Category: Physician Retirement Planning

So, you are finally done with all of your education and you are now actually earning an income. You want to start saving for retirement but the number of investment options can seem overwhelming. Many people turn to their company’s 401(k) and a “target date” mutual fund that automatically invests a certain percentage of the fund allocation in U.S. and foreign stocks and a certain percentage in U.S. and foreign bonds. When the investor is young, a higher percentage goes into stock and as the investor ages, the percentage invested in bonds increases. In fact, 24% of all money held in 401(k) accounts is in target date funds. Although this approach is simple and works reasonably well for most people, the savvy retirement investor can do better with understanding of the 4 buckets of retirement assets and the 4 types of retirement investments.

Retirement Investment Summary

Deferred Compensation Accounts

• Do include:
  • Stock and bond funds in a pre-determined ratio
  • REIT funds
• Do not include:
  • Cash
  • Tax-free bond funds

Roth Accounts

• Do include:
  • Stock funds
  • REIT funds
• Do not include:
  • Cash
  • Bond funds (until you are close to age 72)

Regular Investments

• Do include:
  • Cash
  • Stock and bond funds in a pre-determined ratio
  • Tax-free bond funds
  • Any stocks held in individual companies for your entertainment (non-retirement) purposes
• Do not include:
  • REIT funds
  • Certificates of deposit

The 4 buckets of retirement assets

The money that you use in retirement is going to primarily come from 4 sources or “buckets”: (1) defined benefit income, (2) deferred compensation, (3) Roth accounts, and (4) regular investments.

First, there is defined benefit income. This is a dependable amount of money that you get every month from a source such as Social Security, a pension, or an annuity. For most people, Social Security will not be enough to cover a retiree’s expenses. If you can get one, a pension is a great component of a balanced retirement asset portfolio but pensions are increasingly uncommon. Annuities have their place for some investors but for the majority of people, annuities are too expensive and too complicated to be worth it, particularly if you have a moderate to high income during your working years. Defined benefit income can serve as an important safety net in retirement so that even if there is a major recession, you still have enough income coming in each month to ride out that recession, without having to sell your stock or bond funds at a time when you can potentially take a substantial loss on those funds.

The second bucket is deferred compensation. This includes IRAs, 401(k)s, 403(b)s, and 457s. This is money that you put away into an investment without paying income taxes on it while you are working. When you withdraw the money in retirement, you pay regular income tax on those withdrawals at whatever your income tax rate is during that year. Any interest and dividends generated from the investments in deferred compensation accounts just gets added to the value of the account so when you take that money out, you pay regular income tax on the withdrawal no matter whether the money in that withdrawal was derived from your original deposit into the account, interest earned on that investment, dividends earned from that investment, or the capital gain in value of that investment. At age 72, the IRS requires you to take a portion of money out of deferred compensation accounts each year; this is called “required minimum distributions”. If you have a lot of money in your deferred compensation accounts at age 72, those required minimum distribution can push you into a high tax bracket; this is why many advisors recommend drawing down from your deferred compensation accounts early in retirement, before age 72. For many people, deferred compensation accounts will be their main source of retirement income.

The third bucket is Roth accounts. The most common of these is the Roth IRA but some people can invest in a Roth 401(k) or Roth 403(b). This is money that you pay income tax on during the year that you earned and deposited the money into Roth account. That money then grows tax-free in the account with the addition of any interest or dividends from the investments. When you withdraw money from the Roth account, you do not pay any tax on it. Money in Roth accounts are not subject to required minimum distributions so you can leave money in these accounts beyond age 72. Regular Roth IRAs are only available to people with lower incomes; however, a “back-door Roth IRA” is available to anyone and is a great idea for most middle and high income people. The Roth 401(k) and Roth 403(b) are only advisable if you anticipate that you will be in a higher tax bracket in retirement than you are when you are working, which is uncommon except for young people early in their careers when their annual income is relatively low.

