Category: Physician Retirement Planning

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Physician Retirement Planning

Why Everyone Should Have A Roth IRA

Traditional wisdom holds that you should only contribute to a Roth IRA if your income tax rate in retirement will be higher than your current income tax rate. I would argue that everyone should have a Roth IRA as part of a diversified retirement portfolio.

What is a Roth IRA?

With a Roth IRA, you pay income taxes on money you earn today and then put that money in the Roth IRA. That money then grows without you having to pay interest, dividend, or capital gains taxes each year. When you retire, you take that money out to spend in retirement and you do not pay any taxes on the withdrawals. If your taxable income in 2021 is less than $125,000 (filing single) or less than $198,000 (filing jointly), you can contribute money you earned directly to a Roth IRA after paying 2021 taxes on that income. If your taxable income is higher than those limits, you can still contribute to a Roth IRA but you cannot do it directly. Instead, you have to do a “conversion” where you first contribute to a traditional IRA and then convert the money in that traditional IRA into a Roth IRA. This is sometimes called a backdoor Roth IRA. There is a limit to the amount that you can contribute each year: $6,000 if you are under age 50 years old or $7,000 if you are over 50.

Roth IRAs have one additional advantage for retirees – there are no required minimum distributions. For traditional IRAs and other deferred compensations investments, when you reach age 72, you are required to withdraw a certain amount of money from your deferred compensation plan accounts. The percentage of the total of all of your deferred compensation plan accounts that you are required to withdraw will be based on your life expectancy. As an example, a 72-year-old retired married couple with $500,000 in their combined deferred compensation plan accounts would be required to withdraw 4.0% of the value of these accounts ($20,000) in 2021.  On the other hand, an 82-year-old married couple would be required to withdraw 4.3% ($21,500) in 2021. Roth IRAs are exempt from required minimum distributions so those funds can be left alone each year if desired. This can be an advantage if you: (1) want to leave money to your heirs, (2) are saving for a planned large expense in a future year, or (3) believe that you are going to live longer than the IRA life expectancy tables would predict.

The four retirement income buckets

OK, in reality there are a lot more than 4 sources of money that most retirees can draw from, but for most people, retirement income can be divided into four general categories:

  1. Fixed income. This includes annual Social Security benefits, pension income, and annuity income. This is a predictable amount that does not change from one year to the next (although it may increase slightly for annual cost-of-living adjustments). This income will be taxed at your ordinary income tax rate.
  2. Deferred compensation. This includes a long list of retirement savings options including 401(k)s, 403(b)s, 457s, SEPs, RCPs, and 415(m)s. A traditional IRA can also be included in this group if you are able to contribute pre-tax income directly to the IRA – this is the case if you are not covered by another retirement plan at work. You can also contribute to a traditional IRA with pre-tax income if you are covered by another retirement plan at work and your income is < $66,000 (filing single) or < $105,000 (filing jointly). Deferred compensation grows tax-free, so you do not pay any taxes on interest, dividends, or capital gains. When you withdraw money in retirement, the withdrawals will be taxed at your ordinary income tax rate.
  3. Post-tax investments. Although this can include everything from investment real estate properties to investment artwork, for most people, this will be stocks, bonds, and mutual funds. These are investments that you buy with your disposable income after you have paid income tax that year. Each year, you will pay taxes on interest and dividends from these investments (at your ordinary income tax rate that year) and when you sell these investments, you will pay taxes on the difference between the purchase price and the selling price (at your capital gains tax rate).
  4. Roth accounts. Although the most common of these is the Roth IRA, there are also Roth 401(k)s, Roth 403(b)s, and Roth 457s. All of these Roth accounts are similar in that you pay regular income tax on the money the year that you contribute to the account and then pay no taxes on the withdrawals.

Why you need a Roth IRA

There are two ways that a Roth IRA can save you money on taxes. First, if you have disposable income after paying this year’s income tax and you want to invest for retirement, you can either put it in a post-tax investment (for example, by buying shares of a mutual fund) or you can put it in a Roth IRA (either directly or by doing a Roth IRA conversion, depending on your taxable income). If you put it in a post-tax investment, then you are going to be taxed every year on the interest and dividends and then when you withdraw the money in retirement, you are going to be taxed on the capital gains – over the years, that will add up to a lot of taxes. On the other hand, if you put that same money in a Roth IRA, you will never pay any taxes on interest, dividends, or capital gains. Therefore, everyone should maximize contributions to a Roth IRA before putting money in a post-tax investment for retirement purposes.

The second way a Roth IRA can save you money on taxes is by taking advantage of periodic changes in federal income tax rates. As I described in a previous post, income tax brackets are one of the most misunderstood parts of the American tax system. What is important is your effective income tax rate and not your tax bracket. The effective income tax rate will vary widely depending on how the U.S. Congress sets taxes. It is a certainty that tax rates will change every few years, largely depending on which political party is in power. Having a Roth IRA allows you to maintain a consistent annual disposable income in retirement while weathering the ups and downs of income tax rates. To demonstrate this, let’s look at the effective tax rates in 2016 versus 2020.

 

In 2016, the effective federal income tax rate on an a taxable income of $250,000 was 21% or $53,500. In 2020, the same income of $250,000 was taxed at 16% or $40,000. In other words, you would have $13,500 more in disposable income after taxes in 2020 than you did in 2016. In fact, in 2020, you would have to have a disposable income of $430,000 to be taxed at 21% which was the effective tax rate on $250,000 in 2016. Similarly, if your taxable income was $160,000 in 2016, your federal income tax would be 17.5% ($28,000) but in 2020 your federal income tax would be 13% ($20,800), a $7,200 difference in disposable income.

In retirement, during years when the effective income tax rate goes up, you want to draw relatively more money from a Roth IRA and in years when the effective income tax rate goes down, you want to leave the Roth IRA alone and draw more money from your deferred income accounts. By using this strategy, you can maintain a constant disposable income while minimizing income taxes.

It is inevitable that federal income tax rates will go up in some years and down in others during a person’s retirement years. American taxpayers want low taxes but they also want federal services such as Social Security, Medicare, a strong military, investment in transportation & infrastructure, and perhaps in the future even national healthcare. Our political party system results in a see saw effect every few years with pressure to decrease taxes followed several years later by pressure to increase federal services. I would argue that for most people, it is impossible to predict whether their federal income tax rate will be higher or lower in any given year during retirement than it is during the years that they are working. The reality is that over the duration of their retirement years, it will likely be both. Having a Roth IRA allows you to take advantage of these inescapable swings in the effective income tax rate in order to maximize your disposable income.

April 18, 2021

Categories
Physician Retirement Planning

The Ways Physicians Retire

Recently, an older primary care physician in solo practice called me to ask if our hospital would buy his practice when he retires. I’ve seen a lot of physicians retire over the decades and there are several different ways that physicians do it. This post is all about the retirement paths that physicians can take.

First, I did not offer to purchase the physician’s practice. In the past, retiring physicians often sold their practice which meant selling their patient’s paper charts. But, nobody does that anymore. With the availability of electronic medical records, those paper charts are essentially valueless – the medical information is already on-line. There are situations when a physician will purchase office space and equipment from a retiring physician but since most physicians lease office space, this is also becoming quite rare. Also in the past, junior physicians would have to buy into a practice to become a senior partner with the proceeds often becoming severance pay to the senior physicians at retirement. This practice has also nearly disappeared with a industry wide move to hospital-based employment and large multispecialty practice group employment. As a consequence of these changes, physicians no longer have the option of cashing out at retirement. However, this has also opened the door for many other ways for physicians to retire.

Going Cold Turkey

Some physicians one day just stop practicing altogether. This can be a pretty abrupt change in lifestyle for a doctor who has been working 60 hours a week plus taking call. It is like driving your car all day at 70 miles an hour on the highway and then pulling off onto a 15 mile per hour side road. Many doctors who spent years dreaming of a life of nothing but golf or fishing find themselves suddenly unfulfilled and untethered from a time when their skills were valued and needed. This can result in a sudden identity crisis. Some physicians unexpectedly find that what they miss most when no longer in the hospital or the office is the human contact with other doctors, the other healthcare staff, and the patients. Loneliness and isolation can be unanticipated consequences of sudden and complete retirement. Nevertheless, making a complete break from medicine can avoid the day to day reminders of a past life when the physician was valued and needed as can occur when one  gradually slows down medical practice. For many physicians, going cold-turkey in retirement allows one’s legacy to be remembered for being the doctor that they were when they were still at their best rather than for being remembered for the doctor that they used to be.

The Fade Away

Another retirement option for physicians is to slowly cut back, making retirement a more gradual process. The hospitalist or emergency medicine physician can just take fewer and fewer shifts. The family physician can stop taking new patients and reduce the number of days in the office per week. This results in a much less abrupt lifestyle change than retiring cold turkey and allows the physician to remain socially engaged with patients and other healthcare workers. A downside of dialing back is that the physician can become less relevant than those other physicians who are working fulltime – the physician can feel tolerated but less valued than in the past. You are no longer asked to be on key committees or included in key decision-making. Also, the practice of medicine takes practice, just like it takes practice to be a high-performing athlete or musician. There is a risk of losing one’s skills as one becomes increasingly part-time.

