Financial Waterfalls for New Residents and Attendings

[Editor’s Note: Well, it’s July again, the start of the medical year. We have hordes of new residents and new attendings this month and it seems appropriate to direct something their way. In addition to some great financial advice, however, we’ve got three special things going on this week here at The White Coat Investor in celebration of the new year.

First, we’re celebrating Financial Independence Day (don’t tell Jefferson I’ve co-opted his holiday) with a 15% discount on Fire Your Financial Advisor, our online course to help you draw up your own written financial plan. That sale is running from June 30th to July 7th and you’ll need to use the code “INDEPENDENCE” to get the discount when you check out. This course has helped hundreds of docs get a handle on their financial life.

More Free Stuff at WCI!

Second, we’ve found two new ways to reach out to doctors and other high-income professionals. Over the years, I’ve discovered that some people prefer blogs and podcasts while others like forums and videos. Still, others prefer email newsletters and online courses or Twitter and live conferences. No matter how you prefer to consume financial information, we’re trying to get it to you in your preferred format. However, two things we haven’t had until this week were a private Facebook group and a subreddit. So we’ve just started the White Coat Investors Facebook group and a r/whitecoatinvestor subreddit.

The White Coat Investor Facebook Group is private, meaning you have to apply and be accepted to get in and what you write and ask there will be visible only to members of the group and can’t be searched online. You don’t have to be a doctor to join the group, but you do have to be a high-income professional (or spouse of one or student who will soon be a high-income professional) AND not a financial professional in order to join. Like everything we do at WCI, this is also a for-profit venture but you’ll notice the level of sponsorship and promotion (even of WCI products) to be much less than what you’re used to on the blog, podcast, newsletter, and forum, and it is still 100% free to you. Mostly, it will be a place to become financially literate, interact with your peers, ask “stupid” questions, and get candid recommendations. If you prefer Facebook groups to blogs and public forums, this is for you, so join today!

The White Coat Investor subreddit is a place on Reddit for people to talk about personal finance and investing for high-income professionals without getting “money-shamed” by people telling you that you have first world problems as happens in other subreddits. It is in keeping with the non-promotional nature of Reddit, and may be the least promotional (and profitable) piece of the WCI “Empire.” But if you love the Reddit format, it would be great if you would stop in there periodically to help people out. We’re also looking for moderators for both the Facebook Group and the subreddit, so contact us in those places if you’re interested.]

White Coat Investor Waterfalls

Today’s post is inspired by one of our speakers at the WCI Conference, Sarah Catherine Gutierrez, CFP. She presented what she calls “The Waterfall” of tax-efficient investing. As you fill one cup, it spills over into the next cup as demonstrated on this slide.

Doctors love this kind of thing – a list that tells them exactly what to do with their money. Reality is a little more complicated than just a list, so a hardcore hobbyist can usually pick a few nits with any list that can be made, but they’re still pretty useful as a rule of thumb. Today what I would like to do is present a “waterfall” for both new residents and new attendings. I’m sure the comments section will be full of nits, which is great. None of this is set in stone. But I think it will still be useful to many readers. Let’s start with the residents. Be aware the I’m not just talking about money in my “waterfalls”, I’m also talking about time and life energy.

Resident WaterFall

Insurance

As you can see, our first bucket on the waterfall is insurance. If your time, energy, and money is so limited that you can’t afford to do anything else, I recommend you get yourself some disability insurance. An individual policy (with a nice future purchase option rider) is probably best, but a group policy at a minimum. Life insurance comes next, at least for those with someone else (usually spouse and/or kids) depending on their income. If you have children, you also need a will. The next step is an emergency fund, but this should be a resident sized emergency fund. It is likely a four-figure amount. This is enough money to replace a washing machine, fly to a funeral, and maybe even buy a beater without taking on new debt. Traditionally, an emergency fund is 3-6 months of expenses. Dave Ramsey recommends against a 3-6 month emergency fund for anyone with debt, simply because they have better things to do with their money. I agree that a huge emergency fund isn’t a major priority for residents. First, your job and pay is very stable as a resident. Second, you have a ton of great uses for your money, probably including a six-figure 6%+ debt. Finally, direct contributions to a Roth IRA can be taken out at any time tax and penalty-free and so in that respect can serve as an emergency fund. It just doesn’t make sense to have a five-figure amount sitting around earning 1-2% while passing up the tax benefits of Roth accounts and paying 6%+ interest. But $1,000? Sure. $2-5K. Okay. Maybe even up to $10K. But no more than that for a family primarily relying on the earnings of a resident to survive. That takes care of the “insurance” section.

