WCI #61: All About Residents

This is the White Coat Investor Podcast where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high income professionals stop doing dumb things with their money since 2011. Here's your host, Dr. Jim Dahli.

Welcome to White Coat Investor podcast, episode number 61 all about residents.

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The day today comes from Morgan Housel who said in what other field does someone with no education, no relevant experience, no resources and no connections vastly outperform someone with the best education, the most relevant experiences, the best resources and the best connections? These stories happen in investing. That's certainly the truth. It's pretty amazing with index fund investing just how many very smart people you can outperform. I wanted to remind you about our financial Independence Day sale we're having this week. It's only for a couple of days more after you hear this podcast if you're listening to it the day it came out, but we're offering the Fire your Financial Advisor course at 15% off from June 30 through July 7 in celebration of Independence Day. If you haven't taken this course yet but you don't have a written financial plan, this is your chance. It's not the cheapest thing out there, but it is very comprehensive and allows you to finish the course with a written financial plan that you might pay thousands to a financial advisor to help you develop. But the best part about it is you now have the knowledge to develop it and to modify it as needed going forward so that you can manage your own investments, which may save you literally millions of over the course of your career. Also, if you haven't checked it out yet and you're into Facebook, I encourage you to join the White Coat Investors Facebook Group. It's a private group so you have to apply to do it, but if you're listening to this podcast, you probably qualify to be in the group. We're just looking for high income professionals, but not financial professionals who are interested in a private way to talk to others about financial questions and to get recommendations. In this episode, we're going to talk all about issues facing residents. Every one of the questions today comes from a resident and we'll be talking about issues specific to them. The idea for this came from a listener who wrote in saying most of the podcast episodes have at least a few tidbits of information or answers to questions asked by residents. But I was wondering if you would be able to do or have thought about doing one podcast episode dedicated 100% to residents. I know my focus for the next three years will be to get the most in residency and I won't have the salary or time to invest or plan heavily towards retirement. But as it is almost July 1, it would be really cool to have all the important pertinent info recapped in one place. My friends always ask which episode to start on and it is hard to pick one that would be right for the brand new doctor soon to get their very first resident paycheck. Off the top of my head, some topics could be loan repayment, refinance loans, or not buying disability insurance which accounts residents should focus on starting to fund, buying a home versus renting, importance of living like a resident after residency, and anything else you wish you would have known financially when first starting a career in medicine. Okay, let's hit some of those topics today. The first one was about loan repayment. Should you wait the six month grace period or not? Well, since the advent of these income driven repayment programs and particularly revised pay as you earn and the public Service loan forgiveness program, you actually want to make as many payments as you can during residency. And the reason why is under repay, your payments are subsidized, but they're not subsidized if you're in a grace period. Basically, the government pays for half of the interest that your payment doesn't cover. So if you have a $200,000 6% loan and the interest on that is $1,000 a month and your payment is $200 a month, well, $400 of that additional interest gets added on to the balance of the loan and $400 is wiped out by the government under repay. So if you're not making those payments, if you're in the grace period, all thousand dollars gets added on to the balance of your loan. Obviously that's less than ideal, especially if you could get the government to cough up 400 bucks a month toward your loans. So you want to get those loans going as soon as possible. Now I know a lot of people have run into trouble trying to get trying to avoid that grace period. But some people have been able to do it by consolidating their loans right as they graduate from medical school and start making payments right away. And that's obviously the ideal, especially under the public service loan forgiveness program, right? You want to make as many tiny payments as you can because you have to make 120 of them. And if you don't make tiny payments, you have to make full size payments later as an attending. So you're far better off making $100 or $200 payments during residency than you are making $5,000 payments as an attending. The less you pay as a resident, the more there is left to be forgiven after 10 years. And so really, you don't want to take advantage of those grace periods, you know, just to get out of $100 or $200 a month