Use The Future Value Function To Project Your Retirement Date
One of the best things to do when you're first getting serious about your finances is to figure out your “number,” i.e. how much is “enough.” Until you're about to retire, the amount you want to spend in retirement is tough to pin down, but it's a good idea to make some reasonable estimates to give you some idea where you sit. So I asked my P.A. when she wanted to retire. She said, “I don't know, but I'd like to be able to in 13 years at age 50.” I then asked, “If you had a paid-off home, how much income each year would you need in order to live?” After some thought she said, “$36,000.” Of course, I instantly felt guilty because I'm such a spendthrift, but this wasn't about me so I got over it. So we talked about the 4% rule and then multiplied $36K by 25 to get her number- $900K. We then took what she was saving (which was quite good actually), what she had already saved, a reasonable after-inflation rate of return (I usually use 5%) and plotted it out using the Future Value Function. (Technically, I used the NPER function, but it's all the same.) What she discovered was that despite having quite a good savings rate, she wasn't going to be financially independent at 50. But she'd probably make it by 53. She thought that sounded pretty good too. But it's good to know. Just having that information will often push you to make more and save more and actually reach your original goal.
Your Bank Isn't Paying You Anything
This particular P.A. is a great saver. She paid off her substantial student loans within a couple of years of getting out of school and was saving a good chunk of money each month. She noted she occasionally listened to Dave Ramsey, but felt like she had outgrown that since she was debt-free and saving big chunks of money. What was bothering her, however, was that her money wasn't making any money.
WCI – “Where is your money sitting right now?”
P.A. – “In the local credit union.”
WCI – “What is it earning?”
P.A. – “Oh, I think 1%.”
WCI – “No, it's not. Let's look it up.”
Sure enough, as expected, her credit union savings account was paying 0.1% on a six figure amount. News Flash! Your local bank or credit union doesn't pay any significant interest. So we talked about online savings accounts. I keep my short term savings and emergency fund at Ally Bank, which currently pays 1%. Sure, 1% isn't great, but if she had her money there for the last year she would be $900 richer. Beats a kick in the teeth.
401(k)s Are Great
Here's the worst part. All that money was in a taxable account and she wasn't maxing out the 401(k) nor using a Roth IRA. Now, she has an awesome employer (me and my partners) and a great 401(k). The 401(k) is full of low-cost Vanguard index funds, has low additional fees, and offers an fantastic match (150% of the first 6% of your salary put in there if you're a full-time employee.) She's a smart lady, so she was getting her full match. But she was also saving a bunch of money outside of her 401(k) without maxing it out. That doesn't make much sense. Like other people I talk to all the time, she didn't even know how to log in to the 401(k) website, much less what her money is invested in. Lucky for her, all the options in our 401(k) are good and the default option ensures she has some sort of reasonable allocation. But she has no idea what it is, and she recognized that was a problem. I also pointed out that the default option involves an additional fee she didn't have to pay if she could manage her asset allocation herself.
Tax-deferred for Peak Earnings Years
Another question she had was about how she was putting money into the account. She wasn't sure what to do, and knew the match was tax-deferred (as it always is,) so she put her contribution into the Roth 401(k) option despite the fact that she was in her peak earnings years and really hadn't saved all that much into retirement accounts. Now, Roth 401(k)s are great, but when you're in your peak earnings years and your current tax-deferred account is tiny now and won't be more than a million at the time of retirement, it's pretty much a no-brainer to go tax-deferred in your 401(k), so she's going to change that (making sure she increases how much she is putting in to the account for the fact that a tax-deferred dollar is worth less than a tax-free one.)
