I realized something recently. I'm not sure why it took so long. It seems simple and obvious now. You've probably already realized this, but if not, here's a nugget of truth:
You Can't Spend More Than Half Your Income
I'm not talking about net income. Physician on FIRE challenges those seeking FIRE to “live on half.” That's not what we're talking about here. I'm talking about the answer to this question:
How much of my gross income can I spend each year and expect to be able to sustain my standard of living throughout my life?
It turns out the answer to that, at least as a general rule of thumb for a high-income professional, is “about half”. Why is that you ask? Because the other half has to go to taxes and savings. It has to. The taxes aren't optional and they're going to be fairly high for most of us during our peak earnings years. The retirement savings is optional, I suppose, but not if you wish to actually avoid eating Alpo.
Take a look at the math.
Taxes Eat Up Lots of Your Gross Income
First, let's think about taxes for a bit. When I was making the average physician income, my effective tax rate was in the teens. But it turns out I was a fairly unusual case. Most docs pay an effective rate in the 20-30% range, some a little more, some a little less. So if you subtract out 30% of your gross income for taxes, that leaves you 70%.
Safe Savings Rate
Next, let's look at what kind of a savings rate is needed to provide a reasonable retirement. Long term readers know I generally recommend docs use a 20% saving rate. Will they be okay with 15%? Probably. But 5-10% just isn't going to cut it. Let's demonstrate why it needs to be higher than that with a simple future value calculation.
Let's take a doc making $200K who starts saving for retirement at 35 and hopes to retire at 60. She earns 5% real on her investments and saves 20% a year? How much will she have at age 60 and how much of her pre-retirement income will that replace? Plug this into your friendly spreadsheet:
=FV(5%,25,-40000) = $1,909,084
Spending more than half your income is riskier than rappelling
Multiply that by about 4% and it gives you an income from your portfolio of about $76K real per year. That's about 38% of your pre-retirement income, which is smack dab in the middle of that 25-50% range that a typical doctor needs in addition to Social Security to maintain her standard of living in retirement, assuming the kids are launched and the house is paid off.
So subtract out another 20% from that 70% you had after taxes and that gets you to 50%. That's what you can spend if you hope to avoid ever having to decrease your standard of living. Said another way, if you spend more than that regularly, you're going to have a lower standard of living in retirement.
Higher Earners Have It Worse
The percentage gets even worse if you make and spend more than the typical doctor. That's because the tax code is progressive. It is progressive during your earnings year and it is still progressive in your retirement years. In addition, the more you make and spend the lower your relative contribution from Social Security will be.
Consider another example:
How much peak earnings income does it take to create a sustainable $400K a year after-tax spending level? A lot more than you might imagine. Let's start at the end and work back to the beginning.
In order to spend $400K a year in retirement, you need about 25 times that as a nest egg, or $10 Million. At that sort of spending level, Social Security can almost be ignored. But wait, you need $400K in after-tax money. At that sort of tax bracket, you're probably looking at an effective tax rate of at least 24%, perhaps 32% even in retirement. So we're really talking about perhaps a $13 Million nest egg.
How much do you need to put away each year at 5% real to have $13 Million after a 25-year career?
=PMT(5%,25,0,13000000) = $272,381.
So add that on to your $400K. Now we're up to $672K you need to earn in order to sustain a $400K spending level. But wait, we haven't considered the taxes as you're earning the money. At that sort of income level, perhaps 35% of what you earn is going to be going to the tax man. That means you need a gross income of $1.04M during your career to sustain a $400K spending level throughout your life. That's 38%, significantly less than the 50% for an “average doc”.
Sobering isn't it. I've written before that you can never grow all the way into your income. If you're smart, you'll never grow into more than half of it and you'll begin your career living like a resident on much less than that. And we're not even talking about retiring early here. This is just regular old retirement.
What do you think? Did you imagine that you would only be able to spend 40-50% of your gross income when you applied to med school? How much of your gross income do you spend after taxes and savings? Do you think that is too little or too much? Comment below!