payment as a resident. You can afford that as a resident. And particularly if you're going for forgiveness, you really want to be making those payments. Next question. Should I refinance my loans or not, and should I use a variable or fixed rate loan? Well, that depends. It's kind of a complicated question. As far as private medical school loans go, you can refinance those safely, anytime. If you can get a better rate from one of the four companies that is refinancing student loans for residents, then you should do that for a private loan. There's no benefit to keeping it with the original lender. If you can get a lower rate, you're not going to get any sort of income driven repayment program. You're not getting any sort of forgiveness program for it. So you might as well refinance them. Bear in mind that all four of those companies offer you some sort of lower payment as a resident. So your payment can be anywhere from $0 a month to $100 a month, and you can afford that. That's probably lower than what your payments are in the repay or the pay program for your federal loans. So for those private loans, refinance them right away. As far as the federal loans go, you may or may not want to refinance those. If you're sure you're not going for public service loan forgiveness and you're going to be paying these things back, then it's just a matter of finding the best interest rate. And that might be your subsidized interest rate. Under repay, you have to calculate what your payment would be and what your effective interest rate would be under that program and then compare that to what they're offering you. If you refinance so you want to apply with those four programs, see what they'll offer you, calculate out what your effective rate would be under repay. And that's variable. It's obviously different for everybody. Then take the lower one. If you're not sure if you're going to be going for public service loan forgiveness, then don't refinance. You want to stay in the government programs. And until you're sure that you're not going to be working for a 501 after residency. It really makes me cry when I run into residents, or rather attendings, who've been making payments for years. And if they had just been in some sort of government program, their loans would have already been forgiven. I mean, an academician that's five, six, seven, eight years out of residency and still making payments, it's really kind of sad actually, because their loans should be gone at this point. All right, variable versus fixed rate. I'm a big fan of variable rate loans and I'll tell you why. When you get a fixed rate loan, what you're really doing is buying a variable rate loan and paying a insurance premium. That insurance premium you pay to the bank in the form of a higher interest rate. And what that does is it allows the bank to run that interest rate risk rather than you running it. So the downside of a variable rate loan is that you don't have that insurance. In case of interest rates rising rapidly, and particularly in our current environment where the Fed has said they're going to raise rates for a while, you kind of know they are going to go up. And so if you are, you know, in a live like a resident period after residency and you're expecting to pay these things off in two or three or four years, you can afford to run that risk. If you think you're going to be making payments for 15 years, maybe you want to have a fixed rate, but that's going to be individual for everybody. So really evaluate what the consequences would be if rates went up. And if they're not that bad, go ahead and take the variable rate loan. You'll likely save a lot of money. Basically, anybody who's used a variable rate loan from 2008 or so until now has actually come out ahead of those who took out fixed rate loans over that entire time period. Now, that doesn't mean that'll be the case going forward, but bear in mind, when you take a variable rate loan, two bad things have to happen. Rates have to rise, and they have to rise significantly, and it has to happen early in the course of your payback period. For instance, if you're planning on paying back your loans over five years and the rates don't rise for four years and they only go up 1%, you're still going to come out ahead with a variable rate loan. Okay, let's talk about buying disability insurance. Pretty much everybody needs disability insurance if they're relying on their income. Until you're financially independent, you need the stuff. And it's frustrating because it's expensive. It's so expensive that residents honestly can't afford to buy as much as they need. I mean, the ideal would be to buy enough that if you get disabled, your lifestyle stays the same as what it would have been, becoming an attending and living the rest of your life working. But obviously, not only will the companies not sell you enough disability insurance to be able to do that when you're a resident and on a lower income, but you can't afford it anyway, quite honestly. So typically what a resident does is they buy a benefit of 5,000 or maybe $7,500 a month, and then they can't do anything until they become an attending, above and beyond that. So as an attending, they do one of two things. If they're still healthy and insurable and haven't taken up any bad habits like rock climbing, they just buy another policy. If they have had some health