Shedding Unwanted Career Baggage

Over time, every physician builds up career baggage. You are put on a committee that you never get off. You pick up an administrative task that never goes away. Toward the end of a doctor’s career, all of that baggage can really weigh you down. For some physicians, retirement means stopping doing these non-patient care duties that they may not really enjoy doing but continuing to see patients. But with continued patient care comes continued patient phone calls, electronic medical record “inbasket” management, paperwork, etc. that will still require daily physician involvement. Nevertheless, this form of retirement can allow the physician to continue to do what he or she really enjoys while shedding unwanted administrative tasks.

Move To The VA

Columbus, Ohio is one of the largest cities in the U.S. without a Veterans Administration hospital. However, we have a very large outpatient VA clinic. Many physicians in Columbus are drawn to the VA clinic in retirement. It is 9-5 Monday through Friday work with no weekends and no call. The patients appreciate you and there are no pressures from insurance companies. You get a set salary and if you are there for at least 5 years, you are eligible for benefits through the Federal Employees Retirement System (FERS). For physicians who have been in a financially-strapped solo practice and unable to save much for retirement, FERS can be very attractive. An active, unrestricted state medical license allows you to practice at a VA anywhere. It may still be full-time work but full-time at a VA clinic is usually less time than full-time in a private practice. In addition to the Veterans Administration health system, there are many other, similar employment jobs available for physicians who still want to practice medicine but want to get rid of some of the headaches of private practice.

Emeritus Status

For physicians in academic medicine, emeritus status can be a great option. You can continue to attend conferences and grand rounds. You often get free parking at the University and access to the library system. You can continue to do research, write papers, and teach. You may even get to have an office somewhere on campus. Typically, emeritus faculty have a considerably lower salary than regular faculty (or no salary at all) but also have the freedom to “just say no” to pretty much anything they don’t want to do. In many universities, emeritus status physicians can still see patients, but often for a time-limited number of years after retirement. Emeritus programs can be a win-win for both the physician and the university. The physician can remain engaged with teaching, research, mentoring, or clinical care in a part-time basis. The university gets an experienced faculty member to contribute the university’s mission at little or no cost.

Volunteer Medicine

For physicians who retire financially secure, volunteering can allow the physician to continue to utilize their skills for the benefit of society. An advantage of volunteering is that the physician can decide what to volunteer for, when to volunteer, and how much to volunteer. Locally, this can be at various free clinics or on health department boards. It can be on medical missions abroad or at a Red Cross blood center. However, just because you are not getting paid does not mean that you cannot be sued so be sure that you check into medical licensure requirements and the need for medical malpractice insurance.

Locum Tenens

As a locum tenens physician, you agree to provide temporary coverage of a practice for a defined amount of time. This often happens when a physician has to leave the practice for a period due to pregnancy, illness, military reserve requirements, etc. Sometimes it is because someone left the practice and that physician’s replacement will not finish residency for several more months. Or for whatever reason, there are more patients than doctors at a location. Locum tenens jobs often come with a per diem allowance for housing and food. They may also pay for your transportation to/from the practice location as well as your malpractice insurance. The downside is that the physician may have to apply for a medical license in a new state and travel may require absence from family and friends at home. It can also be difficult to get oriented to a new electronic medical record, practice model, and medication formulary. However, locum tenens is often a good option for the physician who wants to work for a few weeks or months a year and doesn’t mind having to travel to do it.

Consulting

This is a pretty broad area and can include working as an advisor to businesses or governments, providing expert opinion to attorneys or insurance companies, surveying hospitals for accreditation organizations, and providing editing or reviewing services for media. The physician can utilize the knowledge and analytic skills that she or he has garnered over the years. It can provide at least a modest stream of income with part-time work and that work can often be done from one’s own home. Even a relatively small amount of consulting income can provide an opportunity for schedule C income tax deduction for expenses such as medical licenses and subscriptions.

Do Something Completely Different

Many physicians sent most of their career dreaming about how they would like to start a winery, or open a restaurant, or create a bed and breakfast. Physicians who have saved well during their medical careers may have a substantial sum saved up that can form the capital investment necessary to start their own business. But many of these ventures can end up being another full-time job with long hours and the pressures of employee management, sales, marketing, and accounting. The harsh realities of being a boutique entrepreneur can turn those dreams into a small business nightmare.

For some financially secure physicians, a carefully planned second career after medicine can provide a way to stay engaged with other people and work days that are free of the weighty demands of managing chronic disease, nights on call, and mountains of paperwork. But the old adage “The grass is always greener on the other side of the fence” can often hold true for physicians starting a second career.

Social Media

Currently, there are 689 million TicTok users, 600 million blogs (including this one!), 340 million Twitter users, and 1.75 million podcasts. Add in webcasts and YouTube accounts and the number of social media users exceeds 1 billion. Launching a social media site can be attractive to the retired physician because content can be recorded whenever there is some free time in the week with no worries about deadlines. And the material can be about anything from medicine to public policy to hobbies.

On average, physicians plan to retire about 5 years later than the average American, at age 68 versus age 63. There are several reasons for this later retirement age, perhaps most importantly that physicians have a long training period and most do not actually enter the medical workforce until after age 30, many years later than the typical American. The retirement choice that each physician makes will depend on one’s physical health and financial health as well as one’s individual wants and needs. But the possibilities can be endless…

March 28, 2021

Categories
Physician Finances Physician Retirement Planning

The 15 Commandments of Physician Financial Health

For physicians completing residency or fellowship, managing finances can be bewildering when that first paycheck as a practicing physician comes in. There was no class in personal finance in medical school. So, here is a short course on the basics of financial health: 15 rules to live by.

1. Have an emergency fund

This is the very first thing that a newly practicing physician (or anyone, for that matter) needs to do to ensure financial safety. No event in generations has made this more clear than the COVID-19 pandemic which brought unemployment rates higher than any time since the Great Depression.

But unemployment comes in cycles and it is certain that there will be 2-3 additional spikes in U.S. unemployment during your working career. Although physicians were relatively immune to the 2020 COVID-associated unemployment spike, it is common to suddenly find oneself out of a job if the hospital terminates the contract with your practice group, the hospital closes, or a hurricane destroys your hospital. Although physicians can usually find a new job somewhere, it can take several months to process a hospital application or obtain a medical license in a different state. You need a minimum of 3 months-worth of expenses and preferably 6 months-worth in a safe investment (checking account, savings account, or money market account).

2. Eliminate excessive debt

A newly trained physician has a lot of pent up consumption. The roommate that you graduated from college with 7-8 years ago drives a new BMW, vacations in the Turks and Caicos, and just joined a country club. Meanwhile, you’ve been driving a 15-year-old Chevy that was handed down from your aunt, your only vacation last year was to visit your in-laws in New Jersey, and fine dining involves a Domino’s pizza. You want to catch up and that first paycheck is going to be more than you made in the past 4 months of residency. You will be tempted to max out your credit cards in anticipation of that paycheck and you’ll be tempted to put that first paycheck towards a new house/car/vacation. There will come a time for expensive purchases but have patience and do not take on excess debt, especially early in your career. If you cannot pay off your credit cards every month, then you are buying too much stuff. Too high of a monthly mortgage payment or car loan will financially suffocate you for years to come.

3. Buy insurance judiciously

Everyone needs health insurance and most people need some other type of insurance. When you are first starting out in your career, you will have lots of people trying to sell you things, especially insurance policies. But be careful and only buy the insurance that you actually need:

  • Life insurance. This comes in 2 main types: term and whole life. When you buy life insurance, you are making a bet with the insurance company – you’re betting that you are going to die when you are young and the insurance company is betting that you are going to die when you are old. Term life insurance is relatively inexpensive and straight forward: you pay the insurance company a set amount each month and the insurance company pays your beneficiaries if you die while your policy is active. Whole life is a lot more complicated and considerably more expensive – it is the marriage between term life insurance and a savings account and that marriage cost you much more than the individual cost of the insurance plan and the savings plan individually. The insurance agent will try to sell you on whole life in order to put his or her children through college. My advice is that term life insurance is necessary when you have young children or a spouse who does not work – once you are close to retirement, you no longer really need it. Avoid whole life insurance.
  • Disability insurance. Every physician should have disability insurance until they retire. Unlike life insurance which is there to support your dependents if you die prematurely, disability insurance is there to support both you and your dependents if you become disabled. After you retire, you no longer need it.
  • Umbrella insurance. Once you become a practicing physician, you will have a big red bull’s eye on your back that every plaintiff attorney in the country can see. They know that you don’t bother to sue a person at fault who is broke, you sue the person who has money… and physicians have money. If you or a family member are involved in a motor vehicle accident with injuries or if a pedestrian falls and breaks their neck on your sidewalk, you need excess coverage. Buy a $1 million policy.
  • Annuities. These are the opposite of life insurance and can be considered as death insurance: You are placing a bet with the insurance company that you are going to live a long time and the insurance company is betting that you are going to die soon. However, this is really what a pension is – a way to insure that you still have an annual income if you live longer than you expected to. So, buying a simple annuity is a lot like purchasing a pension. The problem is that annuities can be extremely expensive and insurance companies often dress them up with all kinds of extra features that you don’t really need (and most people don’t understand). Insurance agents make a bunch of money on annuities, so they will push them very hard. They still might be worth it for people with a relatively lower income. For high-income physicians, avoid them – your regular investments will be substantial enough to buffer your retirement and will be much less expensive than an annuity.

