Q.
A two-physician family in their upper thirties living in an expensive part of California earns about $550K per year. They have excellent financial habits, maxing out both retirement accounts and 529 accounts for their two pre-school-aged children, as well as having built a sizable taxable account of approximately $600K. They have a generous emergency fund of approximately 12 months worth of expenses and their mortgage payment including property taxes is only $3500 per month, or approximately 8% of their income.
Their children will soon be entering kindergarten and they, unfortunately, live in a notoriously poor school district. Should they pay $36,000 per year per child for private school tuition or should they move to a nicer, more expensive house (estimated at $1.6-2.4M) in a better public school system? What if they had another child?
A.
This question was sent in by a regular reader on behalf of a partner but illustrates a common dilemma for physicians and other well-to-do families. At first, when I read the email I thought, “Well that's a first-world problem if I ever heard one,” but in reality, it's a California (and Manhattan, and other expensive cost of living areas) problem.
Now, before I go any further, I need to preface this by saying to all the Californians out there that I really do get it. I spent a month as a med student living in Northern California and a month as a resident living in Southern California. California has incredible weather, lots of fun cities, and an irresistible combination for outdoors lovers of both incredible beaches and incredible mountains. Some of the best weeks of my life have been spent climbing in the Yosemite Valley. However, California is a rather toxic place for a physician to live.
California and the Physician Wasteland
On the blog, we have two posts arguing about whether physicians were rich or middle class. This is worth arguing about for doctors in many parts of the country, but in the Bay Area, doctors are decidedly middle class. High cost of living areas are usually coupled with higher salaries, but for California physicians, this is not the case.
My daughter 400 feet up a wall in Yosemite
The pay is pretty similar to that in other parts of the country, and in some specialties even lower due to very low MediCal reimbursement and a high percentage of self-pay patients. This is coupled with the high cost of living, high state tax rates (combined with a highly progressive state tax structure), and in some areas such as LA, high malpractice premiums.
California often leads the nation in many trends, and I wouldn't be surprised to see California lead the way in future physician shortages as doctors flee the smog, traffic, and toxic work environment for Nevada, Utah, Arizona, or Texas.
The Third Way
So, my first answer to the question above is that the choices are not necessarily limited to big house vs private school tuition. You can always go practice in Texas or Indiana or a myriad of other physician-friendly states where your take-home salary will be decidedly higher, and relatively much higher as you won't be competing with .com millionaires for housing and schools, thus making your cost of living much lower. I was surprised to see private school tuition so high as there are very nice private schools available in my city for around $10K per year, but I suppose in California that anything is possible.
The $6 Million Question
Before shelling out $36K a year for tuition, let's consider the opportunity cost. If you invested $36K a year at 5% real for 13 years from age 5 to age 18, and then let it ride until the child turned 65, the child would have $6.3M in today's dollars to retire on. That would provide a pretty awesome retirement, even in California, without the child ever having to save ANYTHING for retirement. Even if you just wanted to give the kid a head start in life, you could just give her the $637K upon graduation from high school. This is no small investment.
The Affordability Question
The couple making this decision first ought to consider whether they can afford EITHER option.
My rule of thumb for housing expenses is 20% of gross income should cover interest, principal, taxes, insurance, and utilities. This couple is currently living well under that, but a $1.6M 30-year mortgage ($2M house) and a 1.2% property tax rate would run approximately $9600 a month. Add on some utilities and insurance to get to about $10,500, and you're looking at 23%. It's a little high by my rule of thumb, but by the usual standards in California, still pretty affordable, especially considering much of the mortgage interest and property tax is deductible at an extremely high marginal rate.
This couple has enough to make the downpayment and should be able to afford the payments. My other rule of thumb is that the size of the mortgage should be no more than 2X the gross income. A $2M house ($1.6M mortgage) is a little high at 3X, but still, by California standards, not too bad, and they could make a bigger downpayment if they wanted to lower it further. Certainly, with more disposable income and high marginal tax rates, the rule of thumb can be stretched a little.