When I look at some of the older retirement calculators, they would assume that you would spend 70% of your final salary in retirement. Even Wade Pfau calculated his safe savings rate under two retirement spending assumptions: 50% of final salary and 70% of final salary. When you look at his results in table 1, the 50% assumption is more realistic if you want to spend the same amount during your working career as you do in retirement.
Here’s Wade Pfau’s article for those interested:
https://www.onefpa.org/journal/Pages/Safe%20Withdrawal%20Rates%20A%20New%20Approach%20to%20Retirement%20Planning%20over%20the%20Life%20Cycle.aspx
Yes, come to think of it. 30% tax rate. 20% savings rate. Half of gross for spending. Pretty clever. I spend a lot less than that, but it is good to have a rule of thumb for an upper limit on spending. Glad to see you are coming up with new insights after all these years.
Very Thoughtful. The importance of a high savings rate in your early career cannot be overemphasized. When you look at your expenses taxes and savings should always be at the top. If you neglect to save enough early on you will not be able to retire comfortably. I think you can dial it down when you reach “enough”.
Having watched physicians over my career my observations indicate that most do not live beneath their income. Many do not save outside of their tax advantaged savings (which isn’t enough). I have counseled fellow physicians using the same financial calculations you demonstrate. There is a deeper psychology at work here. I believe that this website draws those of us who get it. Those who don’t will not likely change. I had an awesome career. My family enjoyed without skimping a very nice life. I spent much less than my income and invested prudently. I now have resources in retirement that provide income far above my needs and wants. I think you approach this smartly by addressing savings rather than some fancy investment maneuver that increases returns. Nice post.
But if on retirement you have income to support far more than needs and wants, did you optimize spending while younger? Or were you needlessly frugal and missed opportunities for more balanced spending? 🙂
Q-school-
you kinda’ miss the entire point. any fool can spend. takes discipline and emotional intelligence to not waste your money. besides i have yet to meet anyone that has ever said, “dang i wish i had saved less”. i only meet broke people (or very well off people from others’ money) who like to tell me chill out and spend more. i know for myself “winning” is leaving my family with a legacy, whether that is cash or something tangible. Not zero. a legacy.
My family missed absolutely nothing. Paid for two college educations and two very elaborate weddings. Lived in a nice home. Drove nice cars. Traveled extensively and really never felt that we were skimping. I think the key was hanging out with middle income people. My children benefited by not whitnessing overindulgences and crazy rich behavior amongst their friends. My net worth after three years of retirement at age 68 is in the low 8 digits. My physician friends who hung out with major oil company CEO’s tried to keep up by buying multimillion dollar homes, driving over the top cars reloading every two years, making stupid “prestigious” investments in winery’s and building crazy stupid ski resort homes. I know for a fact, having counseled some of them, that they are not going to be able to retire at a level anywhere approaching even a modest lifestyle.
I think a person could actually be a REALLY GOOD SAVER only using tax advantaged savings, but maybe not a SUPER DUPER SAVER by filling up a taxable account too. I am a SUPER DUPER and save about 35% of my gross income, but I would probably end up okay just filling the tax protected space too.
403b(18,500) + 457b(18,500) + HSA (6900) + 2 BD Roths (11,000) + 403b match (10,000) = 64,900.
If you actually make 5%, and have a short 20 year career, you should break $2 million. That would be a decent life in the Midwest. If you work 30 years you’d really be well off.
I think your scenario of only tax-protected savings is only true if that represents 20-30% of one’s gross income. But not if one is making a gross income of $400,000 plus and therefore accustomed to annual spending of over $200,000. Yes, you certainly can live on $2,000,000 at 4% withdrawal rate in the midwest, but it might not be the lifestyle you have been used to or hoping for in retirement. I think that is why the idea of not spending more than 50% of gross is the key point in this post in relation to high income professionals.
With the risk of seeming too legalistic, where would college savings fall in this scenario; under the “spending” 50%, or the “savings” 50%?
