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.
Emergency Fund
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 for a few reasons:
- 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!
Definitely a nice model to think through this process. I am glad you highlighted HSAs, because this often slips my mind given that I do not have the option with my current employer plan.
I would argue to match your 401k/403b before making heavy student loan payments because this is akin to “leaving money on the table.” I recommend matching and then paying down debt quickly. Once a plan is in place to do that within five years, then fill up the rest of that retirement space with additional money.
Completely agree with your argument to pay down debt instead of trying to beat the interest rate in the market, by the way.
TPP
That’s a reasonable argument. Truthfully, if you can’t pay off loans in 5 years AND get your match, you’re probably living too high on the hog (or did so during school.)
simple solution to all of the above
all efforts on…what for it…..
Make More Money!!!!
So much time and effort on managing the past – as in debt
Spend your time on making more and the rest is easy…period end of story
While I agree that way too many people (including docs) don’t realize they CAN increase their income, often dramatically, just more income does not solve all financial problems. Exhibit A:
https://www.rollingstone.com/movies/movie-features/the-trouble-with-johnny-depp-666010/
This is extremely helpful. I am a 32 yo who just graduated from a “top” IM program in a high COL area and am starting as a hospitalist in a 5013c. I may switch to primary care or go back to fellowship in 2 years, as I don’t know if I would be happy doing this long term. Base is around 180k and with moonlighting already on the books will increase to about 220 pretax.
Only about 90k of my 170k loans are pslf eligible, making the benefit for forgiveness pretty low. I am planning on refinancing all of it with FR for a 10 year rate of 3.35% with a minimum monthly payment of about 1700. The reason for the 10y is that I would like the option of having a lower payment in case I do go to fellowship and take a pay cut (1700 could be covered by 2 ML shifts a month).
My partner and I are not married at this time, but are looking to buy a house as we want to stay here. They make about 70k/y and have about 50k for a down payment. The problem is 500k is basically the bottom of this market, and as we are in a neighborhood that’s “up and coming” with no signs of a bubble bursting we feel pressure to buy in a year instead of waiting because we may essentially get priced out of our own neighborhood (where they grew up) if we wait. At this time our rent is pretty cheap (say 1g/mo each covers our expenses) but we also don’t know how long that willlast for
So my waterfall looks like: rent, disability insurance, life (comes with contract), max out 401k and match, pay the monthly refinanced loans and then save the rest for combination of down payment and “fellowship fund” I could put away around 5-6k/mo or more depending on the ML amount. At the time of refinancing in a month or so I will have about 25k in savings.
Does this sound foolish? One of our main goals is to live and own in the area we do now, but I feel like if we wait the “recommended” time of several years we may get priced out or get significantly less for the money.
I know I’m making it harder for myself by not having my career path 100% decided, but we all know things change and I just want to be prepared.
I’d be a little hesitant to refinance the direct loans to a 10 year. I mean, you ought to get PSLF in 7 more years, no? Especially if you go back to training. The rest I would refinance of course.
My PSLF situation is a little tricky.
My total debt is about 160K.
-72,000 of PSLF eligible loans that I have 2.5 years of PSLF qualified payments on. Avg interest rate 5.58%. Currently in RePAYE with my monthly payment around 300-350 dollars based on my residency salary to date.
-Even though I thought I was on top of it, I screwed up and realized that I have about 47,000 in combined Perkin’s loans and Health Professional/Loans for Disadvantaged Students (interest rate 5%) that WOULD have qualified for PSLF if I had consolidated them earlier in training, but I did not. I made no payments on the LDS (in grace for training) and $250/mo for the past 2.5 years on the perkins, but those payments do not count for PSLF. If i were to consolidate just these two loans now , the 10 year clock would just be starting. I also have also not been able to get a straight answer if I am allowed to have different loans on different PSLF “timelines.” (meaning the above loans which could be forgiven in 7.5 years, and these loans which would be forgiven in 10 years, obviously I would not consolidate them all together as that would reset the clock on all of them).
-The remainder is 42,000 private at 4.84% –no brainer to refinance
-The above makes it very difficult (for me at least) to crunch the numbers about how much i stand to benefit from pursing PSLF on either of both of the 72K amount and the 47K amount, especially if I dont go to fellowship and stay with an attending’s salary, or somehow wind up at a non 5013c. Im scared of screwing myself either from paying too much uneeded interest by staying in PSLF vs leaving potential money on the table by exiting PSLF.
Not expecting anyone to figure out this decision for me, but Ive been agonizing over what the more responsible choice would be.
I guess I could just stick with the PSLF for all eligble loans and save the difference just in case.
You can pay someone to figure it out for you:
https://www.whitecoatinvestor.com/student-loan-advice/
But I agree there is no sense entering PSLF NOW for loans you haven’t been paying on during your training. What gets forgiven is the difference between real payments and the tiny “in-training” payments.
Just wanted to say, thank you for the link above. I scheduled a complimentary 30 minute with Joy Sorensen Navarre, president of Navigate (link in the above comment) and it was extremely helpful, and laid out the math behind the various scenarios (as well as could be estimated based on future unknowns such as income and family size). Highly recommend, probably the most high yield 30 min conversation about student loans I have ever had in my life, and it was free (besides of course my voluntary payment of recommending her both online and in person).