Pay For Health Care Pre-Tax
She was saving up some money (again in that 0.1% savings account) for an upcoming delivery, about $4K. Now, we provide nice health insurance-a High-Deductible Health Plan coupled with a Health Reimbursement Account (HRA) for our employees. That basically turns the HDHP into a low deductible health plan. We essentially pay most of the deductible out of the HRA. But her share of the delivery was still going to end up being something like $4K, which she was going to pay with this money she had saved up. So we talked about HSAs. At first I thought she qualified to use one, since some HRAs don't disqualify you from an HSA. But ours does, since it is not a “limited purpose HRA.” Too bad, that would have been a sweet $4K deduction for her.
Read Some Good Books
We also discussed the importance of having personal finance and investing as a hobby and of reading some good books. There is no more profitable hobby out there than becoming your own financial planner and managing your own investments. Not only do you get to avoid having to pay for expensive financial advice, but you simply pay more attention to and optimize the aspects of personal finance that are under your control whether you're using a professional or not (like savings rate.) I made sure she had a copy of If You Can and told her to take a look at my latest favorite book, How to Think About Money by Jonathan Clements. Then I showed her my list of recommended books.
P.A.s, NPs, optometrists, physical therapists, and occupational therapists are all white coat investors who can benefit from solid financial planning and investing. They generally don't command the higher incomes that physicians do, which makes optimizing the income they do have critical. There is definitely less room for waste. However, their advantage is less of their money goes to taxes, they start earning sooner, and they generally come out of school with much less debt. Take advantages of these aspects to get a jumpstart on your doctor friends and co-workers.
What do you think? What advice do you give to P.A.s and others with similar incomes? In what ways is the financial life of a P.A. different from that of a doc? How would your life be different if you didn't have the income to max out all tax-protected account options? Comment below!
The taxation at peak earning years is a concept that I find lots of people I talk to, or see online, don’t understand. In fact, I was just counseling a co-worker who had jumped through a lot of hoops to do a backdoor ROTH IRA. He was getting the match in the 401k (so contributing 6%) and had heard somewhere that above the matched amount you should do a ROTH. Well that’s great, but he and his wife together are in peak earning years and make over $200k per year combined. They could easily max out their combined 401ks and do the ROTH.
How do I know they could max all of them? Because he was also “investing” $4k per month in a whole life policy. Luckily I was able to educate him on the subject, including sending him several articles from your site. He actually read his contract, cancelled the policy (and fired the so-called advisor who sold it to him), and is now maxing out his 401k.
At lower than doctor level incomes (but still high compared to an “average” person) professionals of all kinds need to be on the lookout for bad advice and unscrupulous salespeople. As you say, there’s less room for waste, so mistakes like this can have a much bigger impact on their financial future.
The major difference/advantage of being a PA Is the significantly shorter training. Many physician assistants are able to start working at age 24 while accumulating less debt than their M.D. counterparts. While your PA is past the live like a student/resident phase, a motivated PA could
be hundreds of thousands, if not over a million dollars, “ahead” of their M.D. counterparts by the age of 30-32 if the PA saves a lot of money in their 20s while the M.D is still in residency accumulating debt.
Six figures in a savings account? That’s both impressive and sad at the same time. I’m impressed at her diligent savings — most Americans don’t have an adequate emergency fund, let alone > $100,000 in one, but sad that she has missed out on the upwards trajectory of the stock market and some sweet tax deductions offered with the tax deferred space over the years.
Good for you for getting her on the right track.
Best,
-PoF
WCI- please read The Only Investment Guide You’ll Ever Need by Tobias and add it to your amazon list. It’s really good- as you may recall, it got me on the right track a few years before you got out of high school and started helping us all.
All- how do you decide ‘peak earning years’? My kid is a rocket scientist (but Mom is still her financial advisor). Easy last year with only 6 months full salary to choose Roth, but in a hopefully normal career/salary trajectory (is there such a thing anymore?) for a nonphysician when is the likely time to switch from Roth to tax deferred? The other glitch in my calculations for her: she says she will work until 65 because she loves her job. I once did too and then semiretired at at 50 after husband fully retired at 46. She won’t even sock away enough in CASE she wants/needs earlier retirement.
