Savvy Retirement (Part 1)
Saving for retirement is usually viewed in 1 of 3 ways:
1. “I’ll get to it. I have plenty of time.” Just like residents will eventually study for their boards or they’ll eventually log their duty hours.
2. “I should, I just haven’t.” Just like we know we should exercise 5 days a week for 30 minutes each time.
3. “I only have x amount of years to save!!” Just like a resident feels when they only have 1 month before their boards.
Which perspective do you think a Savvy Doc has?
The biggest challenge a physician (along with most professionals in fields that require prolonged periods of training) struggles with is the fact that we are late to the retirement game. While our peers have been putting aside money into retirement accounts since they were 22, it’s often not until we are in our early to mid-30s until we start saving.
We are behind and it’s problematic. Not only do they have 10 years of saved income set aside, but they have 10+ years of GROWTH of that income. This can be a difficult to concept, so here’s a great visual to help:
Let’s compare Susan (gray) and Bill (green). Susan invests for only 10 years, but she starts at age 25. Bill invests for 30 years, but he starts at age 35. At the time of retirement at age 65, Susan’s $50,000 grew to a larger amount than Bill’s $150,000.
This is the result of time. Take advantage of this. Prioritize saving for retirement. Something is better than nothing, even if it means only saving $100/month during residency.
Defining Your Retirement Plan
There are many vehicles (accounts) in which someone can put aside money for retirement. There are employer-sponsored plans, such as a 401(k) or a 403(b). There are individual retirement accounts (IRAs). There are also SIMPLE IRAs, SEP IRAs, and profit sharing plans (PSPs). Of these, most of you will have likely heard 401(k) and IRA.
A 401(k) is a retirement vehicle that allows employees to contribute a portion of their wages to individual accounts. Employers may also contribute to the 401(k), which is an often underrated component of a benefits package. The only way to set up a 401(k) is through your employer. This means that you can’t go to a banker, investment advisor, or a brokerage firm to open one.
401(k) earnings are tax-deferred. This means you don’t pay taxes on the money you put into the 401(k) or its growth and earnings until you retire.
The maximum employee contribution is $18,000/year (tax year 2016). This means the most you can put into your 401(k) by yourself is $18,000, or $1500/month.
Maximum Total Contribution: $53,000/year (tax year 2016). This means that between you and your employer, you can put aside up to $53,000/year into a 401(k). Employers make contributions in 2 ways: Non-elective contributions or through matching. We will discuss this further later in the Savvy Retirement Series.
IRA (Individual Retirement Arrangement)
In an ideal setting, an IRA is a retirement account that you would put money into after you’ve maxed out your 401(k) contribution for the year. If your employer does not offer a 401(k) (as may be the case for many residents and fellows), then putting money into an IRA would be a great alternative to save for retirement.
Unlike a 401(k), anyone with earned income can open an IRA. There are many ways to open an IRA — through a bank or financial institution, stockbroker, mutual fund, or a life insurance company.
The maximum contribution is $5500/year (tax year 2016) and $6500 for those that are 50 and older. As you can see, the amount you can contribute to an IRA is considerably less than a 401(k)
Other retirement plans may include:
403(b): Retirement plan for employees of public schools, tax-exempt organizations, ministers
457: IRS-sanctioned tax-advantaged employee retirement plans offered by state and local public employers and some non-profit employers.
When it comes to employer matching, these terms are really important to pay attention to:
Matching Contributions: Matching dollar amount contributed by an employer to the retirement savings account of an employee (401k, etc.) who makes a similar contribution.
Vesting: Practice of delaying an employee’s ownership of the company match (or any other employer contribution, such as profit sharing) for a specified number of years. So a company match contribution to a 401(k) plan will grow as part of the overall account value, but the employee can not rollover or take distributions on any portion of company match money that is not vested or owned by that employee.
This is a difficult topic, so here are some examples to help better understand:
John Smith makes $200,000 and has elected to contribute 6% of his annual salary to his 401(k) plan. John’s company will match 50% of his contributions, only up to 3% of his salary ($0.50 for every dollar John contributes, up to 3% of his salary which is $6000). John contributes $12,000 (6%) and his company matches him $6,000.
Rachel Bailey makes $200,000 and has elected to contribute 5% of her annual salary to her 401(k) plan. Rachel’s company will match 100% of her contributions, only up to 7% of her salary ($1 for every dollar she contributes, up to 7% of her salary which is $14,000). She contributes $10,000 (5%) and her company matches her $10,000. She misses out on $4,000 of employer matching.
Liz Johnson makes $200,000 and has elected to contribute 6% ($12,000) of her annual salary to her 401(k) plan. Liz’s company offers a 6% match which is vested after 3 years. Each year, Liz contributes $12,000 to her 401(k). Each year, her company also contributes $12,000 to her 401(k). The total yearly contribution to her plan would be $24,000. Liz has decided to end her employment with this employer and rollover her 401(k) plan to her new employer. If Liz has 0% vested, then she will only be able to move over $12,000 of the $24,000 into her new plan.
Knowing what these different retirement accounts are and how they differ is important in choosing where to put your money. Stay tuned for the rest of this series to learn about the differences in retirement accounts, traditional vs Roth contributions, tax savings and credits, and how to choose what investments are best for you.