How confident are you that you will be able to retire comfortably? In 2014, only 18% of workers said that they are very confident they can retire comfortably. That means that the vast majority of people – 82% – are either unsure about retirement or just plain scared. In spite of the common misperception that all doctors are rich and set for life, many physicians find themselves in the 82%. According to a 2014 Fidelity Investments report, physicians are on track to replace only 56% of their income in retirement, far below the 71% that Fidelity recommends. Even though they have above-average incomes, most doctors also face several disadvantages when it comes to saving for retirement.
In many professions, a person graduates from college at age 22 or 23, enters the workforce and is able to begin saving for retirement. Not so for most physicians who, because of the amount of schooling involved, do not enter the workforce until their 30’s. Not only do they miss out on some of the benefits of compound interest, but they also have a shorter amount of time in which to save. Furthermore, many doctors come out of school with immense student loans that take years to pay off, shortening their savings horizon even more. Because of their higher incomes, physicians are not eligible for all tax-advantaged savings programs and tax benefits and will also receive lower social security benefits in retirement. Regardless of these disadvantages, with their high compensation, physicians should be able to retire comfortably, and there are several ways in which they can maximize their retirement savings to give them such confidence.
Maximize Tax-Advantaged Accounts
Many employers offer a 403(b) or 401(k) plan which allows employees to save up to $18,000 ($24,000 for those over age 50) a year pre-tax. According to the Fidelity Investments report, 60% of physicians less than 50-years-old and 30% of those over 50 did not save up to the limit. Tax-advantaged accounts are one of the most effective ways to save for retirement and entirely too many doctors are not taking advantage of the opportunity. For a doctor that finds himself in the 33%+ tax brackets, being able to save for retirement prior to paying out that 33%+ puts him in an incredible position to build wealth for a comfortable retirement. One of the first things anyone looking to bolster their retirement savings should do is take advantage of every benefit offered by the IRS and maximize their tax-advantaged accounts.
Open an IRA
Another tax-advantaged retirement savings vehicle that anyone with an income or a spouse earning an income can utilize is an IRA, or Individual Retirement Account. If maximizing your 401(k) or 403(b) contributions is not enough for you to ensure a comfortable retirement, by opening an IRA you can save an additional $5,500 ($6,500 for those over 50), and your spouse can do the same, even if you are the only one earning an income. One caveat, though, is that if you or your spouse has access to a retirement plan at work, your ability to deduct IRA contributions on your tax return is limited by your adjusted gross income ($118,000 for married filing jointly and $71,000 for single or head of household), and most doctors earn too much to qualify. However, if neither you nor your spouse has access to a retirement plan, all contributions are tax deductible.
Convert Your IRA
There are two types of IRAs, traditional and Roth. In a traditional IRA, as discussed above, contributions can be tax deductible, but usually not for high-earning physicians. With a Roth IRA there are no tax deductions, but the account grows tax-free and there are no taxes on the withdrawals once the account holder reaches age 59 ½. Also, there are no required minimum distributions, so money can be left to grow tax-free in the account in perpetuity. Only those with an adjusted gross income under $184,000 can contribute to a Roth IRA, so most physicians are ineligible. However, there is a way to move money from a traditional IRA to a Roth regardless of income level called a “backdoor” Roth conversion.
At the end of the year in which you contribute to your traditional IRA, you must submit a Roth Conversion Form to your brokerage, who then distributes the money from your traditional IRA into your Roth account. You have to make sure that your tax preparer knows that the distribution went to the Roth so that you are not taxed on it. It is fairly simple if you are starting from scratch or have never received tax deductions on your IRA contributions. However, if you have accounts where you have already received a tax benefit, such as an IRA that was rolled over from a 401(k), or one where you previously received tax deductions, it is more complicated. You can’t simply contribute $5,500 in the current year and then convert it tax-free. The tax basis is based on the total in all IRA accounts. If your current year contribution makes up 10% of your accounts overall, then only 10% of your conversion is tax-free and you have to pay normal income taxes on the other 90%.
