Hey everyone, it’s Finance Fridays again. Today I’m going to talk about “Another Case for a Roth 401k”.
Another Case for a Roth 401k?
Yea. I’ve talked about this a little bit recently. In my opinion, there are only a few select times when a doctor should use a Roth 401k.
The “best time” would be during residency, as I’ve detailed in my prior post series:
Roth 401k/403b in Residency
- Roth 401k/403b in Residency
- Roth 401k/403b in Residency How To
- Roth 401k/403b in Residency Portfolios
- Roth 401k/403b in Residency Analysis
- Roth 401k/403b in Residency Case Report
However, I did a more recent post flushing out my reasoning, which you can find here:
The long and short of that post is that, in my opinion, there is virtually no reason for an attending physician to use a Roth 401k, in terms of efficiency. In a very small subset of people, who ardently believe that taxes will increase to socialist levels, for example, up to 50% or so, then perhaps it might make sense for them. I don’t think that we will see tax rates that high in the United States of America during my lifetime. Also, even we do see tax rates that high, it would probably still be more tax efficient to do a Traditional 401k. The reason for this is that tax rates will likely increase disproportionately for high-earners (physicians). This would mean that if a “normal” tax rate is 50%, high-earners would probably be taxed even higher, at like 65% or something like that.
Long story short, unless something drastically changed, you will almost certainly pay more taxes as an attending than you will in retirement.
Why talk about Roth 401ks again?
Well, I was surprised to here from a colleague that some of their physician friends, who are “good savers” have been using a Roth 401k for the last 10 years. That’s a lot of prepaid taxes. From a retirement standpoint, it’s great that they’ll have essentially zero taxes to pay on their 401k in retirement. However, if you zoom out that means that these individuals paid significantly more every year which could have been used elsewhere. While I do understand the want to “prepay your taxes” and “no taxes in retirement”, I don’t think these people understand how inefficient this is.
If they had saved that money into a taxable account, with just my standard 3 fund portfolio, I think they would have done very well over the last 10 years. I think the problem is that they didn’t understand what it meant to “prepay their taxes”. Never forget about the magic of compound interest. If someone had explained it to them like I just did to you, would they have opted for a Roth 401k instead of a traditional? I doubt it.
Moving on, I thought about it a little more and thought of “another case” for using a Roth 401k. This may sound kind of weird, but bare with me.
Another Case for a Roth 401k
I think another reasonable case for using a Roth 401k over a Traditional 401k is pretty specific. I think it’s better to explain by example.
You’ve done been practicing medicine for 20 years, diligently maxing your Traditional 401k, Backdoor Roth IRA, Taxable Account, and other investments. The kids are all grown up, and are either in college or already graduated. Since you’ve put away some money for them in their 529s, they’re going to be ok. Your student loans have long been paid off. Your house, which was previously a significant liability, now has 20+ years of payments into it, and now it’s a pretty significant asset. In fact, since the kids are gone and it’s just you and your spouse — you’re not really sure you need this 4 bedroom house anymore and maybe it’s time to downsize…
So then you start to think… maybe I can retire early. But if you’re like me, you’re a little cautious. Like I’ve said before, as a physician, you can’t be out of practice for too long before you lose a lot of your knowledge, which makes it very difficult (or impossible) to go back. So maybe you consider dropping down to part-time or just doing locums, kind of a like a transition to retirement.
Here is a great place to utilize a Roth 401k.
By dropping down to part-time or doing locums work, your salary will probably be 40% of what it was as a full time attending. This could be right around (or close to) how how much your taxable income will be in retirement. Maybe you’ve even figured out exactly the taxable income in retirement you would expect and that number is the salary you intend to earn for the year.
This “transition to retirement” is great. You get more free time to figure out what you want to do in retirement, but you also “get use to” how much money you’ll expect in retirement — without actually be retired. Then, you get the added bonus of stockpiling a little extra money into a Roth 401k during this “transition period”. You may find out that you could retire without too much problem, or you may find out you need a few extra years. Or, you may find out that working part-time is pretty great so you push retirement back a little more.
Needing to work versus wanting to work is very different.
Utilizing a Roth 401k here makes sense if you will prepaying the taxes at a lower rate than you expect in retirement, or at least not at your highest rate as a full time attending. That said, you don’t have to. You could still just use a Traditional 401k if you think you still make too much — this is just another potential case for using a Roth 401k. It all depends on you and your plans.
This is part of my plan 15-20 years from now… I want to try this “transition to retirement”. I kind of have the feeling that I already know what I’ll choose though. I’m pretty sure that I’ll just end up staying part time until my pension kicks in at age 60… Don’t quote me on that though, we’ll see. As for my wife, if she wants to retire earlier than me that’s fine. She jokes about wanting to do a “non-medicine job” like a Starbucks barista, or Pilates instructor, or something like that. If she does, I’ll have her use a Roth 401k too.
When we retire, I’ll reference this post and see what actually ends up happening. My money is on my wife becoming a Pilates instructor and me working part-time… but we’ll see.
What do you guys think? What would you do in your “transition to retirement”?
Another Case for the Roth 401k is during a “Transition to Retirement”
Needing to work versus wanting to work is very different.
I think I’ll end up being part-time and my wife will be a Pilates instructor in our “transition to retirement”.
What do you guys think? What would you do in your transition to retirement?
Agree? Disagree? Questions, Comments and Suggestions are welcome.
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