The fourth bucket is what I will call regular investments. This is money that you pay regular income tax the year that you earn it and then invest that money in stocks, bonds, etc. You can pay taxes on these investments in three different ways: interest, dividends, and capital gains. Interest income is taxed each year at your regular income tax rate. Dividends can be taxed two ways: “ordinary dividends” are subject to your regular income tax rate the year that you earned the dividends. On the other hand “qualified dividends” are taxed at your capital gains tax rate the year that you earned the dividends. A typical U.S. stock index fund will have approximately equal amounts of ordinary and qualified dividends each year. When you sell an investment, such as a stock, you pay capital gains tax on the amount that that investment has increased in value since you purchased it. For most people, the capital gains tax rate will be lower than their regular income tax rate. The current capital gains tax rates for people married filing jointly are 0% for annual income < $80,800, 15% for annual incomes $80,801 – $501,600, and 20% for annual incomes > $501,600. The IRS also has a 3.8% dividend surtax for anyone with more than $200,000 in annual investment income (this is uncommon). Note that interest, dividend, and capital gains taxes only apply to regular investments and do not apply to deferred compensation investments (which are taxed at your income tax rate) or Roth investments (which are not taxed at all).

The 4 types of retirement investments

Okay, this is a little oversimplified. In reality there are more than 4 types of investments but I am not going to include less common investments such as fine art, jewelry, wine collections, and digital currency as these are considerably less common in the typical retirement portfolio. The main 4 types of retirement investments most people have are (1) stocks, (2) bonds, (3) real estate, and (4) cash. Knowing which of these to put in each of your retirement buckets depends on how they are taxed and when you will want to use them.

The first type of investment is stocks. It is inadvisably risky for most people to buy stocks in individual companies. It is preferable to buy shares of mutual funds which are composed of stocks from many different companies, thus allowing you to spread out your risk. For American investors, stocks can be divided into U.S. stocks and foreign stocks – a diversified portfolio will have some of both. In the short-run, the value of stocks can swing widely, losing value some years and gaining value in others. However, in the long-run, stocks will outperform all other kinds of investment.

The second type of investment is bonds. Once again, most people don’t buy individual bonds but instead buy shares of bond mutual funds. Bonds can come from U.S. companies, the U.S. government, local governments, and state governments. Some government bonds are tax-free, meaning that you do not pay tax on the income from those bonds. However, tax-free bonds tend to pay the investor lower yields than taxable bonds. Bonds can also come from foreign companies and foreign governments. An advantage of bonds is that their value does not fluctuate from year to year as much as the value of stocks (in other words, bonds have less volatility than stocks). However, over the long-term, the return on bonds is less than the return on stocks.

The third type of investment is real estate. Most of us cannot easily go out an purchase a plot of land or a building as a retirement investment but we can invest in shares of real estate investment trusts (REITs). Functionally, these are similar to mutual funds and an REIT will own many different properties, such as apartment buildings, office buildings, warehouses, retail centers, etc. Like stock mutual funds, the value of REITs can fluctuate widely from year to year and will outperform bond funds in the long-term. However, REITs are subject to different economic forces than stocks, so the performance of REITs may not mirror the performance of the stock market in any given year.

The fourth type of investment is cash. These are investments that do not earn a very high return but are relatively safe and dependable; their value does not fluctuate much from year to year. Because the annual inflation rate will usually be higher than the annual return on cash investments, those cash investments will actually lose value over time; for this reason, you do not want to have too much of your retirement portfolio in cash. Included in this category are checking accounts, savings accounts, and money market accounts. Some people include certificates of deposit (CDs) in this category but I consider cash as money that you can take out with immediate notice; the problem with certificates of deposit is that those funds are locked up for the term of the CD and so you cannot access them on short notice without paying a penalty. Another disadvantage of certificates of deposit is that the yield on the CD is taxed as interest, in other words, at you regular income tax rate.