Given their very low cost of living, they can probably also afford the $72,000 per year for private school tuition assuming they stay in their current house. Since less than 10% of their income goes to housing now, they should be able to save 20% for retirement, pay 35% in taxes, pay 13% in tuition, and live off 22% ($121K, or $10-11K per month) of their income, assuming their earnings stay the same. They'd certainly be trading more wealth, fancier vacations, a nicer house, or earlier retirement for the private school education, but what better to spend your money on than your children?
It appears that both options are affordable for this couple, although adding a 3rd or even a 4th child would probably rule out the private school option.
The Case for the Bigger House
It's easy to make the case for the bigger house. A large percentage of the payments would be tax-deductible at a very high marginal rate. The asset is likely to appreciate, and when all is said and done, they'll own a very valuable asset that can always be traded for a cheaper house in California or elsewhere in retirement. In a way, their payments are part consumption and part investment. Plus, you get to live in a bigger, nicer house in a safer, nicer neighborhood. Why should you have to live in a dump when you make a half million a year? Home equity is pretty exposed to creditors in California (homestead exemption is only $100K for a couple) but so is a taxable account.
I'm also a big fan of supporting good public schools because it not only benefits my children but also society as a whole. Aside from a few years at an inexpensive private college, the other 20 years of my education were all at quality public institutions, and I turned out just fine.
The Case for Paying Private School Tuition
Most people who purchase private schools believe their children are getting a better education there than in the surrounding public schools, although that is not necessarily the case. For better or for worse, private school students, especially at a school costing $36K a year, are only going to interact with rich kids and are going to want to keep up with them.
There is also the benefit of not having a large fixed expense like a mortgage. If one doctor stops working, or their salaries decrease substantially, they can always stop sending the kids to the private school, so this option is perhaps a bit more flexible than buying another house.
They also get to avoid the transaction costs which are not insubstantial on California-priced real estate. The $400K they would otherwise use for the downpayment can also be profitably invested elsewhere. In 15 years at 5% real, that would be worth $832K. The property tax may also not be deductible if caught by the AMT as some docs in a high tax state like California are.
My Recommendation
The first thing to consider is whether or not they're willing to leave California. If they are, that's what I would do. But I understand most Californians feel much more strongly about living in California than most non-Californians. So if I really felt I had to stay in California for family or lifestyle reasons, then I would move to the more expensive house. Housing costs would go up approximately $84K per year, but a good chunk of that is paying down principal and purchasing an appreciating asset, whereas all of the $72K per year in tuition payments would be consumed, and they would also get the benefit of living in a bigger, nicer house in a nicer neighborhood. It would become an even better deal to buy a new house if private school tuition goes up or if they have more children.
In the end, you have to spend your money on what you value. You can buy a big house, private school education, a new boat or even plastic or laser eye surgery.
What do you think? How would you advise this couple? Comment below!
Values are extremely important when dealing with such matters; what’s the point in being highly educated and making a good living if you have to put up with living in a less desirable locale like Utah, Arizona, Nevada & Texas!
I am a Californian living in Texas currently and I can’t wait to move back.
-There is a glut of physicians here so I took a hefty pay cut moving to Texas.
-if you are not a tea-party republican, if you are a minority, if you are poor, if you like having amenities like roads, parks, trails, libraries, if you don’t want to pay hefty property taxes, pay more for utilities, pay more for produce, pay more in sales tax (was 7.75% in California, 8.25% in Texas and poised to go up),if you like having a beach, mountain or desert close by, if you can’t stand guns or pick ups, if you don’t like a place where you get traffic tickets in the dozens, bad drivers – you get the idea,
Do not move to Texas!
I’m a Texas physician and I will chime in as well:
-There is a glut of physicians here so I took a hefty pay cut moving to Texas.