My view is that the college savings come from the spending side of the equation. That is, assuming the back of envelope calculations are right in the post, if you have an additional demand signal on your income (e.g., college savings) that must be met in addition to taxes and retirement savings. Of course you can use a 529 to save for college in a tax advantaged way. But this whole argument is a bit of a red herring. If you wanted to preserve your spending rate and also save for college, then obviously you will save less for retirement and will need to save a bit longer. WCI does not plan to fully fund his kids college, but many choose to do so. I did (x2) and was still able to meet my retirement goals. Sure, there were trade offs, but life is still good.
I am saving and spending $50,000 per year for college for my two children. In addition to saving for retirement. So at least this is indicative of my ability to live on less than 50% of my gross pay. That is how I look at it. Not an inflated long term lifestyle issue.
Spending unfortunately. The 20% is just for retirement.
As a resident, 26% of my gross goes to taxes. I know that you don’t generally have hard and fast recommendations for residents, but I am currently putting away 11% towards savings (Roth) and 11% to pay off student loans. Do you think this is a reasonable strategy, especially since fellowship training will be an additional 3 years after a 4 year residency?
Hard to say if that’s a good strategy without more numbers, but it probably is. Try posting in the forum. Also, I would be shocked if your tax rate is that high. Look at your 1040, divide total taxes owed by gross income.
Tax rate sounds about right if you’re including (high tax) State and 7.65% payroll. Doing a ROTH, so paying taxes on those dollars.
I agree. I’m a resident (in a 2 resident couple) and our tax rate including state and payroll is 25% (federal effective rate is 17%). People always say residents don’t pay much in taxes but it really depends on your situation. We deduct our mortgage, student loans, and charitable contributions but don’t have kids so we still end up paying a lot more in taxes than I thought we would. We are saving about 18% of gross income, I’d like it to be higher but we splurge on healthy, convenient food and time spent with friends/traveling to see family. We only put 4% toward loans right now. I also wonder if we are doing OK when I read about some of the super-savers on this site. But, we are pretty happy with our lifestyle so I hope we will keep it where it is for several years post-training and just bump up the savings rate.
A 2 resident couple is VERY different from a single resident or a one-resident couple when it comes to taxes, unfortunately.
And of course you realize that those who are all over the comments and forum are the 1% of the 1%. You certainly don’t need to do that in order to be successful, especially if you plan to work a full career.
Your numbers are actually pretty unusual. That’s a VERY high effective tax rate for a resident. Are you sure about that? That might be your marginal rate or something. Even if you were single and living in Manhattan, I don’t think you could get to 26% unless you were married to another high income professional.
Putting 22% of your income toward wealth building is also pretty darn good for a resident.
At any rate, yes, I advocate saving money in a Roth account as a resident as much as you can.
I really thought that was correct when you include our state taxes. I tried pretty hard to understand this last year. I thought our marginal federal rate was 25% and effective was 17%. And then about 3% for payroll and 5% state and local. I will admit though that my financial literacy goal for 2017 was to learn more about taxes and I haven’t gotten around to reading any books about them. I still hope to actually do our taxes myself by hand this year and maybe then I will realize this wasn’t correct.
Sorry, I didn’t realize you had put two replies in…retract the above statement. I still need to learn more about taxes though ????
I hope so, but if your effective federal is 17% + 3% payroll + 5% state, you may be right.
I don’t think his tax rate is that far off. Looking at my spreadsheet for 2016 (2 income):
Fed: 17.32
State: 4.46
Payroll: 7.68
Total: 24.85
=(
That probably underestimates the state tax for most high income earners.
https://www.thebalance.com/state-income-tax-rates-3193320
Surprising to see that 19 of 33 states with progressive rates (not flat rate, not zero) have the highest rates kick in under six figures. Minnesota is about 10% over $150K. Ouch.
You hit the nail on the head. I live in Manhattan, and I am married to someone with a similar salary.
I have an app that breakdown the entire paycheck and so far for this calendar year 26% has gone to taxes (federal, social security, Medicare, NY State, NY city and NY SUI/SDI).
