Tag: retirement accounts

What’s a ROTH Account and Why Does it Matter?

There are few inevitabilities in this world, certainly death and taxes. We’re going to skip the former and talk about the latter: Taxes, and why it matters when decided which type of retirement account to choose.

A Tale of Two…Accounts

In the world of tax advantaged retirement accounts, there are two main types that you can have: Traditional or ROTH. The big differences between the two are when taxes are recognized on the accounts. The great feature that both types of accounts share is that earnings recognized (dividends, capital gains) in the account aren’t taxed.

What’s the Deal with Traditional 401k’s or IRAs?

For a Traditional Retirement Account, contributions made to the account are pre-tax dollars, which means that these contributions aren’t taxed and also reduce your tax exposure for the tax year in which they are made. You can’t avoid taxes forever – when you do take a withdrawal from a Traditional Retirement Account, you will pay taxes on that as income.

Most suggest that when you are in your higher income earning years, you should contribute to a Traditional retirement account to defer taxes until withdrawal. This is based on the theory that you’ll have a lower overall tax burden in retirement than when you are working. For example, say you make $300,000 – your effective tax rate (taxes paid/gross income) will be higher than when you take withdrawals in retirement from your various accounts. This is very much based on your personal situation, but it can be used as a general guide.

How about a ROTH 401k or IRA?

ROTH account contributions are made with post-tax dollars, meaning that you’ve already paid federal taxes for that income. Because of this, the money in a ROTH account is never taxed again – however there’s always an outside chance that Congress might change the rules, though most consider this outcome unlikely. For ROTH IRAs, there are additional income limits – once you make a certain amount annually, ROTH IRA contributions aren’t allowed. (I have some suggestions for those who are above or near the income limits). For ROTH 401k and other employer sponsored plans, these income limits don’t exist.

It’s worth noting that there are two main ways to have a retirement account, through employer sponsored plans (401k, 403b, 457b/f) or opened yourself (IRA – Individual Retirement Account). The big difference between an IRA and employer sponsored retirement accounts are the contribution limits. An IRA is limited to $6,000 annually while an employee sponsored plan allows up to $19,500 of employee contributions annually. There is a big advantage to having access to an employer sponsored plan for the higher contribution limits. However, this is only valuable for those that make enough to comfortably contribute the full amount to their employer plans. The ideal situation is to make the max contribution to both your IRA and employer plan, to maximize tax advantages.

I Want to Start Investing, Which Retirement Account Should I Pick?

Though very much an individual decision based on your circumstances, I would generally suggest that if you are in your residency, fellowship, or early in your career, choose the ROTH option to maximize your tax-free account growth over decades. It’s the option that I choose for my 401k and I make contributions to The Surgeon’s and my (the SurgeonSpouse) ROTH IRA annually.

For some real numbers to understand the potential saving and investing opportunity, here’s how much The Surgeon and me can potentially save in tax-advantaged accounts annually:

Surgeon’s ROTH IRA$6,000
SurgeonSpouse’s ROTH IRA$6,000
SurgeonSpouse’s ROTH 401k + Employer Match ($6k)$25,500
Total in retirement accounts for tax year 2020:$37,500

If we take that $37,500 and invest it in the market for the next 30 years, (even if we don’t add any more to the initial investment) and account for an 7% annual increase in the market (not including inflation), this will be worth $285,000. If you make consistent annual max contributions (of $37,500 in this scenario), this could potentially grow to $3.8 million in 30 years.

Given the recent tax cuts and overall tax environment in the US currently, many speculate that this is the lowest tax rates we might see in our lifetimes (as a card carrying millennial here). If we’re basing our investment decisions on this theory, then it’s definitely a wise choice to pay taxes now and invest in a ROTH account.

What’s the TL,DR?

In summary, choose ROTH accounts (if available) early in your career to put away as much money as you can post-tax into tax advantaged retirement accounts. If you don’t earn enough to comfortably make maximum contributions to all accounts (don’t worry! life is a marathon, not a sprint), contribute what you can to your ROTH IRA first.