(Depends on your speciality. I just opened a practice and am growing quite well. The D/FW area is one of the fastest growing Areas of the country for the last several years)
-if you are not a tea-party republican, if you are a minority, if you are poor, if you like having amenities
(I would agree with this. Heavily republican outside of Austin and parts of D/FW). However our roads are actually much better than most states
– Property tax can be high in Texas but comparably not much higher than a lot of other places I have lived. Plus no state income tax. Sales tax isn’t a worry. I have only lived in one location where it was less than 7.5 (Hawaii).
I actually made the same move as Dr. O but have loved leaving california for texas. My pay is slightly higher but there is no state income tax, a large homestead exemption, the schools are much better, and there is an actually vibrant middle class.
I think Dr. O either is getting his info from the huffington post or lives in a pretty conservative part of the state. Because we all know that orange county, san diego, and inland empire arent conservative at all. Or that sf and la pretend to care about the middle class, but have politicians sell working class out for ridiculous union benefits or upper class kickbacks to big companies
The main tax here is sales tax, amd unlike cali, property taxes which allow me to have much better public schools. The traffic isnt as bad, gas is cheaper, and you get about 5x more house for your money (maybe more if you compare to SF)
The only thing i miss is the weather and some of the people i know there. Everything else has been way better. I just hope people in ny and cali dont realize this because theyll come here and mess everything up politically like they did there. Texas is not perfect, but unlike california which isnt perfect in more ways than their residents rationalize to themselves, i openly admit the traffic, sprawl, and weather here arent great. But the positives of texas outweigh the negatives, and ive voted with my feet and dont regret it. Except in july/august– but thats why everything is air conditioned 🙂
A little off topic, but what a cute kid! How old was she when she scaled that rock wall?
I have been begging my wife for years to move to Texas. I have been to Dallas, Houston and San Antonio and they are all beautiful.
California clearly has better weather and beaches but this all comes at a cost. Instead of paying $400,000 for a down payment on a house that would run them about $10,000 per month, they could move a major city in Texas and buy their house outright and probably get a nicer house than the one they would have bought in California for $2 million.
Now, they are bringing in half a million dollars a year, their kids are going to a nice school, and their real estate taxes are negligible. They won’t have a mortgage deduction but they will also have no state tax. I think the state tax in California is approximately 10% so this will automatically save them $55,000 per year. They will have plenty of money to visit California as often as they wan.
Obviously there are personal matters. If all their family is there it would be a reason to stay, or they just love the weather. But these aren’t as important factors, making a move is the best financial decision.
Felix
They will have much more disposable income to do whatever they want with.
Dr. G,
Beauty is in the eye of the beholder. I lived 7 miles from work in Cali and it took me 15 minutes to make it there, now I live 20 minutes from work in Texas and it takes me 45 -60 minutes to make it there. So I am filling up more often, crossing out the gas savings.
The drivers are so brazen (everyone drives a pick up truck)that I have been involved in 3 accidents here, very one of them have been the other party’s fault.
Quality of schools here depend on where you live, like everywhere else in the country.
I would love to say Texas is a low tax, low service state but that would not be accurate. They tax just as much by labelling them as fees and fines while nickeling and diming you to death.
On a lighter note, it’s nice that we are in a vocation that gives us the option of choosing where to live. While Dr. G and I are California transplants to Texas, he is loving it while I long to be back in the golden state.
Homeschooling is an option no one here has mentioned yet. It’s on the rise, not just among families with a stay-at-home-parent, but even among dual-income couples with children. Sometimes the public school system has set up a hybrid school that caters to homeschooling families – where they can drop the kids off, where there is help with curricula, and where there is a high structure with some accountability. If the kids are moderately to profoundly gifted, homeschooling might be an even better academic option than the average private school.
Certainly, before you leave for Texas et. al., it is worth your time to actually set foot in the local public school and sit in on a class to make sure whatever you’re hearing about it is actually true. Too many people listen to hype (good or bad hype) and fail to evaluate the school for themselves. It might be that this so-called “bad” school is the victim of rumor, and might just be a great fit for your children.