Putting the right investment type in the right asset bucket

So far, we’ve seen that there are 4 basic buckets of retirement assets and 4 basic types of retirement investments. The next step is to determine how much of each type of investment to put in each bucket of retirement assets. The decision will be based on how each investment is taxed in each bucket, how far in the future you plan on taking money out of the investment, and the short-term volatility of each type of investment.

Defined Benefit Income Bucket

For the most part, you are not going to have any say in how the money in your defined income bucket is invested. Social Security income will be determined by congress and pension payments will be determined by a central pension committee. You can have some limited control over annuity investment by purchasing different types of annuities.

Some advisors argue that an investor is better off not contributing to a pension and instead investing that money themselves. Although I agree that most investors can outperform their pension, the key advantage of having a pension as a component of a balanced retirement portfolio is that by having the guaranteed monthly income from the pension, you can afford to put a larger percentage of your other retirement investments in stocks than you otherwise would. In the long-run, those riskier stocks will result in higher overall returns.

Deferred Compensation Bucket

Most people will start to withdraw money from their deferred compensation accounts shortly after retirement. Therefore, the composition of your deferred compensation account will depend on the number of years until you retire. If you are younger, then the stock-to-bond ratio should be primarily U.S. and foreign stocks with relatively little bonds – you have plenty of time to weather out the year-to-year volatility of stocks. As you get closer to retirement, the proportion of bonds should increase and the proportion of stocks should decrease. The idea of the “target date” mutual fund is that you choose a fund that corresponds with your planned year of retirement and the fund automatically adjusts the ratio of stocks to bonds each year as you get closer to retirement. Target date funds are designed to meet the needs of the average person but the problem with target date funds is that we are not all average and the target date funds do not take into account an individual person’s unique circumstances that can affect the ideal stock:bond ratio for that individual’s retirement portfolio. The ideal ratio of stocks:bonds will depend on (1) your own willingness to accept risk inherent in stock market volatility, (2) whether or not you will have defined benefit income in retirement, and (3) how long you expect to live in retirement. One strategy is to look at the stock:bond ratios from investment companies such as Vanguard, Fidelity, or Blackrock and use those ratios as a starting point. If you are risk-adverse, then increase the percentage of bonds in your portfolio. If you will have a pension or if you anticipate living a long time in retirement, then increase the percentage of stocks in your portfolio. A small portion of the deferred compensation fund should be real estate, for example, 5-6% of the funds invested in an REIT.

Do NOT put a lot of cash in your deferred compensation accounts – you want investments that are going to grow in value over time in these accounts. Do NOT put tax-free bonds in your deferred compensation accounts – these bonds will not increase in value as much as taxable bonds and the annual interest generated by these bonds does not get taxed each year in the deferred compensation fund, anyway.

Roth Bucket

Ideally, you want Roth accounts to hold investments that are going to have the highest long-term increase in value. Therefore, your Roth accounts should be mostly composed of stocks, both U.S. and foreign. Because your Roth account is not subject to required minimum distributions at age 72, you will likely want to withdraw money from your Roth accounts at an older age than you start to tap into your deferred compensation accounts (in other words, you want to spend down your deferred compensation accounts before reaching age 72). As with your deferred compensation bucket, a small amount of the Roth accounts should be in REITs, say 5-6%.

Do NOT have cash investments in your Roth accounts – there is little to no tax advantage. Do NOT have bond funds in your Roth accounts (at least when you are younger) – since you will not start to take withdrawals from your Roth accounts for 5-10 years after you start to take withdrawals from your deferred income accounts, you can afford to have a higher percentage of stocks in your Roth bucket than in your deferred income bucket. As you get close to age 72 (or whatever age you anticipate starting to withdraw money from your Roth account), you can then begin to shift some of the Roth funds into bonds. Even more importantly, do NOT have tax-free bonds in your Roth accounts ever – the Roth accounts are already tax-free and tax-free bonds will have a lower annual return than regular taxable bonds.