I read it years ago and agree it is great. It would make a good addition to the recommended list. In fact, I think it’s there. Let me double check….yup, it is:
http://astore.amazon.com/whicoainv-20/detail/0547447256
Peak earnings years are hard to define and sometimes even when you think you’re there, you’re not. I assumed I was at peak earnings when I made partner, then WCI started making good money and now it could be argued I should have been doing all Roth all the time up until about 2015.
I’m still trying to figure out “peak earnings” myself, but I’m relatively certain I’m not there yet. I’m in the earlier portion of a military officer career in research engineering, so I figure a very rough rule of thumb is either a) when I reach what I think will be my “Terminal” rank or b) the job I get right after I retire from the military (still the plan) and start my “second” career, which in theory will pay significantly better. At the moment, I think Roth is advantageous for me.
This article was especially good for me because I think military officers, and probably many civilian engineers, fit in this “better than most but not Doctor level” category of income. The online savings account tip was especially good because I had not realized I could get a %1 rate (I have been using USAA, which is terrific for a great many things but simply isn’t offering that on their savings accounts).
Speaking of military investing issues: any plans to address the new “Blended Retirement system”, WCI?
My kid is at NASA and I dunno if Boeing or whatever private company you’re likely to work at as a civilian pays more or less than the military. But I expect if you went to civil service from military the jump might not be too much? And remember to count your untaxed BAQ etc in a consideration of your compensation. So if you’ll have just as much coming in to the bank account as a civilian, you’ll still probably be in a higher tax bracket. Especially if you have any (as you most likely will) untaxed combat service months in a year.
Anyway if you figure out what is peak salary timeframe for an engineer do tell so I can review that with my daughter!
Right, all good points Jenn. Anecdotally, most folks I’d consider mentors who have gone from a military career to civil service/government contractor tell me I’ll make significantly more even with BAH taken into account, and that has been consistent with younger friends who simply separated for a variety of reasons. I’m perfectly comfortable with my current military compensation (assuming there is no funny business with BAH, which we’re hearing rumors of), but it seems engineers could potentially bring a higher market value on the outside as compared to other careers with military analogues. And prospects tend to be good, because your having worked in the military in some form of leadership is seemingly attractive to at least the defense industry and related government opportunities (such as civil service, or the national laboratories). Hopefully that all plays out.
As for timeframe for peak earnings, just speaking observationally I’d say somewhere between 20-30 years experience. Keep in mind my observations are mostly from civil service, but that’s probably relevant if she is at NASA and plans to stay there. It depends on how high up the promotional system she climbs, of course. Unless you operate as your own private business, engineering (at least in the government) depends on set salaries corresponding to levels of responsibility, rather than filling up schedules as densely as possible as I gather is more possible for physicians. Toward this end, one could argue there’s more earnings potential to go on a more management rather than technical path…but this is a highly personal choice that plagues many engineers. There’s legitimate personal satisfaction and happiness considerations there.
Lots of engineers in the community where I live. NASA is big here too. My observation is that salary increases are gradual and predictable. Some people get bumps by changing companies. The really successful engineers in this area are people who started Research Park companies and were later able to sell them to a larger company or do an IPO. Lots of these people spin off from NASA and the military and their peak earning years are impossible to predict.
If you’re in the military then yes, Roth is almost surely right for you. Very few military members should be deferring taxes.
Would you be interested in submitting a guest post on the blended retirement system? 🙂
I would be interested, at least about my perspective/situation on the matter. I can send you an email to talk more, if you like.
I can at least help you calculate the guaranteed and projected return going forward if you have an in-force illustration. You can also pay a pro like James Hunt to help you.
This has nothing to do about peak earning but more about tax brackets. If your current tax bracket is higher than what your retirement tax bracket will be then a tax differed account is the better choice.
This becomes especially true if you will do conversions in your retirement using your taxable account to live off of.