4. Start saving for retirement early

The secret to building a sizable retirement fund is compound interest. It is true investment magic. Over the past 50 years, the U.S. stock market has averaged an annual 10.9% rate of return. So, lets assume that after expenses, you get a 10% annual return. If you invest $36,000 into your retirement fund today, how much will you have in 35 years when you retire?

Compound interest is the secret to turning $36,000 into $1,012,000 for your retirement. Therefore, the earlier you can start saving for investment, the less burdensome investing will be – even a small amount of investment early in one’s career can make a huge difference. But most people do not just contribute to their retirement account in 1 year, most people contribute something to their 401(k), 403(b), 457, IRA, or SEP every year. Once again, compound interest is magic:

5. Use 529 plans for your kid’s college savings

College is expensive and it keeps getting more expensive, faster than normal inflation. For most families, college will be the largest expense they will have after their house. One of the challenges is that unlike retirement, where you have 35 years for compound interest to create wealth, you only have 18 years from the birth of your child until that child has college expenses. Therefore, it is essential that you start saving as early as possible, preferably the year the child is born. There are a number of investment options to save for your child’s education but none are better than the 529 plans. Their advantage? The investment grows tax-free and then when you take the money out for educational expenses, you don’t have to pay any taxes on the withdrawals. Furthermore, you can usually deduct contributions from your state income tax – in Ohio, you can deduct up to $4,000 per year of contributions into each child’s 529 plan. No other college savings investment comes close to these tax advantages of the 529 plans.

When our first child was born in 1988, our goal was to have enough saved up to pay for 4 years of a public university in Ohio by the time that child was a senior in college. So, we put $5,000 into a college fund the year she was born and then had $100 automatically transferred from my checking account into the college fund each month. For our children born later, we increased the monthly transfer a bit to allow for inflation. By the time each of them was in college, their college funds had enough to pay for a public university.

But 1988 was 33 years ago and college will cost a lot more 18 years from now. So, to pay tuition, room, and board for a public university in Ohio in 18 years (estimated at $255,000), you would have to start with $15,000 initial investment and additionally save $250 per month. If your goal is for your child to go to a private university, for example, the University of Notre Dame, you’re going to need $764,000. That means that you’ll need to start off with $15,000 initial contribution and add $1,000 per month.

6. Don’t pay someone else to invest your money

Physicians finishing residency or fellowship are inundated with letters from financial advisors who want you to become their client. They will invite you to free financial planning seminars, they will take you out to nice dinners, they drive nice cars, and they have really nice offices. They make a living off of other people’s money. I will argue that physicians are smart enough to do their own investing, at least early in their careers and you are better off putting a little more money into your retirement account than into a financial advisor’s fees. But this is contingent on taking enough time to learn about investing and financial intelligence. 10 hours of homework can save you thousands of dollars in the long run.

7. Choose retirement investments strategically

Your choice of what type of retirement accounts to invest in today should be guided by what you believe your effective tax rate will be in retirement. In general, income tax rates will be lowest during residency and fellowship, will gradually increase over the course of a physician’s practice career, and then will fall again after retirement. The strategy is to pay income taxes at a time in your career when you have the lowest effective income tax rate. Therefore you need to know which taxes you pay in the distribution year (when you withdraw the money) versus the contribution year (when you earned the money).

When a physician is a resident or fellow (and thus having a relatively low income tax rate), a Roth IRA is the most tax-advantaged retirement investment. This can be as direct contribution to a Roth IRA if one’s income is below the Roth contribution threshold set by the IRS. Alternatively, it can be as a post-tax contribution to a traditional IRA that is then converted to a Roth IRA if one’s income exceeds the Roth contribution threshold (the “backdoor Roth”). The income tax-advantaged time to contribute pre-tax investments (403(b), 401(k), 457, and SEP) is during a physician’s practice years when their income tax rate is relatively high. During these earning years, the following is my recommendation for prioritizing retirement contributions:

  1. Matched 401(k) or matched 403(b). Never turn down free money and if your employer is going to match your contributions with free money, take it!
  2. 457. This type of retirement account is offered through government agencies/institutions. The advantage of the 457 over the 403(b) and 401(k) is that if you retire before age 59 1/2, you cannot take money out of the 403(b) or 401(k) but you can take money out of the 457.
  3. Non-matched 401(k) or 403(b). The 401(k) is offered by for-profit companies and the 403(b) is by non-profit companies.
  4. Simplified employee pension plan (SEP). Use this if you have self-employment income, for example, honoraria and expert witness income.
  5. “Backdoor” Roth IRA. Use this after you have maximized contributions to the above retirement options.
  6. Regular investments. You will pay regular income tax on the annual interest and dividends. You will pay capital gains tax when you sell stocks, bonds, or mutual funds on the accrued value of those investments (selling price minus purchase price). Most physicians will be in the same capital gains tax bracket when working and when retired (15%) So there is no tax advantage of selling these when working versus when retired.
  7. AVOID TRADITIONAL IRAs. Except during residency and fellowship, nearly all physicians will have a taxable income that will exceed the threshold set by the IRS for pre-tax contribution to a traditional IRA. Therefore, traditional IRA contributions will be post-tax contributions. The problem is that when you take money out of a traditional IRA in retirement, you will pay regular income tax and that tax rate will be higher than the capital gains rate that you would be paying if you had instead put that money in a regular investment.

8. Your first mutual fund should be a no-load index fund

Your most powerful tool in investing is the magic of compound interest. However, annual expenses of a mutual fund can erode those benefits of compound interest. For example, lets assume you invest $100,000 for 20 years with an 8% annual return. Fund A has an expense ratio of 0.21% and fund B has an expense ratio of 1.15%. At the end of those 20 years, the total cost of fund A will be $19,190 and the cost of fund B will be $96,260. That is a $77,070 difference! Index funds have annual expenses that average about one-eighth those of actively managed funds. In addition, if you have to pay a front-load (commission) when you purchase the mutual fund, then you not only pay the cost of that commission but you also lose all of the compound interest wealth that you could have obtained had that money stayed in your account. Some people would argue that it is acceptable to pay a commission or a higher annual expense for an actively managed mutual fund because the professional fund manager can pick stocks and bonds that are more likely to increase in value. The problem is that more often than not, this just is not true – index funds actually out-perform actively managed funds. The following graph shows the annual return over the past decade for U.S. index funds versus actively managed funds. The only area where actively managed funds out-performed index funds was in corporate bond funds. Data from the previous decade looked exactly the same.

9. Don’t buy individual stocks

If professional stock analysts who run actively managed mutual funds do not perform as well as the index, why would an amateur expect to pick stocks any better? In an analysis of the Russell 3000 index between 1983-2008, only 36% of individual stocks performed better than the Russell 3000. By purchasing an index fund, you are purchasing a small piece of dozens, hundreds, or thousands of individual stocks thus spreading out your risk. Only purchase individual stocks for entertainment purposes with money left over after you contribute to your investment accounts.

10. Timing the market doesn’t work

There is an old adage that “Time in the market beats timing the market”. If the professional mutual fund managers do not have a crystal ball to predict when the stock market is going to rise and fall, then neither do you. Lets say you invested $10,000 in a broad stock index fund in 1990. If you did not touch that money and left it alone, by 2020, you would have $172,730. However, if you were taking money in and out of your investment trying to optimally time the market and you happened to miss out on the 10 single best days in the stock market over that 30-year period, you would only have $86,203. No one can predict that the next day is going to be one of the best (or worst) days of the stock market. Day trading is for entertainment but not for investment. That being said, I do have one character flaw when it comes to investing: when the stock market falls by 5%, I invest a little in stock index funds; when it falls by 10%, I invest a bit more; and when it falls by 20%, I invest as much as I can afford.

11. If you don’t understand it, don’t buy it

This applies to any type of investment. If you don’t know what a company manufactures, don’t buy stock in that company. If you can’t figure out how an annuity works, don’t buy it. And if you have heard of Bitcoin but don’t really understand how it works or how it is made, don’t buy it.

12. Know your investment horizon

Over time, stocks outperform bonds. However, in the short-run, stock prices are much more labile than bond prices. So, if you anticipate that you will need money in 3 years, say for a down payment on a house, don’t put that money in stocks. Instead put that money in a less volatile investment such as a bond fund or a certificate of deposit. On the other hand, you are saving for your planned retirement in 30 years, your money should be primarily in stocks because you can ride-out the year-to-year volatility of the stock market over a 30-year time period in order to achieve the higher long-term yields.

13. Diversify

Just like diversifying your stock portfolio by buying an index fund provides greater financial stability than buying individual stocks, diversifying your entire investment portfolio creates greater investment stability. Early in your career, this means having a retirement portfolio that is composed mostly of stock index funds and then later in your career, increasing the percentage of bond and real estate funds. In an ideal world, a diversified retirement portfolio would include a pension, a 401(k)/403(b)/457, a Roth IRA, and individual investments.