This is my first posting on this great website, but it couldn’t have been on a more applicable topic. Like Dr. O, I too hail from California. Undergrad at UCLA, medschool at UCSD before re-locating because of the military. Never, EVER, did I even consider the possibility of living anywhere other than Southern California. The weather, the mountains, the beaches….
But ignorance is bliss. I didn’t worry much about taxes and cost-of-living back then. A frugal student can live most anywhere and pay little in taxes. Now I have a family and a two-doctor income. Cost-of-living, state income taxes, malpractice premiums, and the resultant potential for an extra $100-200K in disposable income are a tremendous consideration.
I’m sorry Dr.O lives in a crappy part of Texas, but there are some damn crappy parts of California too (Bakersfield, Fresno, Riverside, El Centro, etc…) if we really want to compare apples to apples. I’d be damned to live in a place like that and still endure the high taxes, over-regulation, and high malpractice premiums that sadly define California.
And since when did Utah, Arizona, and Nevada become such undesirable places to live? Ironically, that’s precisely where the mass exodus of businesses and high-salaried professionals from California are moving to.
Until California goes bankrupt and restructures (highly doubtful), I foresee a continued exodus of physicans like myself from California. Folks who’ve made the concious decision to trade in the beautiful weather of So Cal for States with some semblance of Governmental restraint and fiscal sanity.
Have they considered charter, magnet, or parochial for grade school? I can’t say I know much about these but they’re certainly less expensive options. Then switch over to private in high school when it might give them a leg up for college admissions.
Are they happy where they are living? Moving to a “nicer” neighborhood has alot of hidden costs, i.e. the urge to Keep Up with the Joneses, that could cost much more than $72K a year.
Very cute daughter by the way…I’m impressed with her climbing skills at such a young age!
Another alternative is to have a tutor to make up whatever the local schools might not do so well. In addition you can come live here in Jackson Tn. Low costs, reasonable weather, decent private schools etc. You probably won’t make as much but won’t need as much either.
The outline and details you give of this couple could be me and my wife. The only difference is that we already live in Texas. We were faced with the decision to move for a bigger house and better school disctrict or send our two kids to private school. Because we have been smart enough to have our financial/investing house in order prior to leaving residency, and because of the low cost of living in Texas, we were able to build a custom home (bigger than the last) AS WELL AS send our kids to private school! Additionally, we have the ability to have a live-in nanny to help with shuttling the kids and looking after them when we are both late from clinic, early to surgery, or on call. It is worth saying that the choices you make, make a difference. We had the opportunity to start our practices in California, but decided against it due to the expesive cost of living. True Cali is beautiful, but by living in Texas, we have the disposible income to travel all over the world.
i plan to move back to Texas when i retire. The worst part about Texas from a physician standpoint is that they are really slow at licensing and you have a silly jursiprudence exam which adds zero value to the care you deliver. Im ambivelent on the 1 hour of ethics per year requirement. I dont think it adds much but maybe they arent focusing on me.
The licensing, while still a 3 month wait, has improved significantly as of late. It was 6 months to 1 years easily before.
Lest anyone forgets we also have great tort reform here. Beyond that the tort reform was made part of the state constitution, so it will take much more than a political whim to reverse it.
Perhaps another option would be buy condo or rent a place in good school district. Live there during week or enough to legitimately establish residency and spend weekends at current home or nicer home further away.
There is no place like the west coast— of Florida that is. Great weather, beaches, no income tax and reasonable property taxes (higher yes – but based on values that are much less then the left coast or the northeast).
However, i assume these folks are not moving. This is a tough question especially when you have the means to send your kids. I think this goes beyond finances and you have to go with your gut. Then ignore what others say once you have decided what is best for your kids.
Agreed, however, Florida is a tough state malpractice-wise. TX, CA, and IN are much better.