Well, peak earnings determines likely tax bracket during earning years, but indeed must watch out for being richer in retirement (higher tax bracket anyway) than while working because of saving so well or later on deciding to move more into Roth for inheritance or some other purpose. Because I THINK we are at a low tax rate now I basically fill up/max out our current tax bracket with Roth conversions. Who knows? Maybe Trump will lower my taxes or make capital gains taxes on my taxable accounts way cheaper than the rate I pay now for income including Roth conversions.
My plan: get to at least 50% Roth but not exceed tax bracket by so doing in any year, then reassess. (Will probably know how much we will leave as an inheritance by then as increase in tax deferred accounts sometimes outpaces our conversions- hmmm another reason to consider going into the next higher bracket for conversions…)
Of course it is directly related to tax brackets, which are related to your earnings. If you’re at “peak earnings” you’re in the highest bracket of your life and you are almost sure to be able to get the money out later at a lower effective rate.
your peak earning year/s can only be determined retrospectively. in most healthcare jobs the max is reached as soon as your schedule fills up. I think people burn out and reimbursements decline so the peak earnings are hard to maintain.
This is a great point.
Anybody starting their medical career should listen to this point Hatton1 makes. I have learned from Hatton1 through the years.
Suppose you knew what your needs were. Not just hours and rates determined by outside forces, but what your needs are. Then you could meet those needs by working as much or as little as you needed. This would give you enough for your needs (and savings), and also give you time to enjoy life. This is hard after years of being told what to do in your training and your job.
Thanks Harjot.
Well done WCI! One more FIRE aspirant set on the right track. When she becomes more comfortable with her path, she can read blogs like ours to stay current and stay motivated.
With a baby on the way, it’s not too early for her to start thinking of a 529 plan.
Nicely done. I am holding on to a traditional 401K until I go part time (in 10 years or so). Then I can slowly convert all that money into roth at a lower tax bracket.
Must feel good to help someone out during your shift. It amazes me how few people invest into their 401k. Also the days of decent interest from banks is long gone (think ING in 2003).
Always wondered about this conversion. I mean the max you can convert to roth from 401K is $5500 right? what if your 401K is like 1 million plus? would never be able to convert that to roth…I guess I see alot of this conversion and this and that as small potatoes unless I am missing some big caveat.
I think it depends on your employer and not the IRS. For instance, I could convert all $100K + of my traditional 401K to a Roth tomorrow through my employer but would have to pay the taxes at my current high income bracket to convert it (on capital gains and i also think on principal – someone please confirm this).
Therefore, if I wait when I got part time in the future, my tax bracket will be lower. If you have enough money to pay taxes on $1 mil then go ahead but it is likely smarter to convert chances at a time for a few years.
Cool. Some tax arbitrage.
No limits on conversions, only contributions.
I try with the nurses some times too. I’m amazed at the debt to income ratio of many of them.
Just about fell outta my chair once hearing one of my scribes admit >200,000 in school loan debt somehow
I see this all the time – people with student loan debt/income ratios that are all out of whack. This tax season I had a couple with a joint AGI of $38K show me >$9K of student loan interest for 2016. That’s a pretty expensive education to be assistant manager at a car rental chain.
I love the comment on making personal finance a hobby. No question it will hold one in good stead for the rest of one’s life.
A close friend (early 60’s) owns a multi-million business and works very hard. He’s actually the one who got me interested in finance back in the 80’s. While we were golfing, he brought up what he was doing for his employees (401k) and who he was investing with. I asked what the ER was for the fund, and surprisingly he said he didn’t know what Expense Ratio meant. I then explained it to him, but he said the expense ratio cost was of no concern. Then I mentioned SWR and he had no idea what that was either.
He’s a smart guy, does the books for the company, but when it comes to personal finance he’s unfortunately behind the learning curve.
When I approached a senior HR exec about introducing a high deductible plan with HSA, he had no clue. He wasn’t concerned about high ERs within our 401k either. The agent who came by once a year during open enrollment was slick.
Another FIRE and Boglehead convert WCI! Great job.