14. Pay off student loans strategically

The average U.S. medical student graduates owing $200,000 for medical school and an additional $25,000 from undergraduate college. The monthly loan repayment is around $350/month during residency and then balloons up to around $2,000/month after residency. So how should a newly trained physician approach having a staggering $225,000 debt on the first day of their career? First and foremost, always pay off monthly loan payments on time – the penalties for late payment are severe. However, if you have money left over at the end of the year, should you try to pay off the student loan early or put the money into a pre-tax retirement investment? Although it is laudable to strive to be debt-free, it is better to be debt-smart. The first $2,500 of student loan interest is tax-deductible which has the net effect of reducing the net interest rate that you actually pay each year. If you do the math, you come out ahead if you put that extra money in a 401(k)/403(b)/457/SEP rather than try to pay off the loan early. The bottom line is don’t postpone retirement investment by trying to pay off the student loan too quickly.

15. You are your finances best friend and worst enemy

When it comes to investment, a little knowledge is dangerous but a lot of knowledge provides security. I’ve seen many smart physicians who spent thousands of hours training to care for the health of their patients but less than 2 hours training to care for their own financial health. I’ve seen physicians put all of their retirement investments in money market funds rather than stock funds because they were afraid of risk, even when retirement was 25 years in the future. I’ve seen physicians invest heavily in an individual stock based on a “tip” from a golf buddy, stock broker, or family member. I’ve seen world famous physicians having to live frugally in retirement because they couldn’t conceive of a day that they would not be practicing medicine during their careers and so they never saved for retirement. I’ve seen physicians sell off most of their investments in 2009 when the great recession hit and then do it again in March 2020 when the COVID-19 pandemic hit because they thought that the end of the financial world was coming.

Investment, and particularly investment for retirement, is a marathon and not a series of sprints. Develop a plan for the long-term and then stick with that plan during short-term rises and falls in the marketplaces. It is OK to periodically re-balance your portfolio and to modify your investment plan as you get older and as your financial situation changes but those modifications should be based on long-term goals and not short-term fears. There is a difference between gambling and investments. Gambling is a series of short-term expenditures but you know that over the long-term, the house is always going to beat you. Investment is a series of short-term expenditures but you know that over the long-term, you are always going to come out ahead.

March 11, 2021

Categories
Physician Retirement Planning

Strategies For Asset Allocation In Your Retirement Accounts

In the past, I mainly advised new physicians in our department about retirement investment options at our university. More recently, my children have asked advice about their retirement planning. After you have made the decision about how much money you can invest in your retirement accounts, how do you go about deciding on what kind of investments to direct that money into? A few years ago, one of the wisest physicians at our university had recently retired and lamented to me that every year he had dutifully contributed the maximum he was allowed to his 403b plan but that he had allocated all of it to a very low interest money market fund and consequently, the value of his 403b was not enough to cover his expenses in retirement. Successful retirement planning means getting the right investment allocation in your retirement accounts and that allocation will vary depending on the type of account and your age.

The 4 Types of Retirement Accounts

There are many different types of retirement plans and all of the various plan numbers and names can be overwhelming at times. The plans you have access to will depend on your employer. For example, if you work for a for-profit company, you may have access to a 401k. For a non-profit company, it may be a 403b. And for a government agency, it may be a 457. Your employer may or may not provide a pension plan. However, all of the retirement investments can be divided up into four general categories:

  1. Roth accounts (including the Roth IRA, Roth 401k, and Roth 403b). These are investment accounts that you purchase after paying income taxes. They grow tax-free and when you take money out of them in retirement, you do not have to pay tax on the withdrawals.
  2. Deferred compensation accounts (including the traditional IRA, SEP IRA, 401k, 403b, and 457). These are investments that you direct pre-tax income into. The investments grow tax-free but when you take the money out in retirement, you pay regular income taxes on the withdrawals, based on whatever your income tax bracket is the year you withdraw the money.
  3. Post-tax accounts. These are investments that you purchase with money that you have already paid income tax on and are not subject to withdrawal rules in retirement. These can be broken down into financial investments (such as savings accounts or shares of stocks) and non-financial investments (such as artwork or real estate properties). For the purposes of this post, I am only going to consider the financial investments. The tax you pay on these investments depends on the type of investment: interest is taxed as regular income, dividends are usually taxed as capital gains but some types of dividends are taxed as regular income, and investment appreciation is taxed as capital gains.
  4. Defined benefit plans. These include pensions and social security. They generally give you a fixed income every month for as long as you live and you pay regular income tax on the monthly payments. Nearly every American has some form of a defined benefit plan since most Americans are eligible for Social Security. However the amount that each person gets from their defined benefit plans can vary widely – Social Security will pay out a relatively small amount where as a pension may pay out a very large amount each year. An annuity works similarly, with a portion of the fixed monthly payments being subject to regular income tax. The specific investments in most defined benefit pension plans and annuities are chosen by the company or institution that administers the pension or annuity so the individual investor does not have a choice of how the funds in the pension or annuity are invested.

Roth Account Allocations

Not all Roth accounts are the same. For example, the Roth IRA is not subject to required minimum distributions at age 72 (the IRS requires you to take a certain amount out of a regular IRA, 401k, 403b, or 457 each year after age 72). However, the Roth 401k and Roth 403b do have required minimum distributions after age 72. You can get around this by rolling your Roth 401k or Roth 403b over into a Roth IRA. Because the Roth IRA is not subject to required minimum distributions, many people will not start taking withdrawals from their Roth IRAs until well after age 72. For this reason, the investment horizon for your Roth IRA should be further in the future than the investment horizon for your deferred compensation accounts. The result is that your investment allocation will be different for your Roth IRA than for your other accounts. Strategies for your Roth IRA include:

  • A higher percentage of equities. Because your investment horizon is longer for the Roth account, you can and should invest in more higher risk stocks rather than lower risk bonds compared to the investment mix in your other retirement accounts.
  • No tax-free investments. Certain types of investments grow tax free, mainly municipal bonds. These generally pay lower interest rates than other bonds but the interest is not taxed. Since you do not have to pay income tax on Roth account withdrawals anyway, there is no advantage to investing in tax-free bonds, only the disadvantage of getting lower interest rates.
  • No cash investments. Cash investments include money in your checking account, savings account, or money market account. Although not exactly cash, I would also lump short-term certificates of deposit into this category. The main cash investment that most people will have access to in a Roth account is a money market fund. Because money market funds pay very low interest rates, you really lose the tax advantages of the Roth account by putting Roth money into a money market.
  • Use your Roth account to re-balance. Periodically, you should re-balance your retirement investments to be sure that you are maintaining a desired percentage of stock and bonds. You do not incur capital gains tax when you sell shares of mutual funds within your Roth account in order to exchange those shares for a different mutual fund. However, when re-balancing, remember that your Roth account should be more heavily weighted to stocks than your deferred compensation accounts. Also, be aware that you may be charged administrative fees every time you sell or exchange shares of mutual funds so do not get carried away and be exchanging shares too frequently.

Deferred Compensation Account Allocations

For many people, the majority of their retirement investments will be in a deferred compensation fund: 401k, 403b, 457, or traditional IRA. You do not pay any tax on these accounts until you withdraw money in retirement. Then, you pay regular income tax on the withdrawals. At age 72, the required minimum distribution rules come into play, meaning that the IRS requires you to withdraw a certain percentage from your deferred compensation accounts every year.

  • Get the right mix of stock and bonds. The first issue to be addressed is what ratio of stocks to bonds should you have. There is not a one-size-fits all answer to that question and the ratio will depend on your age, how long you plan to work, and how much in defined benefits you can expect. As a starting point, the percentage of stocks in your account should be 120 minus your age. Next adjust that percentage upward if you plan on a later retirement age or downward if you plan to retire early. Then adjust the percentage upward if you have relatively more defined benefit income in retirement, for example, a large pension. I am 62 years old, so using the equation, I should have 58% of my retirement investments in stocks; however, I will have a pension from our State Teacher’s Retirement System so I have adjusted that percentage upward to 66% in my deferred compensation accounts.
  • Be more conservative than you are in your Roth account. Because of the required minimum distributions starting at age 72, most people will start to withdraw from their defined benefit account several years before withdrawing from their Roth account. By spending down your deferred compensation amount, you can avoid being pushed into a higher tax bracket at age 72 when you may be required to take more out of your deferred compensation account than you actually need to meet your annual expenses.  Because of this shorter withdrawal horizon, you should have a lower percentage of stocks in your deferred compensation account than you do in your Roth account.
  • No tax-free investments. Similar to a Roth account, you should avoid tax-free municipal bonds in your deferred compensation plan since you will not realize any tax advance from the interest in a deferred compensation account and you will get a lower return on your investment.
  • No cash investments. Similar to a Roth account, you should avoid cash investments such as money markets in your deferred compensation accounts, at least until you reach retirement.
  • Use your deferred compensation account to re-balance. Similar to a Roth account, you will not pay capital gains tax every time you exchange one mutual fund for another within your deferred compensation account. But again, be aware of administrative fees charged when you sell or exchange shares of mutual funds within your deferred compensation account.
  • Chose funds with low expense ratios. Small differences in the expense ratio for different mutual funds can translate to big differences in total costs. Let’s take a mutual fund with an expense ratio of 0.75% – it seems like such a small number on the surface – less that one percent. But if you have $500,000 in your deferred compensation fund, you will pay $3,750 each year in expense fees. On the other hand, the same amount of money in a mutual fund with an expense ratio of 0.05% will result in only $250 annual expenses. In other words, you would be spending $3,500 more each year to be invested in the mutual fund with the higher expense ratio. As a general rule, index funds will have lower expense ratios than actively managed funds.
  • Are balanced mutual funds right for you? The default investment in many deferred compensation accounts will be an age-adjusted balanced fund such as a “Retire in 2035” fund. These will have a mix of stock and bonds, both domestic and foreign, with the mix pre-determined by the investment company based on one’s age. As you get older, the investment company automatically re-balances the components with thin these funds based on what is appropriate for your age. For investment novices, these are a great choice (which is why they are often the default investment) but they tend to be 2-3 times more expensive than their component index funds if you were to select the individual index funds yourself. Also, the balance of stocks and bonds in these funds may not be optimal for you if you have additional retirement investments in Roth accounts and post-tax accounts. And if you have a sizable pension, the balanced funds may be inappropriately conservative for your overall portfolio.