Another vote for considering homeschooling. It’s not for everyone, but it’s certainly worth looking at, especially if you’re unhappy with local public (and private) school options. You can give your kids a stellar education and fully enjoy their fleeting childhood. Not only does one spouse spend much more time with them, but family time is much easier for the working spouse to find as well when they aren’t beholden to a school schedule.
A reasonable option, but probably not for a full-time, two-doc couple.
This is my family, pretty much. I live a few miles from Apple headquarters in a $900K crapshack with “good” public schools. But we’re staying in the cheap house and sending the kids to private school. Having said that, $37K for elementary school is really at the very top of the heap. Truly excellent private schools can be had for more like $20-25K around here. I can only think of one or two schools that charge >$35K for elementary and those school really do offer something special.
I’m sorry, the post is relevant, but some of the comments (on both sides) are ridiculous. How about this: You should live in Texas because when the Zombie outbreak occurs, you’ll be safer in Texas. Everyone (and I do mean everyone) carries a gun, has one in their car, or at a bare minimum has one in their house. We also have one of the most generous “imminent danger” laws in the country for the non-zombie criminal element. The police in Texas actively encourage gun ownership and for citizens to get their concealed handgun license. I feel safe from Zombies and mass shootings when out in public because I know at least one in four people around me are packing heat. May Texas live Long and Strong! By the way, we want our gold back from the Federal Reserve!
I have to say, the responses to this particular topic leave me bemused and a bit deflated. Is the country in such sad shape, and are physicians really this materialistic? I want to ‘make a living’ as much as anyone, but have never counted my ‘success’ in terms opulent living/ net wealth. I’ve managed to scratch by, practicing primary care medicine while my wife (not a physician) actually raised our children (you’d be surprised – though you shouldn’t be – what a difference that can make in how they develop, and what kind of person they become), none of whom attended a top-ten first-tier University yet managed to become well educated and successful in their fields. Though still in my 50’s, I’ve been in a position to retire for quite some time – if I wanted to. It seems I enjoy practicing medicine (lord knows it’s not for the money), and being a positive force in my community. And I don’t have to drive a Porsche to feel successful. Seems maybe I’m the odd-man out. And an aside – I live in the Midwest. I’ve visited California, and Texas; nice places to visit… but certainly not worth (to me) the premium cost of living.
I think you prove my point. A sole-earner family doc can earn a nice living for him and his family if he lives in the MidWest. Now imagine your house costs $2 Million. See how that changes things?
I don’t think docs are as materialistic as they appear, but do keep in mind this site focuses predominantly on finances. Talking about money obviously makes you appear more materialistic than if the site were focused on how to best provide charitable care. It doesn’t mean those who come here only care about money and don’t care about providing charitable care, that just happens to be the focus right here and right now. Not to mention the age-old adage – “No Margin No Mission.”
Hi George, I agree with WCI’s response. I think many of us younger readers are aiming for what you already have. I know I am. I for one, enjoy teaching both medical students and residents, and have chosen a career in academic medicine. Though, material gains are not my primary concern, I am interested in educating myself and my students about about the importance of financial literacy.
I hope to one day be in the position that you are in. I would love the ability to practice at age 50 knowing that I can retire if I want to. I think that adds to the joys of teaching and practicing medicine. In order to do this, I feel more so now than ever, young physicians need to take the time to educate themselves in personal finance with an eye on disability insurance and asset protection at the very least.
Also, thank you for reminding us that we are in a very privileged position. Despite my own debt, my disposable income will give me the ability to provide for my children financially, and if I play it right, provide me with more time to spend with my children.
Materialism? Are we reading the same article? The questioner is trying to figure out what financial decision will result in the best education for their children. Isn’t that the very opposite of materialism?
I think “move to a lower cost of living area” is always sound advice. I would assume that the subjects of the question can not do so for one reason or another. If they have the sense to keep their finances in order, I’m sure they would have considered that approach.