Student Loans

Next, we move into the “student loan” section. This is the elephant in the financial room for 3/4 of residents and cannot be ignored. You need a plan for your student loans. Private student loans can safely be refinanced any time you can talk someone into giving you a lower rate. I’d start the day I walked out of residency and repeat every 6 months if they were mine. You shouldn’t have to go into forbearance or deferment as there are 4 private companies that offer payments of $0-100/month. You can afford that. You also need a plan for your direct federal loans. The usual plan is REPAYE, which subsidizes your interest, effectively lowering the rate on your loans. However, there are circumstances (that usually involve being married to another earner) that can make PAYE or even refinancing your loans (only if not going for PSLF) the best option. Get some advice if you’re in that boat.

Maximize Salary and Pay-Off High-Interest Debt

At this point, you want to make sure you don’t leave any of your salary on the table. What do I mean by that? I mean the employer match in your 401(k) or 403(b). Go to HR, ask for the plan document, see if there is a match, and determine how much you must contribute to get it. Contribute that much to the 401(k)/403(b) (use the Roth option if available). Your next priority is high-interest debt. What do I mean by that? I mean those credit cards you used to pay for interviewing expenses. I mean that 9% relocation loan you took out. I mean that 7% car loan you have. Pay it off. Experienced investors salivate over guaranteed 7-30% returns and you’ve got them just sitting around in your filing cabinet.

Financial Education

Your next priority won’t cost much money, but it will cost you some time. You need to become financially literate. Maybe this means investing in a few good books or even the Fire Your Financial Course. Maybe it means paying a few hundred dollars to a financial advisor to help draw up a plan. Maybe it means spending hours while on call pouring through old blog posts or participating on the forum. It’ll be different for everyone, but you need to obtain basic financial literacy.

Health Savings Account

Your next investing priority may be a Health Savings Account. This triple-tax-free account is the best deal going in investing, but most residents aren’t eligible for one as they do not have a High Deductible Health Plan. That’s okay if you’re not, but if you are eligible, be sure to use this account. Your employer might even put some money in there for you.

Roth IRA

Next comes the Roth IRA. As a resident, you may be in the lowest tax bracket you’ll ever be in for the rest of your life. Take advantage of this tax-free account while you still can. Remember you can do one even for a non-working spouse from your income as well. One possible exception to this is if you are trying to minimize your income in order to minimize your Income Drive Repayment plan payments in order to maximize your Public Service Loan Forgiveness, but in the long run, most people are going to be glad they invested in tax-free accounts first during residency. Remember you have until tax day of the following year to make your contribution. Also, if you are doing a lot of moonlighting or have a high earning spouse, you might have to do these contributions through the Backdoor.

401(k) or 403(b)

Next comes your 401(k) or 403(b), again using the Roth option if available other than a potential exception for those going for PSLF who may wish to use a tax-deferred account. If there is no Roth option available, convert the whole thing to a Roth IRA in the tax year you become an attending (assuming you separate from your employer.)

If you still haven’t run out of money at this point, you’re some kind of a crazy super-saving resident (or married to an attending, in which case you might want to combine this waterfall with the one below in a way that makes sense for your situation.) But if you’ve got the cash, here’s what to do next. Pay off your private loans (and even your federal ones if not going for PSLF.) No loans? Then start playing attending. Build up your emergency fund, start saving up a down payment (or paying down the mortgage if you bought a house in residency), and start investing in taxable. And for heaven’s sake go on a vacation.

Attending Waterfall

Insurance

As a resident, you likely were unable to afford or qualify for all of the insurance you needed. Now is the time to add on another disability insurance policy (or exercise the Future Purchase Option rider) and if needed, another life insurance policy. Got married, had a kid, or moved to another state? Update that will! You still need that tiny emergency fund if you don’t have one.