Post-Tax Account Allocations

The amount that you can save each year in a 401k, 403b, or 457 plan is limited. For most people, and especially for physicians with relatively high incomes, those deferred compensation accounts will not be enough to fund retirement. Anyone can supplement these by contributing to a post-tax traditional IRA (and then promptly converting it to a Roth IRA) and some people can contribute to both a 403b and a 457 each year (for example, employees of state-supported universities). However, when you maximize your annual contributions to these investments, you will probably still need to add more money into your retirement investments. This usually comes from the income that you have already paid regular income tax on, which I will call post-tax accounts. These accounts are not subject to the same IRS regulations that deferred compensation accounts and Roth accounts are but they have very different tax implications that can affect your asset allocations within them.

  • Here is where you should keep your cash investments. The whole purpose of having cash in your retirement portfolio is to be able to weather downturns in the stock market. In addition, you need to have 3-6 months of cash in an emergency fund in case you lose your job. In both situations, you want to have immediate access to money without withdrawal penalties. This is the where you should have your money market account.
  • This is the place for tax-free investments. Tax-free municipal bonds are not for everyone. The interest is considerably lower than for non-tax-free bonds and the tax advantages are primarily for the very wealthy. But for some people, having a portion of their retirement investments in tax-free bonds can be an important part of a balanced investment portfolio that will allow the retiree to strategically withdraw money from different funds in order to optimize their tax bracket. If you do chose to invest in tax-free bonds, they should be in your post-tax accounts where you can take advantage of the tax-free interest benefits.
  • Minimize re-balancing. Whenever you sell a stock, bond, or mutual fund, you will have to pay capital gains tax on the appreciated value of that investment. If you purchase $1,000 worth of a mutual fund and then sell it a year later for $1,120, then you have to pay capital gains tax on the $120 of appreciated value. The capital gains tax rate varies, depending on your annual taxable income. For married couples filing jointly, their capital gains tax rate is: 0% if making < $78,750; 15% if making $78,751 – $488,850; or 20% if making > $488,850/year. Therefore, if your joint taxable income is < $78,750, you do not pay any capital gains tax so you can sell or exchange your mutual funds all you want and you do not have to pay tax on the appreciated value. On the other hand, if your joint taxable income if > $488,850, then you will be paying the higher capital gains tax rate of 20% and you are better off holding on that investment until you are in retirement and may have a lower taxable income. One caveat to this is during periods when the stock market declines, such as the 2009 recession or the March 2020 COVID-19 market crash, re-balancing post-tax accounts will incur less capital gains tax since there will be relatively little appreciated value of the funds at that time.

My personal philosophy is that everyone should have retirement investments in each of these 4 types of accounts in order to reap the rewards of a fully diversified investment portfolio. Because each of these accounts has different tax implications, the ideal mix of investments in each type of account is going to be different. Begin planning those allocations as soon as you start to save for retirement.

October 12, 2020

Categories
Medical Economics Physician Retirement Planning

Age Of Physicians By Specialty

At this month’s American Thoracic Society meeting, it was reported that 1/3 of practicing pediatric pulmonologists in the United States are over age 60, a scary number since that indicates we are soon facing shortages of pediatric pulmonologists. It turns out that it is not the only specialty with disproportionately older physicians and these statistics have implications for our future physician workforce. In the U.S., air traffic controllers have a mandatory retirement age of 56 years-old, national park rangers are 57, military officers are 64, and pilots have a mandatory retirement age of 65. In the Roman Catholic Church, priests have a mandatory retirement age of 70. There is no mandatory retirement age for physicians and consequently, some specialties have become very top-heavy with older doctors.

The Association of American Medical Colleges tracks physicians in different specialties by the percent who are under age 55 versus those who are over 55 and the data is summarized in the graph below:

For all physicians combined, 56.8% are under age 55 and 43.2% are over age 55. However, some specialties are disproportionately older or younger. My own specialties of pulmonary (15% under age 55) and critical care (84.3% under age 55) is probably more a reflection that most of these physicians are dual certified and tend to do more critical care earlier in their career and migrate to more pulmonary later in their career. Similarly, emergency medicine with 65.4% under age 55 is a relatively new discipline that did not become recognized as a specialty until 1979 and did not offer a board examination until 1980.  There are some specialties that are more concerning. For example, pathologists, psychiatrists, cardiologists, and thoracic surgeons tend to be older whereas interventional radiologists, nephrologists, and pediatricians tend to be younger. Those specialties that have more than 50% of the physicians over age 55 are likely to be in high demand in the next 10 years as these older physicians retire.

A study in the Journal of Medical Regulation from 2017 analyzed the U.S. physician workforce by a number of parameters, including age. Taking all physicians together, 29.3% of practicing physicians are over the age of 60. The reasons why there are so many older physicians in the workforce are complex and include (1) a later age of entry into the workforce due to lengthy training requirements, (2) a high amount of debt from the cost of education, and (3) less physical demands than many other professions.

The median age of retirement from clinical activities by physicians is age 65 years as shown in this graph from a study published in the Annals of Family Medicine. The retirement age varies by specialty, for example, the median age of retirement from clinical activities is about 64.5 years for OB-GYNs and 66.5 years for cardiologists. Women tend to retire 1 year earlier than men. Because many physicians continue to be active in other professional activities after retirement from clinical activities (such as administration or education), the median age of retirement from any professional activity tends to be about 1 year later than the retirement from clinical activity. Therefore, the median age of retirement from any professional activity is at age 66 years when examining all physicians. But remember that these data are for the median age of retirement and that means that half of all physicians retire from clinical activity after age 65 years.

As a medical director, one of the most uncomfortable tasks I have to do is to tell an older physician with a long history of dedication to the medical profession and the community that it is time that he or she needs to stop seeing patients. It is not because of age per se but because of quality concerns. It turns out that this is a valid issue. A study in the BMJ found that for Medicare patients, the 30-day survival after hospital discharge depends on the age of the physician. 30-year old physicians had a 10.5% 30-day patient mortality rate whereas 70-year old physicians had a 13.5% 30-day patient mortality rate. Although part of these results could be because older physicians tend to have combined inpatient and outpatient practices with an older (and sicker) panel of patients whereas younger physicians tend to be hospitalists that care for a wider age range of Medicare patients, it is also quite possible that older physicians do not practice as high of quality of medical care as younger physicians. This has unfortunately been my experience with some older physicians.

There can be a lot of reasons why physicians retire and last year I wrote a blog post about “When Physicians Reach Their Use-By Date” to reminisce about how some of the more memorable physicians I have known retired. The keys are to have enough self-awareness to know when your clinical skills are lagging behind your peers and to be willing to pick up on subtle hints from those peers that you are not the clinician that you used to be.

So, what does all of this mean? First, doctors retire later than people in many other professions. Second, doctors who chose to work beyond age 65 need to be attentive to their quality of practice. Third, and perhaps most important from a national health care standpoint, certain specialties are dominated by older physicians who will be retiring soon, thus creating demands for those specialties that will be difficult to meet.

The hockey legend, Wayne Gretzky, famously said: “Skate to where the puck is going, not to where it has been”. I think that this has implications for our medical students who are selecting specialties – knowing what specialties are going to be in demand rather than what are currently in demand should affect their career choices.

May 26, 2018

Categories
Physician Finances Physician Retirement Planning

Planning For Retirement For Physicians Part 12: Overall Summary

This is the twelfth and last in a series of posts made in preparation for a presentation I will be making for physicians in fellowship training at an upcoming ACCP meeting. In this post, I’ll summarize the key points from the last 11 posts.

Retirement planning for physicians is different than for everyone else. You make a lot more money. You have a lot more educational debt. Because of how long you trained, you have less years to save for retirement. Because of your income, your children are not going to be eligible for financial aid in college. And you have different insurance needs. Here is my list of the 13 rules to invest by for your retirement.

Start saving for retirement as early as you can afford to. Compound interest is a beautiful thing and you need to make it work it’s wonders for you.