180K/yr as a hospitalist? You are being seriously underpaid. Unless you have a lot of fringe benefits, you are being underpaid by about 40-50% of the national average for hospitalists. The best thing you could do for your finances is make 60K more a year for the same work.
Its hard in a saturated urban area, I would have to have a longer commute to a community hospital, and also my career/research interests at this point benefit from a well known academic affiliation. Its difficult to cut the cord, esp as Im still not a 100% sure what I want my career to look like 5-10 years from now
Let me guess – You work in Boston?
#truth
too many work for ‘top hospitals’ yet never leverage this for $$$
BIG mistake (financially)
how to leverage that is not something that is encouraged or spoken about. If the institution is not providing you with something ( eg the ability to get grants, have a more favorable work/life balance even if its for less money, allow you a career track that otherwise wouldn’t be possible), then it makes little sense to do clinical work for less…
Great article. Succinctly written and even the residents with very short attention spans should understand where their dollars should go. As much financial education I give my residents, most of them just want an algorithm to follow, so I’ll definitely be referring them to this article and that great waterfall graphic.
I think this may qualify as a classic post.
I thought it was really good (and put a lot of work into it), but the comments have been much fewer than a typical Monday post so I can’t really tell if people like it or not. Oh well, that’s part of the fun of blogging. Probably just needs more controversy to really get people talking!
agreed – title is too benign (though accurate)
edit it to – you’re broke and don’t even know it…..Boom!
Not sure I recall receiving an email alerting me to this post on Monday…perhaps that is why readership is lower than expected?
Maybe. The email definitely went out (it’s in my email box) but it was a large email due to the images so it is possible it didn’t hit everyone’s box.
This is a very useful post for those needing a crash course in where the money should go. For those of us already reaching the bottom of the flow chart its just a nice validation that I’m not missing something along the way.
Yes, yes, yes on signing up for disability insurance ASAP! I signed up for disability and life insurance in my first year as a resident and 2 years later, was diagnosed with an issue that makes me unisurable. Thanks for the continuing advice.
Great article, as usual.
One thing I would add to the resident waterfall a little sooner, especially for a single person:
Pay off $2,500 of student loan interest each year of residency to get the student loan tax deduction. It is an above the line deduction (for residents: the line is your adjusted gross income. ie. you can deduct the interest and still take the standard deduction). You will not get this deduction as an attending or with any significant moonlighting income.
For a single person in 2018, the 22% tax bracket is 38,701 to $82,500, which is where a resident’s salary would fall. At tax time with a $2,500 deduction, that would be $550 back on your tax return. You can then put the money towards any of the other things on your waterfall, and you eliminated a chunk of your loan interest. A 22% return beats just about any of the other things on the list.
The deduction is available to anyone earning less than $80,000 (or $165,000 if you file a joint return), but it’s gradually phased out if your modified adjusted gross income is between $65,000 and $80,000
$2500*12% = only $300. A married resident taking the standard deduction would definitely not be in the 22% tax bracket. But whether $300 or $550, it’s better than a kick in the teeth, but shouldn’t be a super high priority. At any rate, most residents will pay most of that each year under PAYE or REPAYE so I’m not sure it deserves its own bucket.
Great post! I just started my last year of residency and will definitely be referring back to this post as I go through this year and start making financial decisions about early attending life! Thank you!!!
I would put financial literacy first for residents! Of course, difficult to do on a resident’s schedule, but it would help put the rest of the waterfall in context.
I agree that most people just want an algorithm, and you put a couple of great ones together to use as a rule of thumb. It’s funny how most of us probably put the “house” part much further up the waterfall.
I’m surprised it has not gotten as many views. I lurked on your website during my 4th year (I am a fresh intern) which encourage me to read a few books on finances during the ‘demanding’ last semester. I’m happy to say that my plan and the one you described are essentially the same. I wish more of my co-interns would read up on finances, but it’s not my place to preach. I was surprise to see that I was one of the few if not the only one to increase my 401K contribution to get the whole match at orientation. I appreciate everything that your doing. I can say that it has made a big impact on my financial well-being.
Wow. Nobody wants free money eh. But to be honest, I didn’t even know what a 401(k) was as an intern.
Myself and another reader are giving a financial talk to some residents next week – and I think we just found our format and resource all in one post. Thanks!
Thank you for what you do.
Wonderful idea!
Jim everything checked except the 457 for junior attending. It is a non governmental. Not my thing.
Thanks for all you do.
GREAT post! I’ve been reading your blog about a year (wish I started sooner – I’ve been out of residency 4 years now) and I think this is one of the best posts. Thanks for all your advice!
Helpful! At this point, I’m relatively familiar with all the concepts, but it is kind of nice to have them laid out in a step-by-step chart without having to overthink it. And in hindsight, it makes me feel good to see that we mostly followed this path flailing about on our own.