Student Loans

It’s also time to readdress the student loan issue. At this point, you should know if you’re going for PSLF or not (i.e. are you directly employed by a 501(c)3 after making a significant number of small qualifying payments while in training?) If you are, that probably means switching from REPAYE to PAYE (assuming that now gives you lower payments due to the cap.) If you are not going for PSLF and are in a typical loan situation owing less than 2X your gross income, then it’s time to refinance your student loans, possibly for the second or third time. If you are in an extreme situation with monster student loans (3-4X+ of your gross salary) and NOT going for PSLF, then you probably should get some student loan advice. First, make REALLY sure you can’t get a job at a PSLF-qualifying institution. Then consider PAYE forgiveness (20 years of payments in exchange for taxable forgiveness of remainder.) Be sure to save up for that tax bomb in year 20.

If you are in the typical situation, i.e. you’ve refinanced your loans, your next priority is to pay enough toward them that they will be gone within 5 years. I’ve had a lot of people push back on this recommendation, but if you live like a resident and don’t have extreme debt, you can do this with money to spare. No rule of thumb is ever 100% and correlation is not necessarily causation, but I can tell you this- the majority of doctors who become financially successful are rid of their student loans within 5 years and the majority of those who do not become financially successful still had loans at 5 years. If you’re going for PSLF (or even an extreme solution like PAYE forgiveness), you still need to make those payments, just make them into your investing accounts, so if something happens to PSLF you don’t come out behind. Working at a 501(c)3 is not a permission slip to not live like a resident for 2-5 years after residency.

Retirement Accounts

Get your employer match and get rid of any high-interest debt as noted under the resident section. Then go for the HSA. At this point, the priority list is a little different during your first six months out of residency as opposed to every year afterward. During your last six months of residency and first six months of attendinghood you will be in an intermediate tax bracket, not as low as what you had as a resident, but not as high as during your peak earnings years, especially if you’re in a partnership track. If you made tax-deferred 401(k)/403(b) contributions during residency, now is the time to convert them to a Roth IRA. If you are eligible for a Roth 401(k)/403(b), use it this year. Your Roth IRA contributions may now need to go through the Backdoor as well, but you still have until tax day of the following year to get them done.

Once you’re into your second year as an attending and either in or approaching your peak earnings years, it’s time to prioritize tax-deferred accounts higher than tax-free accounts. That means you’re probably done with Roth conversions. No more Roth 401(k)/403(b)/457. Max out your tax-deferred accounts (including your 457 if it has low costs, good investing options, good distribution options and if a non-governmental plan, is provided by a stable employer.) Then do your Backdoor Roth IRAs.

Pay off Student Loans

My next priority at this point for those with additional money would be to pay off your student loans even faster. You have peers paying off their loans in 18, 12, 9, and even 6 months. The sooner you have them paid off, the sooner you can move on with your financial life. Don’t fall into this trap of “they’re only 3-4%, I’ll bet my investments can do better than that.” Maybe you’re one of those rare docs who really invests the difference and whose prescribing habits aren’t affected by Big Pharma advertising, but you’re probably not. Yes, the long-term math is likely to work out, but the long-term behavior usually doesn’t.

Boosting Emergency Fund and Buying a Home the Right Way

When the student loans are gone, you’re nearly to the end of your Live Like A Resident Period. Boost that emergency fund up to 3-6 months of expenses before expanding your lifestyle. If you’re not already into a home with a doctor loan, save up a down payment. If you have a doctor loan, consider paying it down and refinancing into a conventional if you can get a lower rate. Invest in taxable, pay off low-interest debt, and maybe even throw something extra at the mortgage – dealer’s choice. This also the place where funding 529s and other savings for the next generation fits in.

Hopefully, you find these two “waterfalls” helpful in your financial planning. This financial stuff isn’t that complicated, and a lot of it is a one-time effort and then put on automatic pilot. Get your finances in order so you can concentrate on what matters most in your life.

What do you think? Do you agree with my waterfalls? Why or why not? What would you change or add? Comment below!