Know your tax rate. It is not your income tax bracket that is important, it is your effective income tax rate and these are very different numbers. You also need to know your capital gains tax rate and which types of income are susceptible to income tax versus capital gains tax. Also, realize that changes in tax laws and tax rates are inevitable and the rates today will very likely not be the rates when you retire.

Tax-deferred investments are almost always better in the long run. Financial advisors who tell you that you will be in a lower tax bracket when you retire and so you should invest in post-tax investments are wrong – your goal is to retire in the same or a higher tax bracket than you are in now. Tax-deferred investments outperform other types of retirement investments.

If you have access to a defined benefit pension plan, take it. We’ve all heard about defined benefit pension plans that went belly up during the great recession and many people got scared of these pension plans. But the reality is that all investments went belly up during the recession. Unlike a blue collar worker or high school teacher for who the pension plan may be the only retirement plan that they have, you will have a lot of additional options and a defined pension plan is a fantastic component of a well-diversified retirement portfolio.

Investment priority listSet a priority list for retirement investment options. Each different plan has different tax implications and some are going to be better than others in the long haul. Employer-matched 401(k) or 403(b) plans are a no-brainer because the you can basically double your money from the outset. 457 plans have an advantage of no penalties for early withdrawal compared to 401(k) and 403(b) plans. If you are at a university, you may be able to invest in BOTH a 457 and a 403(b) plan. Once you become eligible for a 415(m) plan, you will likely have to make a one-time irrevocable decision about whether to contribute to it and how much to contribute to it – I recommend you choose to contribute the maximum percentage of your salary that you can; even if you can’t afford to do that now, you can always reduce your 403(b)/457 contributions for a few years until you are financially able to do both the 415(m) and your other tax-deferred investments. If you have self-employment income (from consulting, etc.), then open an SEP and put the maximum contributions that you can into it. Every year, put money into a traditional IRA and then immediately convert it into a Roth IRA – this gives you additional diversification in the types of retirement accounts that you have. After you have done all of that, then start putting retirement savings into regular investment accounts (i.e., those made up from post-income tax money). Don’t put money in a traditional IRA unless you are going to convert it into a Roth IRA.

Buy term life insurance.  But only buy as much as you need during the time in your life when other people who depend on you need it.

Buy a $1 million umbrella insurance policy. Remember, as a physician, you have a big red bull’s eye on your back that every personal injury attorney in the United States can see.

Seek no-load mutual funds with low expense ratios. The easiest options will be index funds.

Pay off your student loans on time but don’t try to pay them off too early. Being debt-free is always desirable but if you are careful with your personal budgeting and finances, then you will be better off contributing to a tax-deferred retirement plan than making additional early payments on your student loans.

If you use a financial advisor, pay him/her by the hour. Avoid using financial advisors who get paid by investing your money. No matter what they say, they are going to be motivated by making as much money off of your investments as they can. By paying by the hour, you avoid the conflict of interest that comes with getting advice from advisors who work on commission. Some investment companies (such as TIAA-CREF and Vanguard) will have free financial counseling by advisors who are not on commission, take advantage of free advice that comes without a conflict of interest.

For your children’s college savings, open a 529 plan and make regular monthly contributions to it. The tax advantages of 529 plans are huge and the control you have over the account puts these plans far ahead of other college savings options.

Diversification is the foundation for a strong retirement portfolio. Know the right percentage of stocks versus bonds in your portfolio for your age. Your goal is to have the optimal balance between risk and returns – when you are younger, take greater risks in order to get greater long-term returns – when you are older, take less risks in order to get more predictable short-term returns. Don’t forget that a defined benefit pension plan is the ultimate in predictable returns and this gives you a great foundation for portfolio diversification.

Above all, realize that you can be your retirement fund’s best friend or its worst enemy. Knowledge and patience are your most powerful tools in investment for retirement. If you try to beat the market, you most likely won’t since even professional stock analysts usually don’t. You need to make a long-term plan and stick with it. When the stock market crashes and everyone is in a panic, that’s the time for you to put a little extra into your retirement funds rather than pull money out of stocks because even though stock markets go down, they always eventually come back up and as a physician, you are going to have a secure enough job and high enough income to weather economic declines compared to people in just about any other profession.

September 7, 2016

Categories
Physician Finances Physician Retirement Planning

Planning For Retirement For Physicians Part 11: State Teacher’s Retirement System, Yes Or No?

This is the eleventh in a series of posts made in preparation for a presentation I will be making for physicians in fellowship training at an upcoming ACCP meeting. In this post, I’ll be covering the pros and cons of state teacher’s retirement systems. This post will mainly apply to those physicians pursuing an academic career at a university.

Most states have a special pension program for teachers and university professors, including physicians who work at universities. In Ohio, we have STRS, the State Teacher’s Retirement System. Although each state’s teachers’ retirement program will be different, I’m going to discuss Ohio’s STRS. If you work at a university in a different state, you’ll need to be familiar with the specifics of your own state’s system to decide if it is right for you.

In Ohio, STRS is currently financially healthy but that is not currently the case for every state. During the recent great recession, most pension plans really suffered and lost a lot of their value. But they still needed to pay out a fixed amount in pension payments every year. So Ohio STRS, like many other state teacher’s retirement systems, came dangerously close to having projected future liabilities exceed projected future income. This made state legislators and taxpayers nervous since they did not want to have to bail STRS out with taxpayer money. It also made new physician faculty nervous since they were worried that they might end up putting money into STRS and not getting it back out again once they retired. Now that the recession is over, STRS is healthy again but it does illustrate that a pension is an investment and like any other investment, it has risk. Its just that the risk is relatively low compared to most of the other things you can invest in.

One thing to keep in mind about Ohio STRS: it is a substitute for Social Security. In other words, you will not have Social Security payroll tax taken out and consequently, you will not be getting Social Security checks when you turn 65 or 70 if you are a teacher in Ohio. If you have other income, for example, you worked enough years and contributed to Social Security before becoming employed at a university, or maybe as a professor, you have some outside income from consulting, etc. that is subject to Social Security payroll tax, then you may be eligible for Social Security benefits in addition to your STRS pension benefits in retirement. However, the federal government will look at the amount that you get from your STRS pension and your Social Security monthly payments will be reduced, fairly drastically. In my case, because of my work history, I’ll have STRS retirement benefits and will be eligible for Social Security benefits. But my annual Social Security benefits will not even be enough to make 4 months’ worth of mortgage payments.  Bottom line, if you have STRS, don’t count on much (or maybe anything) from Social Security.

When we first become employed as faculty members in Ohio, we have some irrevocable decisions to make. The first is whether to participate in STRS or in the “alternative retirement plan” or ARP. In the ARP, you can put your money into an investment of your own choosing, a lot like a 403(b) or 457 plan. When you take the money out in retirement, you can take it out however you want but when you have taken it all out, it is gone. So, unless you have other investments, you could find yourself at age 70 or 80 and broke with no income.

If you decide to go into STRS as opposed to the ARP, then you have to decide whether to do the “defined contribution plan” or the “defined benefit plan”. For details about the differences between these, refer to the 2nd in this series of posts. The vast majority of physician faculty will choose the defined benefit plan with the result that you (or your surviving spouse if you die) will get a fixed monthly income for the rest of your life. My father was a physician and university professor who died when I was in college – STRS helped support me in my last year of college and in medical school and I am eternally grateful for that support.

There are federal contribution limits for STRS that are currently set at $265,000. That means that you can only contribute to STRS up to that amount of salary and anything over $265,000 needs some other retirement investment option. For many universities, that will be a 415(m) plan that will kick in if you make more than $265,000 per year. The 415(m) plan will typically be with an investment company, such as TIAA-CREF, and it is not with STRS.

If you go the defined benefit route, then you do not get the maximum benefit until you have a certain number of years of service. That used to be 30 but when the recession hit, the number in Ohio was increased to 35. Therefore, if you leave academics to go into private practice, you will not get the maximum retirement benefit.

With any defined benefit pension plan, you are, in essence, taking a gamble that you will out-live other people in your age range and ensuring that no matter how long you live, you’ll always have at least something to live off of. As physicians, there are two variables that make us different than most other teachers in STRS. First, the average teacher starts his or her career after completing their master’s degree at about age 23 or 24. The average physician does not start his or her career as a professor until after completing residency or fellowship between the ages of 27 to 31. Since the years of service to get full retirement benefits in Ohio is 35 years, the average teacher will be eligible to retire at age 57 whereas the average physician with a 3-year residency will need to be age 62 (although in some residencies, you can start contributing to STRS during residency and this will lower the retirement age). Therefore, a physician will typically have a shorter life in retirement to fund than the average teacher. On the other hand, physicians tend to have healthy habits: we have access to good preventive medicine, we rarely smoke, and we usually exercise and eat right. So we hopefully can live to an older age than the average American.

One other aspect of STRS to be aware of is where the contributions come from. There is an “employee contribution” of 14% to STRS and also a “university contribution” of 14% to STRS. On the surface, it looks like the State of Ohio and consequently the Ohio taxpayers are funding university physicians’ retirement accounts to the tune of 14% of their salary. BUT, the Ohio State University, like most other universities, gets the funds to pay for the “university contribution” from the physician practice plans and not from state government. Therefore, in essence, we the physicians fund the “employee contribution” by a 14% reduction in our gross salary and we also fund the “university contribution” by transferring the equivalent of 14% of our salary from our clinical practice income to the university. Thus in reality, the physicians are paying for the entire 28% STRS contribution and the taxpayers of Ohio pay nothing.