In my opinion, given the uncertain state of medical incomes in the future, this couple should do whatever they can do to keep their taxable portfolio intact, ie- not spend it on a downpayment, and continue to grow it, if possible, but not taking on a higher recurring monthly expense.
I think the best option would be if they could find a decent public option in the area, and next best would be a lower cost private or parochial school, as suggested above.
I beg to differ that places like Utah/Arizona/Texas/etc are undesirable. That is certainly going to be a different perspective for everyone. Even if they are, why not live in a place with good schools but use the savings to go on vacation to california/more “desirable” places? Utah and Arizona are just an hour or so by flight that you could fly once a month (or more) for a weekend getaway.
We have friends in Mountain View who, as not-doctors, make considerably less than 550K/year (probably 200K/year). They own a home in a nice school district that they put 40% down for. These doctors in the question can easily afford either private school or a nice, but small, home in a great school district. And with small homes, it’s harder to find stuff to buy, so you save money that way too.
As to which to choose, I’d look at commuting costs and the relative value of the schooling options as deciding factors. Also neighborhood amenities– Mountain View has a lot of nice stuff that you can walk to, and nature is a pretty easy drive (and SF a BART commute) so again, you don’t need to spend so much money living there to have a wonderful life. There are a lot of Northern California suburbs with varying amenities. Look at the complete package.
Hi all,
Love the post. I practice out here in Southern California. I tell the Anesthesia residents who are from out of state to enjoy their 4-5 years of residency in the golden state. When they are done, head back home to their state of origin, or head to Texas. No need to practice in Southern Cal if no ties to the region, ie. family.
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My wife and I both make good incomes (she’s the doctor, I work in the business world) and live in Northern California. This topic is highly relevant as we currently rent, as ridiculous as that is given that we’ve been very fortunate financially, have accumulated significant wealth, and have no debt. We could own a mansion in many parts of the country (could buy in cash in many places), but the costs here mean that the math still seems less compelling than I’d expect it to be.
In addition to the article and points raised in the comments, I would submit that there’s an aspect of market timing that may make sense to factor in here as well, but would be interested to get the thoughts of others and the WCI. What I mean here is that we are currently in the 10th year of an economic expansion, the most noteworthy (although not sole) beneficiaries of which have been tech companies. Being more of a value investor at heart, I suspect that at least some of this is illusory, and there is at least some amount of bubble behavior in the real estate market here. Many will respond to this with “real estate here didn’t go down during the last downturn”, but I call major BS on that. Anyways, my 2c is that there’s a point where it probably makes sense to wait out an economic cycle (I’d argue we’ve been at that point here in NorCal for a number of years) and then evaluate buying once conditions have normalized. Especially when rental vs. buying costs have diverged as much as they have here and we’re able to accumulate significant wealth through other means. Buying into the real estate market now seems like it involves taking substantial risk in wiping out a lot of hard-earned equity the minute sentiment changes on the long-term prospects of companies that don’t make any money. In the meantime, I’ll be building my war chest and still enjoying the many other benefits of living in California.
I’d actually argue that in many places this logic probably holds as well, although to a lesser extent. I think in most places (barring perhaps some shrinking economies like the rust belt), the cost of real estate is the highest it’s ever been. That should probably be a note of caution for any would-be home buyer at the moment. If the math is compelling vs. renting, then sure, but I would be cautious about what assumption you use about house price growth when doing that math. That metric is (as I understand it), very sensitive to small shifts in sentiment and behavior given that prices are based on a small percentage of the total volume of the asset, since most houses are not sold in a given year. In other words, small shifts in the appetite of buyers within our outside the local market (i.e. Californians going to other states or non-US buyers purchasing homes in major cities), and demand and thus prevailing prices could change a lot. Over the long term there will still probably be growth in many places, but tell that to people who bought a place in the Vegas suburbs in 2007.
I know I covered a lot of ground here, but would be interested to hear what you all think.