Welcome back to Personal Finance for Medical Professionals, Part I.  In this series, we follow a curriculum designed to make you knowledgeable and confident enough to manage your hard-earned finances.  This is Lesson Four, The Financial Vitals Checklist Steps # 3-6, where we continue to guide you through the stages of your financial journey using a ten-step checklist.  In the last lesson, we learned how to protect ourselves from catastrophe using insurance and an emergency fund.  If you haven’t already read Lesson Three, click here.   

Maximize Returns

3. Obtain Employer Match

On your financial journey, it is essential to take the easy wins when they’re available, and someone giving you free money is about as easy as it gets.  That’s why obtaining the employer match for your retirement plan is your next most important step.  Not every medical professional is an employee, but if you are and have access to an employer match, take advantage of it.  The specifics of employer match programs vary, but the gist is the same.  If you contribute money to your retirement plan, your employer will match a part of it.  

For example, your employer might have a 100% match up to the first 3% of your salary.  If you make $200,000 and contribute $6,000, your employer will also contribute $6,000.  This is like getting $6,000 for free!  You can also think of it as getting an immediate 100% return on your investment.  Other programs might match 50% up to 4%.  If you make $200,000, you would have to contribute $8,000 to get the employer to match $4,000.  This is a 50% immediate return on your investment.  Anytime you can get a guaranteed 25%, 50%, or 100% return on your investment, you should take it!  This is the definition of an easy win.  

Additionally, this money will continue to grow in your account over time, so that initial return will be several times higher by the time you retire.  To complete this step, you must contribute only as much money as needed to get your full employer match, even if you are allowed to put more into your retirement account.

4. Pay Off High-Interest Debt

The next easy win that will help you maximize your returns is paying off high-interest debt.  What constitutes high interest is debatable and changes over time with the prevailing rates; however, it is always safe to say that credit card debt is high interest.  Credit card debt is a “hair on fire” type problem.  Nothing is more important when your hair is on fire than putting out the flames!  Similarly, if you have credit card debt, you must pay it off quickly.  Interest rates on most credit cards are between 16 – 24%, so paying down a credit card’s balance is the same as investing that money and earning a 16 – 24% return!   If you can receive a guaranteed return of 16% or more, you should take it every time.  

The first step is to stop using your credit cards until you have paid them off and can pay the balance monthly.  The next step is to list all your credit cards from highest to lowest interest rates.  Pay off the highest rate card first, regardless of the balance.  Once the first card has been paid off, work your way down the list until they are all gone.  If you need to work more to make extra money until your debt is paid off, do it.  Remember that your hair is on fire.

If you have any other high-interest debt, you should pay it off next.  I define high interest as anything beyond what I can comfortably expect to earn over the long term in the stock market, which is 9 – 10%.  Therefore, I consider anything above 8% high.  I define low-interest debt as anything below 5%.  Debt financed between 5 – 8% is a gray zone.  The decision on what to do with that debt is more complicated and will depend on your age, income, amount of debt, and individual circumstances. 

5. Fund HSA (if available)

Once you have taken any available employer match and paid off your high-interest debt, one final easy win may be available.  Your next step is to fund a Health Savings Account if you are eligible.   As always, if this step does not apply to you, move on to the next one, but if you qualify, the HSA can be the most powerful investing tool available today.  The purpose of the HSA is to be an adjunct to high-deductible health insurance; for this reason, you are not eligible unless you have this type of health insurance plan.  You can contribute money pre-tax to the account and use it for qualified medical expenses, either in the year of contribution or later.  This allows you to cover some of your medical bills tax-free.

The HSA makes this checklist at #5 because it can be “hacked” as a powerful wealth-building account.  As stated, the HSA allows you to contribute money pre-tax, meaning that you get a tax deduction for your contribution amount.  Contributions can be invested, grow tax-free, and be removed tax-free for qualified expenses at any time, which makes the HSA the only “triple tax-advantaged” account.  