Your comment on personal finance being a hobby is hitting the nail on the head. I find it being my personal mission to spread the Boglehead message of indexing to anyone at work who is interested in keeping and making more money.
My book of choice to recommend is “The Millionaire Teacher,” by Andrew Hallam. I used to be a Dave Ramsey follower but his investing step 4 always bugged me. I mean 100% in growth stock mutual funds…are you kidding me?!? And then top it off with one of his ELP financial advisors.
The Millionaire Teacher opened my eyes to passive index fund investing and haven’t looked back since.
I do have a quick question. I’m not a physician but am a CRNA (mid 30s) who makes over $200k with my wife making over $100k. We split our retirement savings 50/50 into the pretax 403b and Roth 403b.
One aspect the Dave recommends is as much as possible in Roth. He argues that it’s best to tax only the principle ($18k) and let the earnings be tax free since that is where your true wealth comes from. Thoughts? I never read of anyone bringing up his view on the subject.
My thought? Dave’s wrong. Certainly he’s oversimplifying.
You generally want to use tax-deferred accounts during peak earnings years. You should still do a backdoor Roth IRA on the side of course.
There are exceptions to the general rule, of course. More discussion here:
https://www.whitecoatinvestor.com/should-you-make-roth-or-traditional-401k-contributions/
Dave’s main error is he looks at total dollar amount of tax paid, rather than the percentages. It’s a time value of money thing. Paying $50K in taxes today may not be better than paying $150K in taxes later, especially if your money has more than tripled in the mean time and especially especially if you can get that money out of your retirement accounts at a lower rate than you put it in at.
I always wind up confusing myself on Roth vs traditional over time, but assuming no tax arbitrage doesn’t a Roth have the advantage of essentially putting an extra ~40% in tax deferred? Supposing one has 20k of deferred space at a 50% marginal rate you could either A) put 20k in Roth or B) 20k in traditional and 10k in taxable. In A in retirement you take out the Roth tax free. In B you drain your 401k then liquidate your taxable (which has 50% as much as 401k) to pay taxes on the 401k. But since you’re taxed on the taxable accts earnings you come up short and have to use 401k money to pay some of the tax bill. Am I missing something in there?
You mean extra 40% into tax-protected. That is correct. If you are maxing everything out and investing a significant amount in taxable, that is one argument for perhaps doing more Roth. Certainly if you are withdrawing at the same rate you put it in at, then it would make sense to go Roth for this reason. But the usual case is to withdraw at a much lower rate than you put in at.
Yes, I meant tax protected. It’s certainly less of an issue for physicians who are in a high tax bracket for a short time. Whereas say a non-FIRE nurse who works 40 years saving 15% +6% match will likely have SS+retirement*0.0>>yearly salary and may jump a bracket. In any case, it’s a good problem to have.
Pharmacists fit into this category as well. Many of my colleagues are married to other pharmacists or to physicians, giving them significant household incomes. However, most of them have limited personal finance knowledge. Any time a conversation drifts even marginally to personal finance, I always bring up WCI and Bogleheads as a great resource.
“Now, we provide nice health insurance”
“But her share of the delivery was still going to end up being something like $4k”
If your employee has to pay $4k out of pocket to give birth, why do you think you provide nice health insurance again?
You think $4K is too high of an out of pocket max for “good insurance?” Mine is like $12K or something. I didn’t say we were a university or the military!
“(making sure she increases how much she is putting in to the account for the fact that a tax-deferred dollar is worth less than a tax-free one.)”
Do you have any links on how to do that conversion? I try to follow your 20%rule towards retirement so trying to make sure I’m still hitting goal. I make 160k. 18k to 403b. 7k match. 11k to roth ira for me and wife. 36k total but only 11k roth. I had been calculating 22.5% of Gross based in this but now I’m not so sure!
Sure, it’s all about your marginal tax rate. If your marginal tax rate is 33%, then $6,667 in a tax-free account is the equivalent of $10K in a tax-deferred account.