You don’t want to know what we pay for rent. I also know that you advocate to not live in such a high cost of living city for wealth building lol.
But I’m happy to learn that you approve of my strategy so far ????
What app are you using?
It’s called ADP Mobile- but it’s specific for the hospital employees I believe
Speaking of 50%, too bad our tax rates don’t decrease with income like AUM fees do (still paying more in dollar amounts but less in percentage).
Ha ha, not sure you understand what a “progressive” tax code means!
I absolutely do, hence my wish. 😉
We are very close to your higher income scenario and these are the same conclusions i have come to. Our mantra is, “taxes a third, save a third, spend a third”…
You’re meeting my Live on Half challenge, which is based on your take-home pay. Congrats!
That is what we do too.
This post clearly shows the benefit of living like a resident for the first several years, as recommended by your earlier articles.
I’ve been in practice for 8 years, and have saved roughly half my gross income the entire time. It took about 2 years to get to a net worth of zero due to student loans, but due to the high savings rate, I can save virtually nothing for retirement going forward and still have more than enough to retire on by the time I hit 60.
The other benefit of living like this for the first few years out is that it gives you a period of time where you (hopefully) learn how to spend selectively in the parts of life that are important to you and to be frugal in the parts that are not. Had I come out of training and bought the big doctor house and the big doctor car like most of my colleagues, I would be in nowhere near the fortunate financial situation I’m in right now. Thanks for all the tips over the years WCI!
You’re welcome and well done!
Wow, you high earning US folks have it super easy! More power to you. Try a minimum of 45% effective up to over 50% in most of Canada for anything over roughly $400K.
The concepts we discuss on here and other similar venues are critical to put the financial puzzle together right and balance all the personal and family priorities. It’s a worthwhile challenge given other pros and cons of living here.
If you add on health care costs on to our taxes, we’re probably at about the same place!
Thank you WCI wanted someone to respond to having it “easy”. without my healthcare costs I could have paid off my first condo ( premiums, preventative and two surgeries). my cousins who live in canada who make nothing compared to 400k are the ones that have it “easy”. although they would not agree but another story…
for what it is worth…this is a great country or my parents would never have come here, so…
Sorry biggrey but if you have been paying anything near that kind of an effective tax rate over the last 15 years I think you should get a new accountant! As WCI points out, the overall tax burden all in, is not significantly different for someone earning a salary in Canada compared to a ‘high tax’ state. Also keep in mind that you have almost zero malpractice insurance costs regardless of specialty and no risk of personal financial loss if you do lose a lawsuit. On the tax front, for over a decade, benefits of incorporation have been quite favourable for high earning Canadian MDs (though this may be about to change in some ways) and the effective tax rate has been significantly lower than for non-incorporated individuals.
I think where most nonWCI followers get it wrong is assuming a higher return. Almost all forget about inflation, sequence of returns, and fees. I agree that a 5% real is likely accurate but maybe you need a new article to emphasize that.
To be a little less depressing, after your mortgage your housing costs drop dramatically to live in the same place. You still have taxes/insurance/maintenance but your major payment is gone. Another reason to consider house principle payments as savings.
I agree that for any calculation that goes out more than a year or two it is critical to include an inflation adjustment.
Spending 50 percent of your income or less seems like a good rule of thumb for high income professionals. My pushback is against the idea that anyone would need even close to the same spending in retirement to maintain the same standard of living. If you remove a mortgage and education expenses and consider downsizing, expenses could fall in half.
WCI covered this here:
https://www.whitecoatinvestor.com/percentage-of-current-income-needed-in-retirement/
I agree with that last sentence, so not sure what you’re pushing back against.
I agree some big expenses drop but some big expenses increase too. for one, i still know Doctors paying a mortgage in t heir 70s. two, car insurance goes up and 3. (and i could be wrong here) if you have some serious medical issues will a previous high earner pay considerable amount of out of pocket? for me, i may need a driver and someone to wipe my a$$. and i would like to stay in my house i am in now that has a lawn. doesn’t anyone want to leave money for their favorite charity, niece, kids, etc.? just sayin’.