Regular Investment Bucket

This is the bucket that you want your cash investments in. Everyone, regardless of age, should have enough money in cash to cover at least 3 and preferably 6 months of normal expenses. You or your spouse could lose your job, have an unexpected (and expensive) illness, or suffer a financially catastrophic loss such as a house fire.

For most middle and high income earners, it is better to maximize annual contributions to your 401(k), 403(b), 457, IRA, and/or Roth before investing money meant for retirement in regular investments. But if you have maximized your deferred compensation and Roth account contributions and you still have some money left over to invest for retirement, what you invest in? The decision will largely be based on taxes.

If you want tax-free bonds in your retirement portfolio, this is where you should put them – where you can benefit by not having to pay annual regular income tax on the annual yields that these bonds generate. As I stated in a previous post, most people should not invest retirement money in individual stocks – you are better off diversifying your stock holdings. However, if you do want to hold a few individual stocks for your own entertainment purposes, this is also where you should put them.

Most people should have a higher percentage of bonds in their regular investment bucket than in their deferred compensation bucket. There are two important reasons for this. First, if you need money for an unexpected expense before you retire, you are better off drawing that money from your regular investment bucket rather than your deferred income bucket since you will be charged an early withdrawal penalty from deferred income accounts. Therefore, you may need the money sooner than your planned retirement date so you want to have less investment volatility given your potentially shorter investment horizon. Second, since you want to have your Roth account composed mostly of stocks, you will need to have someplace else to put bonds in order to maintain your overall desired stock:bond ratio across all of your retirement buckets.

Do NOT put certificates of deposit meant for retirement saving in your regular investment bucket. You will pay regular income tax on the interest each year and your regular income rate will usually be higher during your working years than during your retirement years. Certificates of deposit are better used for non-retirement savings, for example, savings for a new car or down payment for a house.

Do NOT put REIT retirement investments in your regular investment bucket. Unlike a stock mutual fund that generates about half ordinary and half qualified dividends, REIT dividends are almost all ordinary dividends and thus taxed each year at your regular income tax rate. Because most people will have a lower income tax rate in retirement than when working, you will pay more tax on REIT dividends in a regular investment when you are working than you will on REIT dividends in a deferred compensation account when you withdraw in retirement.

Some financial advisors argue that dividend-generating stocks should be in your deferred compensation bucket and not in your regular investment bucket for the same reason. I do not have as strong of an opinion – the explanation is a bit complicated, so bear with me (if you feel like your head is ready to explode after reading this far, skip reading this paragraph). If a stock mutual fund is held in your regular investment bucket, you will be taxed each year at your regular income tax rate for the ordinary dividends and at your capital gains tax rate for the qualified dividends. On the other hand, if that same index stock fund is held in your deferred compensation bucket, you will not pay annual tax on the dividends each  year – those dividends just build up in the account until you make a withdrawal in retirement and then you will be taxed at your regular income tax rate on that withdrawal. Your income tax rate will likely be higher during your working years than in your retirement years so you might think that it would be better to have dividend-producing stocks in your deferred compensation account. However, your income tax rate in retirement will likely be higher than your capital gains tax rate when you are working. Therefore, in order to minimize taxes, you are better off having stocks that generate ordinary dividends in your deferred compensation bucket and having stocks that generate qualified dividends in your regular investment bucket. Since most index stock funds generate approximately equal amounts of ordinary dividends and qualified dividends, I believe that taxes on ordinary and qualified dividends balance out whether the index stock fund is held in your regular investment bucket or in your deferred compensation bucket. For that reason, I do not believe that dividend generation should be a factor in deciding whether a stock fund should be in your regular investment bucket or in your deferred compensation bucket.

Diversification is the key

Diversification is at the core of every healthy retirement portfolio. That means diversifying across all 4 of the buckets of retirement assets and across all 4 of the types of retirement investments. The optimal amount of each type of retirement investment you have in each bucket of retirement assets will depend on tax implications, your age, your risk tolerance, and whether or not you will have a pension.

August 9, 2021

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

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

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