Try to not to make it too complicated. If you’re in the 20% range, you’re going to be fine. If you’re in the 5% range, you’re not. It’s just a rule of thumb.
I’m glad I’m not the only one who enjoys talking about personal finance with my colleagues. I work in a large orthopedic practice, where I have the opportunity to talk with PAs, nurses, rad techs, physical therapists, and medical assistants. I try to gently introduce the topic and gauge their interest without being too pushy or forward. The majority of people I talk to have only a modicum of interest. However, for those with the X-factor, it can turn into an exciting and rewarding conversation.
I was just looking at your point for her going with a 401k over a roth 401k because she is in her peak earning years. I’ve given this a lot of thought and I believe it’s best to make the decision based on what you think your retirement tax bracket will be. If you think you will be in a higher tax bracket in retirement I would rather pay tax now and go with the roth 401k. If I think I will be in a lower tax bracket when I retire I would go with a regular 401k.
That’s good logic. It really takes quite a supersaver or some other income source to be in a higher tax bracket in retirement than in your peak earnings years though.
I hope I get 5% returns after inflation. I use something closer to 2.5% which my wife dislikes. We are in our thirties so it has a significant impact on what our savings rate must be.
Great topic, WCI! My husband and I have made it our mission to help educate younger people just starting the learning process of personal finance/investing such as resident physicians as well as our own young adult kids.
Another topic that has come up as our own children embark on graduate education, is the difference between attending Physician Assistant school and incurring no debt and earning a decent income ($100,000 plus) after a two year program VS. 4 years of Medical school ($200,000 – 300,000 in debt with compounding interest rates) and at least 4 years of residency before earning an income. Would you be interested in doing a post on this topic to see where the break-even point is in terms of net worth? For example: if two people the same age start school at the same time – one in a PA 2-year program and one in med school for 4 years, who comes out ahead in the long run in terms of savings and net-worth after paying off educational debt?
The doc comes out ahead in the long run barring some crazy extreme debt load and a low paying specialty. But it’s kind of a silly comparison as the jobs are pretty significantly different. Very few physicians would have been happy becoming PAs in my opinion. You know what I think the best bang for your buck is though? CRNA.
To follow up your response WCI, I am a CRNA with a wife who is a PA. She has been saying for years now that if she had to do it again she would have been a CRNA. She loves her job but my pay is nearly double hers.
It’s the best bang for your buck that allows for a great lifestyle and a humbling responsibility.
It’s a humbling responsibility to work anywhere in health care, but different jobs require very different lengths of training and pay very differently.
Training is about the same for PA and CRNA but pay is tremendously different. I love being a PA but the pay disparity is quite remarkable considering the specialty that I work in and the critically ill patients we manage.
I have contributed to a HSA the last 3 years (2015,2016,2017). I have a high deductible plan with an HRA through the hospital I work at. I didn’t realize this disqualified me from contributing to an HSA. What do I do now to reverse the contributions and stay out of trouble with the IRS? Thanks for your help.
I guess technically you need to pull the money out and file 1040Xs and pay taxes and penalties and interest. Not sure if they IRS will even notice though. It’s complex enough that I suspect even some auditors don’t know the rules. Obviously don’t do it again.
http://www.hsaforamerica.com/hsablog/put-too-much-in-your-hsa-heres-the-fix/
https://www.bogleheads.org/forum/viewtopic.php?t=109377
One of the big differences I am finding after listening to the WCI and Financial Residency podcasts is the availability of side hustles. I can certainly have a second or third job but these are limited when compared to a physician. For instance, if I got a job seeing nursing home patients, unless I owned my own LLC and was not an employee of the nursing home or a physician, I would not get to keep my billing but would instead be paid a salary. This limits earning potential. Some states allow PAs to own their own practice and employ a supervising physician but that is overhead that takes away from earning potential. These are some of the little differences I am finding.