consequences come in, what they usually do is exercise a rider they've been paying for as a resident called a future purchase option rider, and that allows them to buy more coverage as an attending. So how much do you need? Well, as an attending, you want enough to cover all your expenses, plus enough to save for retirement. Because remember, these policies generally only pay to age 65 or age 67. If you don't have any additional money on the side besides that, you're going to go straight from your disability insurance policy that might be paying 10 or $15,000 a month to Social Security, which might be paying $3,000 a month. And so that's going to be a pretty dramatic decrease in your lifestyle when you hit age 65 or 67. So the bottom line is, even if you go on disability, you need to be getting enough of a benefit that you can at least save something for retirement as you go through the years on your disability. Bear in mind, most individual policies are paid using post tax dollars. And so the benefits are also post tax. So. So don't count your taxes in when you're thinking about the expenses you need to cover with disability insurance, which for many docs is their biggest expense. All right, which accounts should residents focus on starting to fund? Well, the general rule for a resident is to use a Roth account or a tax free account. Remember, with a tax deferred account, like most 401s and traditional IRAs, you get the tax break up front. And then when you pull the money out in retirement, you pay taxes on it. But for a resident, they're usually in the lowest tax bracket of their entire life. And so it makes a lot of sense to instead pay the taxes now and enjoy tax free benefits later. Not only does the money grow tax free in the account, but when you pull it out in retirement, you don't have to pay any taxes on it at all. So that means Roth IRAs. And you know, if you're married to a high earner, if your spouse isn't attending, you may have to do that Roth IRA through the back door. But that's okay. It's basically the same thing. And then if you're going to invest in your employer's account, check and see if they have a Roth 403. And always, of course, make sure if your employer is offering you a match. And you can find out by reading the plan document that your human resources department has to give you if you ask for it. You can read in there and see if there's a Roth 403 or a Roth 401 account. And you can read in there and see if there's a match. You always want to contribute enough to get the match. That's free money. It's basically leaving part of your salary on the table if you don't get that. So always contribute enough to that account to get the match if you can put it into a Roth account. And if you can save more than that above and beyond, you know what it takes to get the match and what it takes to max out a Roth IRA. Well, put it again into a Roth 403. Now, if you're a super saver and you're saving, you know, maxing out a Roth IRA and you're maxing out your spousal Roth IRA and you want to save more, but your employer doesn't offer a Roth option in the 403 or the 401k, one other thing you can do is to contribute tax deferred contributions into that account. It's nice to get a, you know, the tax break as a resident, I suppose, even if you'd rather get it later. But then the year you leave residency, convert the whole thing to a Roth. Now that's going to cost you some taxes, but you should have an attending income at that point. So as long as you're continuing to live like a resident, you. You can afford to pay those taxes. It's not quite as good as contributing to a Roth account as you go along, because that year you'll be in a little bit higher bracket than you were throughout residency, but you'll still be in a lower bracket than you will the rest of your career, because for half of that year, you only had a resident income. So that's one way that some people get around it when they don't have a Roth 403 account available to them. You know, a lot of people that are in residency ask me about health savings accounts and that sort of thing, but in general, most resident health plans are pretty good. They're not high deductible plans, and so you often don't qualify to use a health savings account. So you may have to leave that until your attending years. And then, of course, 529 is for your children. If you have kids already in residency, that kind of stuff's probably best left until you're an attending. Quite honestly, the tax breaks aren't as good as they are for retirement accounts. Besides, your retirement has to come first, before college savings, even if you have older kids. Okay, let's talk a little bit about buying a house versus renting. Although if you're already in residency, you probably already made this decision. I'm not a big fan of residents owning houses. Can they come out ahead doing it? Yeah, they can. And that's what makes it so difficult, because people look at other residents that made money and think, oh, I want that. I want to make money like they did. What they don't realize is a huge percentage of residents not only had to deal with that hassle of owning a house during residency, but they didn't make money. They came out behind even when they think they made money. Just because you sell the place for more than you bought it for doesn't mean you made money on it. Once you take into account the