I know I just threw a ton of information at you – what questions do you have? Leave a note about your retirement account investing strategies in the comments! Whether you’re just starting out, or a seasoned investor, taxes are always an important component to consider when saving and investing.

-SurgeonJourney

How To Save Money When Your Program Doesn’t Offer a 401k or 403b Match

Working like a dog, Eight days a week?

You’re working those 80 hour weeks (at least), and stoked to be putting some money on the positive side of the ledger after years of studying and taking out loans. Hooray!

Talking with your non-medical friends, you hear about employee sponsored retirement plans like a 401k or 403b (for tax-exempt organizations) and are looking forward to getting a match on your hard earned contributions – BUT WAIT.

NO SOUP MATCH FOR YOU!

In most cases, residency programs do not offer a match for retirement contributions. While conducting research for this post, I reluctantly stowed my righteous indignation (for all residents) after learning more about the regulatory process for 401k and 403b programs.

These employer sponsored investment options are means-tested, specifically meaning that there are onerous regulatory requirements to ensure that an adequate distribution of employees across income ranges are taking advantage of the programs. If there are a disproportionate amount of high-wage earners using employer sponsored retirement program relative to the rest of the workers, the employer can be penalized.

If your employer doesn’t offer a match, particularly for a 403b, it’s likely this is because there will be less administrative fees associated for the plan as it doesn’t need to be means-tested. In this case, you won’t get a match, but you also aren’t hit with more management fees.

For comparison, at the SurgeonSpouse’s non-medical employer, I pay $12/quarter in management and regulatory fees to Fidelity – not that bad, really. The company also shoulders some of the fees, and the choices I have for investment are not amazing – more target funds and less passive-indexing ETFs. Nevertheless, I do get up to 6% salary match on my contributions, so not complaining.

I Don’t Get a Contribution Match, What Should I Do?

While in residency, take a look at you income holistically – I’m going to take an educated guess that (if you’re a resident) you’re in the $55,000 to $70,000 range, depending on your Post Grad-Year. Based on this, you’re going to want to be thoughtful about how you deploy your income from housing to food to entertainment to savings. I get it, you gotta eat – and you should.

Here’s my recommendation – focus on personal retirement plan options, specifically the Individual Retirement Account, or IRA, as it’s usually known. This plan is similar to a 401k/403b in that it provides pre-tax (traditional) or post-tax (ROTH) contribution options, though that’s where many of the similarities end.

The contribution limits for an IRA are lower ($6,000 in tax year 2020) than an employer sponsored plan ($19,000 in tax year 2020) – but you have more flexibility for investment options. Nearly all well-known brokerage houses offer IRA accounts. I use Vanguard and recommend them for their low fee ETFs. Fidelity, TDAmeritrade, and others offer IRAs as well.

How Much Should I Contribute?

This is a very personal question and very much depends on your situation. Say you’re making $60,000 a year. If you do make the maximum IRA contribution, that’s 10% of your pre-tax income – and we haven’t even talked about taxes, housing, loan payments, and living costs.

My advice is that it’s important to begin saving and investing as soon as you can, but don’t eat less so you can save more – you can be thoughtful about how often you choose to eat out and take more affordable vacations, for example.

If you’re looking for a specifically number, set a goal per year and break that up into a contribution each month. Perhaps you want to save $2,000 or $4,000 a year – that’s $167 or $333 a month – not bad! Every year that you save, even something, will grow for the decades to come. Over the long run, the US market grows roughly 8% per year.

Why Contribute at All?

With a high-income on the horizon, it can be tempting to delay saving, but the power of time and compound interest is potent – even Warren Buffett noted it. There’s an apocryphal tale of Einstein & compound interest as well, either way – it’s not wrong. Basically, the more time your money has to grow, the more you will have years from now – with less work. Remember, IRAs don’t allow non-penalized withdrawals until you’re 59 and 1/2 – this is putting money away for the long term.

Image result for einstein compound interest

Additionally, getting into the habit of saving now will help set you and your family up for a comfortable, less-stressful future – particularly as you get closer to retirement.

Questions?

While a seemingly simple question, there are lots of things to consider between employer sponsored and employee retirement accounts. Let me know what questions you have in the comments!