You have two options with an HSA.  You can use it to pay qualified health expenses as they arise, allowing you to pay for these expenses tax-free.   If you are young and healthy, the more financially savvy option is to max out your HSA yearly, pay cash for any qualified health expenses incurred, save the receipts, and invest your HSA contributions.  Your account will grow through your contributions and compound interest, which turns your HSA into a de facto retirement account.  Since you will save any receipts along the way, you can pull money out at any time to cover these expenses.  

Your healthcare expenses will almost certainly increase as you age, and this account is a tax-free way to pay for those expenses.  Just in case you’re perfectly healthy until you die, once you reach age 65, you can pull the money out of the HSA for any reason penalty-free, although you will have to pay income tax.  So, the HSA becomes like any other pre-tax retirement account.  Fortunately, the worst case for your finances is the best case for your health! 

The government understands this is a great deal and caps the contribution limit in 2024 at $4,150 for an individual and $8,300 per family.  A high deductible health plan in 2024 is defined as “. . . a health plan with an annual deductible that is not less than $1,600 for self-only coverage or $3,200 for family coverage, and for which the annual out-of-pocket expenses (deductibles, co-payments, and other amounts, but not premiums) do not exceed $8,050 for self-only coverage or $16,100 for family coverage.  You can find details of HSA eligibility requirements at https://www.irs.gov/pub/irs-drop/rp-22-24.pdf.

     A word of caution here:  If you are eligible for an HSA, take advantage of it.  However, high-deductible health insurance plans are not ideal.  If you are not eligible for the HSA because your insurance is “too good” to qualify, take this as a win and move on.  

Secure your retirement

Sometimes in life, we are so caught up in the moment, in the day-to-day functions of living, that we forget to plan for the future.  This is why the average American has so little saved for retirement.  Now that you have protected yourself and your family and have taken all the easy wins by maximizing your returns, it is time to secure your retirement.  This step will be individualized, depending on your income level, your employment status, and what types of retirement accounts you have available to you. 

6. Max Out Retirement Plan

As you complete steps 1-5 of the Financial Vitals Checklist, you might be unable to max out your retirement plan immediately.  You are on track as long as you are reaching your savings rate goals (see Lesson One)!  Eventually, your emergency savings will be fully funded, and your high-interest debt will be paid off.  Just keep working on the steps in order.  

Roth IRA

Most physicians and dentists will make too much money to invest in a Roth IRA once they have completed training.  In 2023, eligibility begins to phase out at $146,000 for individuals and is completely phased out by $161,000 (married filing jointly $230,000 – $240,000).  Medical residents can typically contribute to a Roth and may be able to contribute the year they transition from a resident to an attending, depending on how much they earn.  Other medical professionals, such as veterinarians, APPs, and chiropractors, will vary.

If eligible, your next step should be to fund a Roth IRA.  In 2024, the Roth IRA allows an individual to contribute up to $7,000 ($8,000 if age 50 or older), and a spouse can contribute the same.  Contributions are post-tax, meaning with money that has already been taxed.  While this does not save you anything up-front, the benefit of the Roth IRA is that contributions grow tax-free and can be withdrawn at retirement age tax-free.  Someone with $1 million in their 401(k) or other pre-tax retirement account is not actually a millionaire.  If they try to remove that money, they will pay income tax.  Whereas if someone has $1 million in their Roth IRA, they genuinely have $1 million.  The government knows how valuable this tax-free growth is, which is why there are eligibility requirements and contribution limits.  

If you are over the income limits and still wish to participate in a Roth IRA, you can do a “backdoor” Roth IRA.  This article from the Physician on Fire blog does a nice job of explaining the process.  https://www.physicianonfire.com/backdoor/.  

Pre-tax Retirement Accounts

Several pre-tax retirement accounts are available depending on your employer and employment status.  These include the 401(k), 403B, 457, SEP-IRA, and the Solo 401(k).  All pre-tax retirement plans are similar, so while I will discuss the more common 401(k), you can extrapolate it to your account type.  The government created these accounts to allow individuals to take control of their retirement savings.  The government allows you to contribute a defined amount each year without taxing it.  You can then invest the money, which grows tax-free until retirement age when the government will tax any distributions at your ordinary income rate.  