transaction costs and the vacancies and the upgrade costs and all that kind of stuff, it also becomes difficult because real estate is cyclical. So, for example, you may be coming into a residency where all the residents that bought made money, and yet all the ones who buy the year you come in end up losing money. And so it can be difficult because if you just do what people are doing now we're doing a few years ago, you can end up doing the exact wrong Thing due to the cyclical nature of it. So be careful with this. I figure after about three years, maybe a third of people that buy end up making money on it. After five years, maybe 50%. And so at that point, it starts being, yeah, it might be a reasonable idea, but the truth is, during residency, you have so much other stuff going on. The last thing you need is take care of a house. And it's not like buying a house in residency is somehow going to catapult you into, you know, financial freedom. You just can't afford a big enough house at even a ton of appreciation during residency is going to make a huge difference compared to what you do with your finances the first few years out of residency. So, in general, I recommend you rent as a resident, but it's not the end of the world. If you've already bought, hopefully you come out ahead, and if you don't, hopefully you don't come out too far behind. Okay. The most important financial thing you can do during residency, aside from maybe getting disability and life insurance in place for the people depending on you, is to have a plan. So you hit the ground running with your first attending paycheck. Basically, you need a plan that outlines how you're going to live like a resident and where those first 12 attending paychecks are going to go. And if you have that, you're going to be ahead of 95% of your colleagues, no matter what specialty you're in. Too many doctors just do what comes naturally, which basically is to have bought a big, fancy, expensive doctor house on credit with 0% down before ever leaving residency. Have a couple of car payments, you know, maybe some credit card payments. And by the time your student loan payments have to start being paid a few months later, you realize that you're really stuck on the treadmill for the next 30 years, and you're not getting off just because you have a lot of payments to make. Anything else you wish you would have known financially when first starting a career in medicine? Well, it's hard to say. You know, there's lots of things we all wish we knew and we've all got to learn as we go along, but. But I think perhaps one of the most important things to learn is just how important your savings rate is. In the beginning, we all like to focus on investments and what your investment returns are, but it honestly doesn't matter what your investment return is. When you only have $10,000 invested, you got to get some money into that account so that compound interest actually has something to work on. And in the first five or 10 years out of residency, your return almost doesn't matter at all. It's all about how much money you're putting in there, and I think that's probably the place to focus and that a lot of people don't realize. Okay, here's a question from a resident. I'm a resident entering my final year of residency. I have a Roth IRA with Vanguard and a governmental 457 that offers an employer match. I will have to roll the 457 money into a retirement account upon leaving residency and was wondering about some general advice about how to go about doing so. I'm a little skeptical that's actually a 457 as most of those don't have a match. But we'll go with it. I'm starting moonlighting soon and I'm considering opening an individual retirement account for which to place that money. I'm also trying to help lower my tax rate that I expect to increase this year due to resident salary increases and aforementioned moonlighting. Should I open up a Solo 401 traditional IRA or Roth 401 at a company such as eTrade that I can use to roll over my 457? Ideally, this would be an account I could also use to fund my backdoor Roth when my income significantly changes. I'm somewhat confused about what sort of personal retirement account to open in order to facilitate all this and not incur penalties. Thanks for your help and consideration. Okay, it does sound like you're a little bit confused. And like I said, you may be talking about a 403 and not a 457, but let's just assume you know what you're talking about with the 457. 457B's come in two flavors, governmental and non governmental. The governmental ones can be rolled over into a 401k or an IRA when you leave your employer. The non governmental ones generally can't and have all kinds of wacky distribution options. Sometimes you have to take all the money out right when you leave the employer. Sometimes you can spread it out over five years. It just really varies quite a bit. But it sounds like this is probably a governmental one that can be rolled into a 401k or a traditional IRA, so that's probably what you ought to do when you leave the residency. The problem is if you roll it into a traditional ira, it's going to screw up your backdoor Roth accounts going forward. You're not allowed to have any money in a SEP IRA. A simple IRA or a traditional IRA on December 31st of the year, you do the conversion step of a backdoor Roth ira. So what you should usually