Let’s face it. As a resident, you have seen your non-medical friends get a financial head start. They entered the real world sooner and started to save for retirement earlier than you have. So what to do? Don’t worry. With some smart decision-making and persistence, you will catch up.
First, you should do a budget and see if you have any money left over to invest for retirement. See what your tolerance for frugality is. It’s good to save money, but sometimes, it’s more important to stay sane during residency by going on a nice trip or eating at a nice place once in while.
In my opinion, your first priority – if you have any money left over – is to pay off high-interest debt if you have any (hopefully you don’t). I don’t mean the 4-5% interest student loan; I mean the 20%+ interest credit card debt. There is very low probability that you are going to make 20% on your investments, and so you are better off paying down the high-interest debt with your spare money. It’s like you are making 20% on your money although it probably won’t feel that way. High interest, compounded, is a scary thing when you are the one owing money.
Next, many financial planners advocate setting aside some sort of an emergency fund. If you get into an accident and can’t work for a few months, you have to have a way of paying the rent, buying groceries, putting gas in your car, etc. If you have parents or a proverbial rich uncle on whom you can fall back, that’s great – they’re your emergency fund. But if not, some sort of an emergency fund is a good idea. Remember, your disability insurance, with all its caveats, won’t kick in for 90 days (elimination period) as we talked about in another post.
Now after you figure out that you have no high-interest debt and that you have some sort of an in-case-of-an-emergency plan, you might think about investing for retirement. But in what?
Let’s take a look at the plan offered by Stanford for its residents – Stanford Hospital and Clinics Tax-Deferred Annuity (TDA). This is a 403(b) retirement plan – much like a 401k plan – available to employees of certain public education organizations, non-profit organizations, and cooperative hospital service organizations. Most retirement saving plans for residents are 403(b)s.
In a plan like Stanford’s 403(b), you make contributions through a salary-reduction agreement (maximum of $17,500 per year as of 2013), and the money grows tax free. At the end of the residency, you rollover your TDA account to an IRA, and the money continues to grow tax free until you start to withdraw from the account. The earliest you can start to withdraw money is at age 59 1/2, but you don’t necessarily have to. This withdrawal is then considered income, and you pay taxes on the withdrawal at your then marginal tax rate. That’s it in a nutshell. You might have the option to do a Roth TDA [or Roth 403 (b)] as a resident, and we’ll look at that in another post.
So should you, as a resident, take part in a 403(b) plan? First, let me say that there is no “matching” done by Stanford on the residents’ behalf. What is matching? In certain retirement plans, an employer contributes a percentage of an employee’s contribution to help with the his/her retirement savings. For example, the Retirement Plan offered to the attending physicians at Stanford matches the first 4% of contribution that they put into the account. That’s free money! In such a plan, one would basically be throwing away free money if he/she don’t contribute at least the amount that would result in a full match by the employer. However, a Stanford resident does not have access to such free money because their 403(b) plan does not match. While this is bad, the good thing is that Stanford residents are not losing out on any free money even if they don’t invest in the 403(b). And as stated before, your first priority should be paying down high-interest debt and having an emergency reserve.
But then, if a 403(b) plan doesn’t match, is it worth participating in as a resident? That’s ultimately up to you, but to make it easier to decide, let’s run some numbers, and think about the advantages and disadvantages.
Probably the biggest advantage of a plan like 403(b) – and also with 401k – is that you get to put pretax money into a tax-sheltered account, allowing your savings to grow tax free while paying less tax. Let me illustrate this in a simple example. Let’s say you make $100/yr and pay 10% in tax annually. At the end of the year, you will have $90 left after tax with no savings. Now let’s say you put 10% of your earnings into a TDA. $10 will go into a tax-sheltered account before you pay your tax, and you will be taxed on $90 and in the end you will have $91 left in total after having paid just $9 in taxes ($10 in a tax-sheltered account and $81 in the bank). By saving in a pretax retirement account, you end up paying less in tax and end up with more money overall. Another advantage of a plan like 403(b) is the salary reduction component: you’re more likely to follow through with your savings plan because the saving is done automatically in the plan through salary reduction.
Sounds all good, right? But what’s the downside? This money you set aside in a tax-sheltered account – with a few exceptions – is not very liquid, meaning you can’t access it until you’re 59 1/2 without paying a 10% penalty to the IRS which makes the whole exercise pointless. So if you think you need this saved money sometime before 59 1/2, it’s probably wise not to put money into it. Also, as a resident, the tax saving is not that great because you’re not in a high marginal tax bracket. Once you become an attending, however, the tax savings matter a lot more because you are in a higher marginal tax bracket, and it becomes more important to contribute to a tax-sheltered retirement plan.
As you can see, there are advantages and disadvantages to the exercise. See what your situation is, and make the right choice for yourself.
Let’s say you do decide to put in the whole $17,500 per year maximum contribution to the TDA. How much money are we potentially looking at by the time you’re around 60 years old? Let’s assume a rate of 5% per year of compounded investment returns. By the end of a three-year residency, you would end up with around $57,000. Now if that money grows at a 5% compounded rate without any further contributions you will have something just short of $200,000 by the time you’re about 60. That’s not a ton of money, but it’s no chump change either.
I know the above discussion was probably a bit convoluted and painful to read. So let’s sum up and list some salient points about investing as a resident.