STRS v ARPSo, should you choose STRS or the ARP? If you think (like I do) that you are going to live a long, long time in retirement, then having a fixed income that you can count on every year is an advantage but if you think you are only going to make it 5 or 10 years after you retire, the ARP is the better option. STRS has the ability to contract with health insurance companies for good group prices on health insurance policies and this can be a plus if you are going to retire before you are eligible for Medicare; no one knows if “Obamacare” will be repealed by politicians in the future so no one really knows if health insurance exchanges will continue to be available in the future – having the confidence that you can get access to affordable health insurance no matter what happens in the future can be a plus. If you think you are going to stay in academic medicine for your whole career, then STRS is a good option but if you think you may leave to go into private practice after a few years, then the ARP is the better option. If you are a control freak and you can’t stand someone else overseeing your investment, then the ARP is better for you since STRS will make all of the investment decisions regarding your retirement account. Lastly, if you are risk adverse, go with STRS – even though STRS (like all investments) has risk, in the long-run, that risk is a lot less than putting your money in the stock market yourself.

So, what is a new faculty member to do? My own advice is that if you have access to a defined benefit pension plan (such as STRS) as one component of a diversified retirement portfolio, do it. As an academic physician, you are going to have a lot of additional investment options including a 403(b), 457, and a converted Roth IRA that will give you that diversification. You may not have Social Security. Having the relative security of a fixed monthly STRS pension for the rest of your life will allow you to be more aggressive in your other retirement investments by not needing to have as high of a percentage of your retirement portfolio in low-risk bonds. This will allow your retirement portfolio to have a higher percentage of stock that are both riskier than bonds but in the long-run, will pay off more.

In the final post of this series, I will summarize the key points from all of the previous posts.

September 5, 2016

Categories
Physician Finances Physician Retirement Planning

Planning For Retirement For Physicians Part 10: Insurance For Physicians

This is the tenth in a series of posts made in preparation for a presentation I will be making for physicians in fellowship training at an upcoming ACCP meeting. In this post, I’ll be covering the types of insurance that you need to get yourself safely to retirement.

You can buy insurance to cover almost anything you can imagine, and there are salesmen out there that will try to. Most physicians will need several types of insurance: home, car, health, malpractice, disability, life, and umbrella.  I am going to focus on just the last 3 types of insurance.

Disability insurance. You’ve likely invested more than $200,000 and between 11 and 15 years in your education to become a physician so you had better protect that investment. The amount and type of disability insurance you need will depend on your individual circumstances. For example, early in your career, you have a lot more to lose if you suddenly find yourself unable to work whereas if you are close to retirement and already have a sizable retirement fund, then you may not need to depend on disability payments to get by. Also, you will need to consider your specialty. A friend of mine who is a general surgeon had to stop operating in his early 50’s due to arthritis in his thumb and that pretty much ended his practice career. On the other hand, another of my colleagues who is an endocrinologist became paralyzed from the waist down and dependent on a wheelchair after a diving accident as a young adult; she practices full-time and is one of the most highly regarded physicians in her field nationally. Many group practices and hospital employers will provide a standard disability insurance policy and you will need to look at your own circumstances to determine if that is enough or if you need to purchase additional disability insurance on your own. Disability insurance policies can have a lot of differences. For example, some will cover student loan payments and some won’t; some are subject to income tax and others are tax-exempt.

Life insurance. This is a tricky one. If you are single with no dependents, you may not need any life insurance since if you die, no one will be left unsupported. But most of us have at least one person other than ourselves who depend on our income. The amount of life insurance that you need will vary depending on how many people depend on your income and for how long they will be depending on it:

  1. If your spouse does not work, you need more life insurance
  2. If you have children, you need more life insurance
  3. If you are early in your career and have not built up a sizable retirement fund, you need more life insurance
  4. If you have a lot of debt (mortgage, loans, etc.) that you don’t want to leave to your heirs, you need more life insurance
  5. On the other hand, if your spouse works, your kids are out of college and you are near retirement, you may need little or no life insurance

There are essentially two types of life insurance, term and whole life. For physicians, term life insurance is the better deal and I would stay away from whole life policies since whole life policies are considerably more expensive and provide coverage that you will not need for your entire life.

Umbrella insurance. This is a policy that provides coverage over and above your regular insurance policies. When asked why he robbed banks, Willie Sutton famously replied, “Because that’s where the money is”. The same could be said for why personal injury attorneys sue physicians: because that’s where the money is. As a physician, you have a big red bull’s eye painted on your back and if you are involved in an automobile accident or someone slips on your sidewalk and gets injured, there is a pretty good chance that they and their attorney are going to go after you for more than your regular automobile or home owner’s insurance policy. I think that all physicians after residency and fellowship should have an umbrella insurance. $1 million in coverage is usually sufficient.

So, in summary, don’t just buy a lot of disability insurance, buy the right amount that you are going to need based on your specialty and how far along you are in your career. Don’t just buy a lot of life insurance, buy what you need when you are younger and when your family is dependent on your income. But do buy umbrella insurance.

In the next post in this series, I’ll go over the advantages and disadvantages of state teacher’s retirement systems for those physicians who are eligible for them.

September 3, 2016

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Physician Finances Physician Retirement Planning

Planning For Retirement For Physicians Part 9: Saving For Your Children’s College Education

This is the ninth in a series of posts made in preparation for a presentation I will be making for physicians in fellowship training at an upcoming ACCP meeting. For most physicians, you will have three major investments over your lifetime: your house, your retirement, and your children’s education. It this post, we’ll examine the options that you have to save for your children’s college education. Although it is not exactly retirement planning, it does impact your retirement plans since if you don’t prepare for college expenses now, you may find yourself either unable to contribute money into retirement when college expenses come due or even worse, you may find yourself having to takes loans or early withdrawal from your retirement account to pay for your children’s college expenses.

If you are a physician, I’ve got some good news and some bad news for you. The good news is that you are going to have a very good income. The bad news is that your kids are not going to be eligible for financial aid when they go to college because you make too much money. So, unlike most Americans who send their kids to college, you are probably going to have to pay the sticker price… and that price is high. This year, the cost of tuition, room & board, books, and fees for the Ohio State University (a public university) is $22,753 for an Ohio resident. My wife’s and one of my daughter’s alma mater, Notre Dame (a private university) is $65,093. And this doesn’t include the cost of transportation and personal expenses. For 4 years of college, that adds up to $91,012 for a public university and $260,372 for a private university.

Even scarier is the fact that the cost of going to college has been increasing at about 5% per year, in other words, twice the regular inflation rate. That means that if you have a child born today, then in 18 years, a public university is going to cost you $54,758 for the first year and $236,013 for the entire 4 years of college. If your newborn child goes to a private university 18 years from now, that freshman year will cost $156,654 and the entire 4 years will cost $675,199. If you have 4 kids, like I have, then you’ll end up spending more on their education than you will to buy your house, so you have to start saving early.

Fortunately, you have several ways to save for your children’s college education: regular investments, Coverdell educational savings accounts, uniform gifts to minors accounts, and 529 plans. Let’s look at the advantages and disadvantages of each.

Regular investments. This would mean putting money in stocks, bonds, or mutual funds in your name and then drawing the money out when you eventually pay college expenses. The only advantage of this is that the money is yours so if your child ends up getting a full-ride scholarship or not going to college, then you can use the money for whatever you want with no penalty since you did not use it for college expenses. The disadvantage is that you have to pay taxes on the earnings: regular income tax on interest income and capital gains tax on dividend and capital gains income.

Coverdell educational savings accounts (ESAs). These used to be known as education IRAs back when I was saving for my kids’ education. The contribution limit is $2,000 per year and the initial contribution is not tax deductible. The money grows tax-free and if the investment is eventually used for education purposes, it is not taxed when it is withdrawn. You can put almost any kind of investment of your choosing including stocks, bonds, and mutual funds in the ESA. An important limitation is that If your taxable income is greater than $110,000 per year filing single or $220,000 if married filing jointly, then you cannot contribute to an ESA. For most physicians, the $220,000 income limit and the $2,000 annual contribution limit make ESAs either not possible or, if possible, then an inadequate vehicle for college savings.

Uniform gifts to minors. This allows you to give money to your children and then it can be invested in any kind of investment that you (or the child) wants. You cannot deduct any contributions from your taxes and as the money grows, you’ll have to pay regular income tax on the interest and capital gains tax on the dividends and capital gains – under the current tax law, the first $1,000 of income is not taxed, the second $1,000 is taxed at the dependent child’s tax rate, and anything over $2,000 is taxed at the parent’s tax rate. Also, once the child reaches the age of majority (18-21, depending on the state), the money is theirs to do whatever they want with. So, if your idea was that they would spend it on college and their idea is that they would by a Corvette, you’ll be seeing a nice new Corvette in the driveway when he or she turns 18. Because of the lack of tax advantages and the lack of control that you have over the money once your child becomes an adult, uniform gifts to minors is not a good option for most physicians.