So here’s something I’ve been mulling on that should be good comment fodder. It’s not an immediate situation, but an interesting question. We are nearing the end of residency and own a home. We will either be selling this home to move elsewhere for “The Job” or will likely sell after 1 year if we stay put (it is quickly growing too small for our growing family). Either way, staying here isn’t a long term option. We got lucky and bought at the bottom of a very strong market–barring any sort of insane economic collapse (in which case, we and everyone else will have other problems), we should clear the same amount (or slightly more) as we owe in student loans on the sale– somewhere around 100k.
Our only other debt will be about $15k on a 3% car loan. Whether we move or stay, we are committed to renting or staying put for at least a year simply to feel out the area/job. In that time, going through the steps on these charts (upping insurance, emergency fund, etc) will be the priority. However, after that I think we will be anxious to buy and house and settle down, simply because we have school-aged children that we want to get settled.
What would you do with the sale proceeds? Immediately wipe out the student loans? Or save them for a down payment and aggressively pay off the student loans over a period of 2-5 years? Something in the middle? Obviously the specifics of the situation in the future might dictate what we do more clearly, but I’d love to hear thoughts on this.
I’d probably wipe out the student loans and then immediately start saving up a down payment. But there’s no wrong answer here.
I see that you recommend converting tax deferred 403b savings accumulated during residency to a Roth IRA (and paying the taxes) upon graduation and using a Roth 401k for the remainder of the year. I’ve been wondering about this. How would I know whether this makes sense for me? I think I’m going to have around $270k in income this year. Seems like I should just roll over my 403b tax deferred savings into my employers tax deferred 401k and continue to delay taxes, no? Thanks!
I have the same question and issue. My marginal tax rate for my first partial year as an attending will be 32%. At what marginal tax rate does it stop making sense to convert tax-deferred savings to a Roth?
Ooh, that’s pretty high. I dunno, I might think twice at 32%. Big jump from 24%.
When reaching end the end of new attending diagram trying to determine if it makes sense to keep my 401k traditional and invest in a taxable account or to use the option to invest in a Roth 401k since my employer offers a Roth 401k option. Hate to miss out on deferring taxes with a traditional 401k but also might make sense in order to put less money in a taxable account?
Difficult choice for sure, especially when you consider the tax protection angle.
Great article! Wondering if you have advice or past articles on what to do with left over money (such as investment strategies for taxable accounts).
Go to bottom of waterfall. Do those things!
My investment strategy is the same for my taxable account as for my other retirement accounts- broadly diversify, take reasonable risk, eliminate manager risk, keep costs low, minimize taxes. The additional “tricks” are pretty minor- like tax loss harvesting and donating appreciated shares to charity instead of cash.
https://www.whitecoatinvestor.com/retirement-accounts/the-taxable-investment-account-2/
I’m at the bottom of the waterfall except for the down payment part. We live in LA, so it’s going to take us a while to save 20% down. Right now we’re putting it all in a high yield savings account, but I think it’s such a waste to have all that money locked in.
I don’t see adventure van on this waterfall chart.
An adventure van is a very reasonable financial goal. Nothing wrong with inserting it into your plan in an appropriate place.
I just realized who you were, punk. Go buy an adventure van, you can afford it you cheapskate.
I just accepted an offer for my first attending job and am really excited to implement this waterfall approach! Thanks so much… great post!!!
Congratulations!
What do you think about dual career spouses for Roth conversions during final year leaving fellowship? We would probably combine for close to 225-250k during the year. Much of that income will be in a high tax state as well (California).
It’s generally a nice time to do it, but it won’t be as nice for you as it usually is. I’d probably still do it though.
Love the waterfall!
For a resident…Why Roth IRA over Roth 403b? Is there an advantage?
Thanks!
Lower costs usually and more control always. But be sure to get any match available.
So i’m receiving employer match on 403(b), now i’m working on paying off “high interest debt”.
Does “high interest debt” include fed student loans at 7% under REPAYE? (after the covid interest freeze thaws)
What’s your effective rate under REPAYE after the subsidy? Maybe less than 7%. But no, I’d say high interest debt is 8-10%+. I’d call 7% moderate interest rate debt.
Hey! Sorry for the delay, never subscribed.
Since i’m a covid baby/graduate, I don’t have a REPAYE yet (have been at 0% interest since graduating), but i would imagine it would be 4-6% as a single PGY2 resident earning 62k/yr, right?
So instead of tackling fed loans (4-6% EIA) or private loans (4.75% IR) since they are not ‘high interest’, I should move down the waterfall investing in my hospital-matched HSA and then roth IRA on top of it all? (roth 403b w/ max employer match, HSA w/ some employer contribution, and roth IRA)
THANK YOU!
I’d definitely get your match before paying on 0% student loans or even 6% loans, yes.
Yep, thank you for your time Dr. Dahle!
I have my match for 403b, now I can invest elsewhere and you’re saying it would be wise to tackle the HSA offering at my hospital, then a self-created non-matched Roth IRA BEFORE I pay any student loans at 4-6% interest.
Appreciate the endless help. Just a young doc trying to overlook the Maybird Gulch from the Pfeifferhorn on a Thursday someday.
There’s not always a right answer of which to do first but your plan is reasonable.
There aren’t a lot of people on the Pfeiff on a Winter Thursday morning.