According to the latest retiree health care cost estimate from Fidelity Benefits Consulting, a 65-year-old couple retiring this year will need an average of $275,0001 (in today’s dollars) to cover medical expenses throughout retirement, up from $260,000 in 2016.Sep 6, 2017
Hopefully, when we are all 65 we will still have access to traditional Medicare and will buy a nice supplement like AARP or Mutual of Omaha. The premiums are dramatically less than any private plan with better coverage overall.
I retired two years ago at 53 with no pension (by the way, I was not a doc but was a high earner) and spend “more” now in retirement than we spent while working. Primary reason is having tons of free time for travel and entertainment. I describe it as having lived below our means (but far from frugally) while we worked and living up to the level of our means now that we are retired.
My advice would be not to assume you will spend less in retirement (although some frugal folks very well might) . Instead assume you will want to live life to the fullest once you are unemcumbered by the governor that is work. After all, we only live once.
Sobering indeed. There is no better way to be ready for retirement then learning to live on less. If you can live on $50 k (which I currently can’t) then you are going to be ready for retirement much sooner than the MD living on $100k and definitely the MD living on $200k. So keep those spending rates low and the savings rates will come with it!
2 mid earners: >450k on avg. Debt paid off except mortgage. 30+% to taxes, 30% savings, 10%college savings/year til 529s funded. 25%ish spent, remainder is also saved if left over. Live awesome comfortable lives, we travel, not sure how anyone could consider spending 25-30% of these salaries as skimping.
The most important aspect is to do this from the start of your career. It’s pretty easy to do if you start out right. If you jump your lifestyle too high in the beginning, it is very difficult to decrease it later. That was one of the reasons I wrote the book “The Doctors Guide to Starting Your Practice Right.” The longer one waits to make a spending course correction, the harder it is to do. But you can do it if you fully comprehend the results you will get. My wife and I chose to life on half our income when we married during my internship year. It was one of the best decisions we ever made.
Cory-
Your comments are cracking me up. They’re always a good comment, but they always include the title of one of your (excellent) books too! I’m curious how effective that is as a marketing strategy!
WCI,
I have no idea how mentioning my book works for advertising. It is an idea I got from you. You mentioned you got tired of repeating yourself so you started a blog and then you can just refer people to an article and shorten your answer. So I do that if one of my books meets the need. But the main reason I do it is my lack of a “Handle.” When you see a comment from WCI or Physician on Fire or WealthyDoc or any other site like that, you know that comment is coming from someone who does something other than clinical medicine. My handle is my name so adding a book reference in the comment sort of serves to let the reader know I have another interest and maybe extra knowledge on the topic. My business name is long, Prescription for Financial Success, so I haven’t yet incorporated it into my name at blog sites. Not sure if that is a good idea or not. But I started out using my name for my “handle,” since finance isn’t all I cover, so for now that’s why I do it.
Live like a resident. Forever. Guarenteed financial safety!
In fact, make any number upwards of 25% and you’ll do great!
I am a genius I know. May be a book is in order
/s
‘Higher Earners Have It Worse’ – LMAO!
To paraphrase Beatrice Kaufman, ‘I’ve been a high earner and I’ve been a low earner. High is better!’ Much, much better. It only becomes a problem if you become a high spender but this is pretty much the story of everything – see LBYM. For the past 15 years we have benefited from quite a low tax rate on income for incorporated high earners in Canada. Currently, the government is promising to roll some of the benefits back for incorporated small business owners – which includes about 70% of Canadian doctors (and hopefully all high earning one’s unless they are crazy!) At the end of the day I think most would ‘suffer’ the extra income…
30% effective tax rate actually seems a bit low for people paying state income and property taxes in many places. Time to pack up for Alaska. Or anywhere far from New Jersey when it comes to taxes.
Most don’t include property taxes when calculating their marginal or effective tax rate. That’s generally assumed to be income tax.