529 plans. These plans allow you to invest money into an account to be used for your child’s college education. The money in a 529 plan grows tax-free and as long as you use the money for college education expenses, you don’t have to pay any taxes on the withdrawals. Additionally, in some states, you can deduct contributions from your state income tax; for example, in Ohio, we can deduct up to $2,000 in annual contributions per child from our state income tax. There is no limit to the amount of money that you can put into a 529 plan but if you contribute more than $14,000 per year ($28,000 if married filing jointly) then there are tax consequences since you will have exceeded the maximum amount that the IRS allows you to “gift” to one person in one year. There are 2 types of 529 plans: (1) prepaid tuition plans that allow you to purchase tuition in selected colleges at today’s tuition rates and (2) savings plans that allow you to invest the money in state-approved investments, usually mutual funds. I’m a bit leery about the pre-paid tuition programs because if you are buying this for your newborn son, you don’t even know what state you are going to be living in 18 years from now, let alone what college he is going to want to go to. Each state has a different 529 plan that uses different mutual funds. Of note, you can invest into any state’s 529 plan that you want; for example, when these plans first came out, I invested into Iowa’s 529 plan even though I lived in Ohio and had never set foot in Iowa in my life. At the time, Iowa’s 529 plan used low-cost Vanguard mutual funds and I wanted access to them. Once Ohio switched to Vanguard funds for Ohio’s 529 plan, I moved the funds from Iowa to Ohio. The state income tax advantage that you get may only apply if you invest in your own state’s 529 plan. If you don’t need to use all of the money in the 529 account for one child, then you can very easily move the money into another child’s 529 account. If there is still a balance in your 529 accounts after you have put all of your kids through college, you can withdraw the balance of the account and use it for whatever you want but you will have to pay a federal 10% penalty on the earnings from the residual account balance. That 10% penalty may seem like a lot on the surface but it really isn’t when you figure all of the tax advantages that you have had with the money in the 529 plan over the years.

So in summary, college is expensive and will get more expensive. There are several options for saving for your children’s college education and my personal opinion is that the 529 plans are the best option for physicians. What I did with my own children was to put $5,000 into each child’s college fund account when they were born (that would be $10,000 in today’s dollars). I then put additional money into each child’s account each month. For Ohio’s 529 plan, that was easy – I set up a regular monthly direct deposit from my checking account into the 529 fund so that it happened automatically at the beginning of each month. That way, I didn’t have to think about it and I was not tempted to use the money for other purposes. At the end of the day, we put 2 of our children through private colleges and 2 through public colleges from the money in their 529 plans.

In the next post, we’ll look at insurance for physicians.

September 1, 2016

Categories
Physician Finances Physician Retirement Planning

Planning For Retirement For Physicians Part 8: Pay Off Student Loans Versus Save For Retirement?

This is the eighth in a series of posts made in preparation for a presentation I will be making for physicians in fellowship training at an upcoming ACCP meeting. In the last post, I discussed how to invest your post-tax money for optimal returns in retirement. In this post, we’ll look at whether it is better to pay your student loans off early or invest in retirement.

First, let’s just get this out of the way, if you have the option, the best way to manage your student loans is to get someone else to pay for them. There are a few ways of getting your student loans paid off. If you are pursuing a career in medical research, there are NIH loan repayment programs that will pay up to $35,000 a year on your loans. There are loan repayment programs if you join the military or if you agree to practice in certain underserved parts of the country. Lastly, when you get your first job out of residency, ask if the hospital or group practice will pay off some of your loans – most won’t but some will (particularly if they’ve been having a hard time recruiting into the position) and the only way to find out is to ask.

The average medical student graduates from a public medical school with $172,751 in loans and from a private medical school with $193,483 in loans. That is a lot of debt for a resident making $50,000-$55,000 a year. If you can’t get someone else to pay off your loan, then you’ll be making monthly payments for a long, long time. The jump in annual income from being a resident to being an attending physician can seem like a lot, and it is, but it comes with a rapid ramp-up in the loan repayment requirements. Plus, as a medical student and resident, you may have been driving your grandmother’s hand-me-down 1998 Honda Civic and living in a one-bedroom apartment… you’re 30+ years old and you’re ready for a lifestyle upgrade. So, it is easy to find yourself spending all of that new income on stuff and not on your future retirement.

Above all, do not get behind in your regular student loan payments. The cost in penalties is just too high and you’ll just fall further and further behind. So, we’ll assume that you are making your regular monthly payments on your student loans and then you have to decide if it is better to make a few extra payments on your loans or if it is better to put some extra money into a tax-deferred retirement plan?

As a general rule, I am pretty debt-adverse and just feel better getting out of debt but if you are disciplined (and to get through 11-16 years of college, medical school, residency, and fellowship presumably you do have personal discipline), then you can use some strategic financial planning and budgeting to give you the best long-term financial outcome. So, let’s make some assumptions in a hypothetical case:

  1. You have $150,000 in student loans. You probably have more than this but it is an easy number to use as an example.
  2. The average interest rate on your loans is 6%.
  3. You have a 15-year repayment period for your loans. This will equate to $15,316 of payments per year ($1,276 per month) of which about $9,000 per year is interest.
  4. You can deduct up to $2,500 of annual interest payments off of your income tax each year.
  5. Your tax deferred 401(k)/403(b)/457 has an 8% annual return on investment.
  6. Your taxable income is $258,000 ($255,500 after the loan interest deduction).
  7. You are married and filing jointly.
  8. We’ll use 2015 income tax and capital gains tax rates.
  9. We’ll compound interest monthly on the loan and we’ll compound capital gains monthly on the tax-deferred retirement account.
  10. You are financially responsible and you project that this year, you will have $20,000 in pre-tax income that you can use to either (1) put in your tax-deferred retirement account or (2) pay income taxes now on the $20,000 and use it to make extra payments on your student loans.

Now let’s take a look at what your financial picture will look like if you make extra payments on the loans versus if you invest the money into a tax-deferred retirement account.

tax analysis 5

The first thing to notice is that with either choice, your taxable income drops to $255,500 because you can deduct $2,500 of your $9,000 in interest payments off of your taxable income for that year. The $20,000 in pre-tax money that you decide to use for extra payments for your student loan becomes $15,3116 after you pay an effective income tax rate of 23.42%. On the other hand, if you put the money into a tax-deferred retirement account, then after 1 year, that $20,000 becomes $21,660 and the value of that money if you were to retire after a year at your current effective income tax rate would be $16,743.

Next, look at your overall financial picture at the end of the year if you make extra payments on your student loans. We’ll define the overall financial picture as your total assets (salary that year + the projected value of your tax-deferred retirement fund [after you pay taxes on it when withdrawing it in retirement] minus your debts (the balance remaining on your student loan). In this scenario, your effective income tax rate will be 23.42% and your overall financial picture will be $37,349.

If, on the other hand, you decide to put money into a tax-deferred retirement account, your effective tax rate will drop to 22.70% and your overall financial picture will be $38,922. In other words, you come out ahead $1,573 by putting that $20,000 in a tax-deferred retirement account as opposed to making early payments on your student loans.

Now let’s assume that your student loan interest rate is a little higher, say 7% rather than 6%:

tax analysis 6

Note that the value of the loan changes due to the effect of the higher interest. If you make extra payments on the student loan, your overall financial balance is $35,920 whereas if you put the extra money in a tax-deferred retirement account, your financial balance is $37,330. In other words, you come out $1,410 ahead by putting the money in a tax-deferred account.

Finally, let’s take a worst-case scenario and assume that you have an exorbitant student loan at 9% annual interest:

tax analysis 7

Now, your overall financial balance will be $33,022 if you make extra payments on your student loans versus $34,103 if you put the money into a tax-deferred retirement account for a net advantage of $1,081 to put the money in the retirement account. The bottom line is that you always come out ahead by putting the money into a tax-deferred retirement account instead of making extra payments on your student loan.

Finally, let’s assume that you do not have the flexibility to put money into a 401(k), 403(b), or a 457. Should you put money into a regular investment after you have already paid income tax on that money?

tax analysis 8

If the student loan is 6% then you come out only $145 ahead by investing the money (for all practical purposes, break-even). If your student loan is 7% (analysis not show), you come out only about $18 ahead by making an extra payment on the student loan (also, essentially break-even). If your student loan is 9% (analysis not shown), you come out $1,428 ahead by making the extra payment on the student loan. In other words, unlike the situation with a tax-deferred retirement fund where you always come out ahead by investing in your retirement fund, the situation with a regular investment funded out of your post-tax dollars is more complicated. If your student loan interest rate is high, then you are better off making extra payments on the loan and if the student loan interest rate is lower, it doesn’t make a lot of difference which choice you make.

Every physician’s situation is a little different and you have to take into account the nuances of your own particular circumstances in deciding whether to put additional money into your retirement account versus make additional payments on your student loans. What is not taken into account in the above analysis is the peace of mind that you get when your student loans are finally paid off and from my own past experience that peace of mind is priceless.

In the next post, we’ll take a look at options for investing in your children’s college expenses.

August 30, 2016