical education (GME), all-inclusive of internship, residency and fellowship. However, just give me a chance here:
Let’s say you are able to set aside $100 of your bi-weekly paycheck toward a Roth 403b, starting as an intern. You set this up before you even started your residency, and it was money you never had to use, so you never felt it. You complete your 3+ years of training… where is it now?
Well, $100 every 2 weeks for 52 weeks is $100 x 26 = $2600
Now let’s plug it into our compound interest calculator — $1, $216.67 a month, 3 years, 6% = $8,278.68
I know, I know… that “isn’t much money” in the grand scheme of things when you owe $300k in loans. But:
Take that $8,278.68 from when you finish residency, and let it compound for 35 years until you’re 65 and…
So you put away $7800 over 3 years during residency… and you have ~$63,600 in post-tax dollars for retirement.
Sensei, $63,600 still isn’t that much…
Hmm, what else can I do to convince you… ok let’s say instead your residency is 5 years long.
Now let’s plug it into our compound interest calculator — $1, $216.67 a month, 5 years, 6% = $14,658.01
Let that compound for 35 years and… you get $112,662.74 to use in retirement… once again, post-tax and therefore tax-free.
So you put away $13000 over 5 years during residency… and you have ~$112,000 in post-tax dollars for retirement.
Ok, I think I’m starting to pick up what you’re putting down now.
Ok, let’s say you’ve done all the things I wished I had done to save as much money as possible. You are able to put away $200 every 2 weeks instead of $100.
So $5200 a year instead of $2600, which, to be honest, sounds kind of difficult if you only make $50k… but not impossible.
Now let’s plug it into our compound interest calculator — $1, $433.33 a month, 3 years, 6% = $16,555.78
Let that compound for 35 years and… you get $127,249.16 to use in retirement… once again, post-tax and therefore tax-free.
So you put away $15600 over 3 years during residency… and you have ~$127,000 in post-tax dollars for retirement.
What if you had done this Sensei?
If I had done this, since I had 6 years of GME (internship, residency, fellowship):
Now let’s plug it into our compound interest calculator — $1, $433.33 a month, 6 years, 6% = $36,272.80
Let that compound for 35 years and… I would have $278,795.89 to use in retirement… once again, post-tax and therefore tax-free.
I would have put away $31,200 over 6 years, but it would be ~ $278,000 when I retire. That’s a healthy start to retirement.
You need to keep your eye on the ball, the post-tax money you save earlier is worth a lot later.
Instead, I have a paltry $5k I saved in a regular 403b at the end of my residency because… well.. I didn’t know.
The longer your training is, the more you should try to put away money into a Roth 401k/403b during your training.
Is there any other benefit to contributing to a Roth 401k/403b during my training?
Yes, but it’s kind of invisible.
Like I alluded to in my The Biggest Mistake of Your Life post, it sets the tone for how you view your finances/retirement. You will have made a conscious decision very, very early in your career that retirement is extremely important to you… Before you ever start to “grow slowly into your [attending] money” you will have already developed a very simple lifestyle during residency itself.
I think it will be very easy to grow slowly into your “attending money” if you were able to grow even more slowly into your “GME money”.
Ignorance is bliss. If you never saw the money in the first place, you won’t miss it.
For this reason, I advocate trying to start with a $100 contribution to your Roth 401k/403b when you start your internship paperwork. A few months into your internship, even with this missing $200 a month, you may realize you didn’t need it… and maybe you could put more away, like the $200 I mention above.
What is “the dream” scenario?
The dream scenario is somehow you make enough money to maximize your Roth 401k/403b at $18k for the year, and you do it for all of residency. This would most likely require some form of help from your parents/family/friends to cover your living expenses (like rent) in order to allow this to happen.
However, if you were able to succeed in maximizing a Roth 401k/403b for 3+ years in residency, then here are the numbers:
Now let’s plug it into our compound interest calculator — $1, $1500 month, 3 years, 6% = $57,305.99
Let that compound for 35 years and… you get $440,458.81 to use in retirement… once again, post-tax and therefore tax-free.
Nearly half a million dollars… in post-tax money… for retirement.
For completeness’s sake… and to make myself cry:
In my “dream scenario” of 6 years:
Now let’s plug it into our compound interest calculator — $1, $1500 month, 6 years, 6% = $125,557.15
Let that compound for 35 years and… I’d have $965,043.15 to use in retirement… once again, post-tax and therefore tax-free.
Nearly $1 million… from putting away $108,000 over 6 years.
Learn from my mistakes. Help me help you.
In general, Roth 401k/403bs don’t make sense for physicians, in my opinion.
The major exception is during graduate medical education (GME) where your income (and tax burden) is at its lowest.
Put away as much money as you can into a Roth 401k/403b as a resident. It will help jumpstart your retirement significantly.
A Roth 401k/403b will also set the tone for your priorities in regards to retirement.
When doing your internship paperwork, try to put aside $100 every paycheck into a Roth 401k/403b, if feasible.
If you can somehow manage to maximize your Roth 401k/403b during your graduate medical education (GME) years.. that’s the dream.
What do you guys think?
Did you fund your Roth 401k/403b during your GME years?
If you’re a medical student, do you plan to fund yours?
Agree? Disagree? Questions, Comments and Suggestions are welcome.
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My wife and I are making retirement a priority. We’re just about to finish up her internship year and we’ve got about 7.5k in Roth accounts between the two of us. I’m our stay at home parent (7mo old daughter) while she goes about her resident business, so we have only the one income, but are still able to save 11k/yr to fund both our Roth IRAs. We do have a little higher income right now due to being in the military, so that helps us save more than normal. I’d like to run our numbers as you did to see where we might come out.
She will work for 4 years for the Air Force, then finish her residency afterward. I anticipate 3 or 4 years of residency (still not 100% sure what specialty)
So: 4 years of saving 23.5k/yr (5.5k for my spousal Roth IRA + the full 18k for Roth 401k (due to increase in pay as a flight doc) = 94k
Add to that what we have already saved: 7.5k + 94k = 101.5k
3 years of residency (back to resident pay so just 11k/yr): 33k or 4 year residency: 44k
Total saved: 3yrs residency: 101.5k + 33K = 134.5 4yrs residency: 145.5k
We will be ~ 35 by the time my wife is an attending. So I’ll assume 25 years of compounding to hit age 60.
Compounding total for 3 yrs residency @ 6%: ~600k
Compounding total for 4 yrs residency @ 6%: ~650k
Not too shabby. My favorite part of the exercise is that this amount does not include me going back to work once the little one goes to school, or our savings once we hit attending land, which, if things go according to plan will dwarf our contributions we can currently make. Could we be in a better spot than we are now? Sure. I worked for a couple of years while my wife was in med school and only saved a couple thousand dollars. But I’m sure as heck glad we discovered the concept of financial independence now, rather than 10 years post residency. The best time to start is always now! Thanks for the great post Sensei!
That’s great. I’m actually going to convert my comment into a post for Friday. However, the long and short of it is that your plan is great.
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Thanks for the awesome post! Quick question. Would you recommend a regular 403b for residents on an IBR plan trying to get PSLF down the line? Since this is tax deductible, it would reduce my monthly payments. But I wasn’t sure if in the end it would still be better to just prioritize Roth 403b since I believe the employer match at my institution applies to both.