This allows you to save money equal to your marginal tax rate times your contribution in the year you make it.  If you are in the 37% bracket and contribute $66,000 to your SEP-IRA, you will save $24,420 in taxes for the year.  Therefore, pre-tax accounts are more valuable for high-income earners with a higher marginal tax rate.  

You’ve already received your company match in step two, so now you can go back and resume contributions.  At this point, you want to dive deeper into the investments inside your 401(k).  Remember that a 401(k) is an investment account, not an actual investment.  You will have to choose your investment strategy within the account.  Since you are not receiving a match on this money, you want to know exactly what type of investments are available inside your employer’s plan and what fees they charge you.  All 401(k) plans are not created equal.  You want to invest in a diversified portfolio while paying the lowest fees possible, usually by investing in low-fee, broad-based index funds or a low-fee target-date fund.  Keeping your fees low has been shown to increase your returns over time.  

401(k) contribution limits for 2024 are $23,000 for the employee and $69,000 total (employee + employer).  Your goal is to max out the employee contribution every year, particularly if you are in a higher tax bracket (>24%).  How much more you need to invest in this step to max out your plan will depend on how much you have already contributed to obtain your employer match.  To max out your 401k, subtract your previous contribution from $23,000 to find the amount you need to contribute.  

SEP IRA/ Solo 401k

Not everyone is an employee or has an employer that provides a 401(k).  You still have options if you are self-employed, an independent contractor, or your employer doesn’t offer a retirement plan.  For the self-employed, including ICs, there is the SEP IRA and the Solo 401(k).  These accounts have some advantages over an employer-sponsored 401(k).  First, the contribution limits are much higher than the 401(k) because you contribute as both the employer and employee.  For 2024, the contribution limit is $69,000.  

Next, you have complete control over the investments within the plan, allowing you to choose low-cost, diversified investments.  Finally, you can contribute through April 15^th for the prior tax year.  This feature is particularly beneficial for new graduates, as they may have delayed payments or have a lot of expenses as they start their careers, leading to an inability to max out their retirement plan the first year.  This is a great way to catch up for the prior year.  The SEP is easier to set up but has the drawback that you cannot perform a backdoor Roth if you have an IRA.  Solo 401(k) plans are slightly more challenging to set up and maintain but allow for the backdoor Roth option.

Your goal is to get money into your retirement account as early as possible, letting compounding interest take effect.  As a medical professional, you will likely be in a high marginal tax bracket, meaning the money you save from a pre-tax contribution is significant.  Money in a pre-tax retirement account grows tax-free.  You must pay taxes when you withdraw the money during retirement, but if you start early, the money will have grown tax-free for 30+ years.  Additionally, you may be in a lower tax bracket upon retirement than you are now.  

If you are a medical professional earning on the lower end of the income scale, this step is where you may start to feel the pinch in your budget.  You may hit the 25% savings rate before you have maxed out your retirement account, especially if you are an independent contractor.  Resist the urge to postpone your retirement account contributions at the beginning of your career.  Cut back on your lifestyle if needed, but ensure you hit the 25% savings mark.  The money you invest now has the most time to grow and is thus the most valuable money you will ever save/invest.  

Only move on to the next steps once you have completed step 6.  If you are struggling, review your budget again to see if there is any waste you can eliminate.  The lower your monthly budget, the easier it is to plan for retirement, and the sooner you can accumulate wealth.  

Final Thoughts

It isn’t easy to think about your retirement, especially at the beginning of your career.  However, this type of long-term planning will set you apart from everyone else.  Building wealth is challenging enough, so take the easy wins where possible!  Pay off your credit cards and other high-interest debt.  Get your full employer match and fund an HSA if available.  Then, move on to funding your retirement accounts.  In the next lesson, we will complete the Financial Vitals Checklist with steps #7-10.  You can download a complete pdf copy of the checklist here. 

Thank you for reading Business Is the Best Medicine.   Stay tuned for Personal Finance Basics for Medical Professionals I, Lesson Five, where we complete the checklist.  Leave comments and questions below and subscribe to the blog to receive all new posts!