Maximize Your Health Savings Account Contributions
One more tax-advantaged way to save money for retirement is to maximize your Health Savings Account, or HSA, if you have one. HSAs are often offered in conjunction with high-deductible health plans and are a way to save money pre-tax towards qualified medical expenses. You should definitely maximize all other tax-advantaged accounts first since that money can be used for anything in retirement, but afterward, an HSA is a great way to protect your retirement savings from taxation. Even if you do not currently have many medical expenses, as you age your medical expenses will increase and you will be able to use the funds in your HSA instead of paying with after-tax dollars.
Minimize Fees
Often overlooked, another thing that can impact your retirement savings is the fees that you pay for investments, advice, and plan administration. Fees and commissions can really add up and the effect on your nest egg becomes exponential as time goes by. If you were to invest $100,000 in a mutual fund with an expense ratio of 2.5%, after 30 years, assuming an 8% growth rate, you would have just under $500,000. Now, if you took the same money and invested it in an indexed mutual fund with an expense ratio of .25%, after the same amount of time with the same rate of return you would have just under $940,000. That’s close to half a million dollars just because of a small difference in fees. The finance industry is notorious for having all kinds of confusing fees, so make sure you understand what you’re paying and how it will affect your retirement savings.
Asset Allocation
Where you have your money invested is second only to your savings rate in determining how much you will have for retirement. Whether your money is invested in growth stocks or treasury bills has a huge impact on your returns. Talk to a financial professional to make sure that you have the correct asset allocation based on your risk tolerance and savings horizon. Remember, even if you retire at age 65, there’s a great chance that you’ll live another 20 or more years, so you don’t want to miss out on 20 years’ with of stock market returns by investing too conservatively just because you’ve reached retirement age.
Take Care of Yourself
One thing you can do to maximize your retirement that has nothing to do with finance is to take care of yourself and maintain a healthy lifestyle. Your biggest wealth building tool is your earning potential, or human capital, and you need to protect it just as intently as you do your investments. Poor health (physical, mental and emotional) can be very costly, not just as it impacts your career and your ability to earn an income, but with expenditures as well. Preventable medical expenses take away from what you could be saving towards retirement. Staying healthy also makes the next recommendation possible.
Work Longer
One of the simplest and most impactful ways to improve retirement savings that many people don’t even consider is to work longer and delay retirement. This is beneficial in two ways; first, more income earning years means more money saved towards retirement, and second, more years working means fewer years retired and living off of savings, which requires less savings.
Practicing medicine makes this much more practicable, as it is more of a mental, rather than physical, discipline, there is high demand, and opportunities for part-time work and shared positions abound. It is not unusual to meet up with 75-year-old doctors who are still practicing. The nature of the profession makes it feasible to slowly ease out of the workforce, as opposed to many professions that require either full-time work or full-time retirement. Medicine allows for many more options, so that you can tailor your work to your retirement needs and desires.
Setup a Defined Benefit Plan
Finally, if you own your practice (or can influence the owners) and want to be able to save more than what your 401(k) or 403(b) and IRA limit you to, you can have your business set up a defined benefit plan. Defined benefit plans have much higher tax-advantaged contribution limits and can be designed to fit the needs of almost any practice and its owners. Depending on your age and income, a defined benefit plan allows you to set aside up to hundreds of thousands of dollars to fund your retirement, making it possible to save a lot, even if you have little time.
Defined benefit plans can be complicated to establish and administer, so it is important that you work with an experienced professional. If you are interested in finding out more about defined benefit plans, I can explain the different options available to you, answer any questions you may have, and help you implement this critical part of your retirement planning strategy. Please contact me at 480.494.8992 or by email at info@ff401k.com.
About Kenny Phan
Kenny Phan is a Managing Partner at FinancialFocus Retirement Plan Services, a 3(16) fiduciary. He works as a pension specialist who partners with financial professionals to design and implement pension plans. His area of expertise is customized defined benefit, defined contribution, and 401(k) plans. Serving financial advisors and businesses in the greater Phoenix area, he is supported by FinancialFocus Retirement Plan Services. Together, they provide comprehensive plan design consultation, administration, document installation, compliance testing, as well as IRS and DOL reporting for qualified retirement plans.