Property tax is more of a consumption tax, like sales tax or vehicle registration. It’s also optional since you can rent and not be subjected to it, at least not directly.
Agreed, except for the bit about it being optional.
It’s not like you can charge tenants an extra $1,000 – $1,250 monthly to cover property taxes. Another example of the weird financial position that residential homes carry. It’s definitely a consumption tax, but it’s the only one you don’t have a choice about paying because the county will unilaterally liquidate your nice investment at a discount.
There’s also the buy-once and pay-annually forever aspect unlike all other consumption taxes.
I think I’m probably just a little confused but it looks like these calculations are not allowing for any draw down of the principle?
I hope this post is a slap in the face for young doctors and medical students. These sort of numbers got me reading personal finance in the first place. I didn’t have WCI back then, just school of hard knocks.
I learned the hard way, that is, take home a few attending paychecks, see the tax bite, pay loans, pay mortgage, spend some discretionary then save for retirement. Wait…. nothing left for retirement. Uh oh, better start reading.
When I lecture to the students and residents in my community on finance, I start with these sort of shocking scenarios. This is a nice Short and sweet post with good rule of thumb.
I agree you certainly can’t spend any more than half of your gross income if you’re a physician interested in a typical retirement age.
However, if you’re interested in ultimate freedom in the peak years of your life (30s and 40s), I recommend you SAVE half your gross for 10 years after residency, which after 30% or so in taxes (on a $300,000 gross income), would be SPENDING around 20% of your gross income, which would be $60,000 per year.
I guess that means I recommend living like a resident for 10 years after residency.
Sure, if your goal is FI ASAP, then save more. That’s a no-brainer. But at a certain point, you’ve got to wonder why you went to med school if your goals include “ultimate freedom in your 30s.” Medicine isn’t the best way to achieve that in my opinion.
Yes, I imagine that entrepreneurship is the best (albeit not at all guaranteed!) path to early freedom.
After starting and running several business, I’m going to nominate “big inheritance” as the best option for early financial freedom.
We are living lavishly on something like 15% of our income, paying 40% in taxes, and investing a lot.
As a young physician I didn’t have much in the way of side income streams beyond some moonlighting. But I did save and invest every year, starting slowly but consistently when I was a resident. And I did max out all of my retirement accounts. And I did invest strategically in income producing real estate.
Most important to my later career financial success are the long term effects of having maxed out retirement accounts for many years, having invested in income producing real estate years ago which has been highly effective at getting rich slowly, and developing a side business.
Saving and investing early and often has been incredibly effective at creating wealth. I highly recommend this plan to all of the young docs reading this blog.
Great post. Another factor when it comes to taxes is the impact as taxable investments accumulate over time. Most articles like this focus on wages, but if you’re a high earner and have a decent savings rate, eventually you’ll have an even more complex and higher tax burden to wrestle with each year as a result of dividends, interest, rental income, K1 distributions, etc.
Obviously it’s a good problem to have, but it can be frustrating and demotivating to see your tax rate tick upward each year and realize how much more money you have to earn to have any meaningful impact to your lifestyle/spending after the compulsory tax and savings increase. I was a bit stunned to realize this when negotiating for a new job recently. After taxes and keeping our savings rate constant, an extra $20k bonus or $10k raise is effectively meaningless when it comes to my retirement projections and budget.
Yes, beyond “enough”, additional money has (and should have) little effect on your actual life.
Do you count amounts paid towards student debt as “saving”? I’m a new attending and am maxing out 401(k), backdoor Roth IRA, HSA which adds up to ~13.5% of my GROSS income. However I’m also trying to pay down student loans as much as I can, which I feel might be more important for my sanity than contributing to a taxable account. Since this money will eventually be diverted to a taxable account when loans are paid down, would you consider that current practice as part of my “savings”? If thats the case then I’m actually saving >25%…
Sure, that’s what I’d do, but 25% sounds kind of low for the “live like a resident” period (which lasts 2-5 years until the student loans are gone.)