do in those situations is roll it into a 401k. And a great 401k to roll it into is your solo 401k which most stocks ought to try to get anytime they have self employment income. E trade is a nice one because it allows you to roll IRAs into it, unlike Vanguard's account. And so that's a reasonable place to do your individual 401k. So in this doc situation the typical thing you would do is you would open this up and use it to make contributions from your moonlighting income. And then anytime you need to roll something over like an IRA or a SEP IRA or a 403 or 401k or 457b, that's governmental, you just roll that into your individual 401k, because that balance doesn't count toward that pro rata calculation when it comes to doing your backdoor Roth ira. But it's still, you know, tax protected, asset protected kind of account. So hopefully that clears up the confusion on that question. Okay, here's another doc in residency writing in, I have $127,000 in medical school debt. I'm entering a two year residency July 2nd. Okay, that's pretty good. Actually $127,000 is way below average. I called my loan servicer and they talked to me about forbearance and repay. What would you suggest I do in the grand scheme of things? I'm planning on paying it off two to three years after residency by living like a resident. That's good. As of right now I'm thinking forbearance and then refinancing after my residency. And I understand the capitalized interest, of course. Please help if possible. Well, forbearance is almost never the right solution. I mean forbearance is the right solution for somebody that can't pay $100 a month. I mean, if you budget is so tight that you literally can't come up with a hundred bucks a month, then maybe forbearance is right for you. But that's almost nobody. I mean, come on, a hundred bucks, you can come up with that even as a resident. And so this doc's planning on paying everything off. So all options are on the table. This doc can either use repayment, see how big the subsidy is going to be from the government, or this doc can use refinancing. You can even get a $0 a month payment with refinancing with those four lenders that will do that. If you don't know what four lenders I'm talking about, go to the White Coat Investor website under recommendations and there's student loan refinancing tab there and click on that. It's got all the special deals we have for refinancing with these private companies, but four of them are listed there as working with residents and having these special resident programs. You don't even have to have an attending contract and can still refinance your loans. But in this sort of situation, I'm going to bet that refinancing is probably the best move for this doc. But of course compare it to the effective interest rate under repay and if that's lower, then do that at least until it no longer is lower. It's one of those things you really ought to calculate every year. Next question. I hope you're doing well. I'm assumed to be a third year pediatrics resident. I wanted to discuss a peculiar situation I'm in with you. I'm a single child. My parents, who have been together for over 30 years, I'm married, don't have kids. My wife is a dental student. She will finish her school when I finish residency. I'm currently applying for a pediatric subspecialty fellowship. Being a single child, how should my parents manage their money? So there is no huge taxation due to the inheritance that I expect 20 to 25 years down the road. Well, you know, a lot of people worry about this because they don't understand how the estate tax works. Maybe your parents are really, really well off and this is actually a legitimate question for you. But in general this probably isn't even a reasonable question to be asking. And the reason why is that married people this year have a 22 million dollar exemption from the estate tax. So your parents can leave 22 million to their heirs before any federal estate tax is due. So are your parents worth more than 22 million? If they're not even close, then you don't even have to worry about this question. It's all coming tax free. Now. Is it possible there could be some income tax? Well, it depends. If they leave you a tax deferred account, when you take money out of that, you do have to pay income tax on it. That's why it's obviously preferable to inherit a Roth ira, which is best because you can stretch those tax free benefits out over decades. Or if that's not a possibility, it's nice to inherit just taxable money as well because you get the step up in basis at death, meaning that your basis in that the irs, when they look at you, when you sell it, they assume you bought it on the day your parents died died. And so you only have to pay taxes on the gains from the time of their death until the time you sell it, which if you sell it right away is basically nothing. And so those are the two nice kinds of accounts to inherit. A traditional IRA or other tax deferred account is also nice to inherit because you can stretch it out over a long time, but you do have to pay taxes as you take the money out. But as far as the estate tax goes, you know your parents have to be pretty wealthy before this even becomes a concern. Of course there are some lower exemptions in some states, so look up your state and see if you have a lower exemption. The states that have lower exemptions are usually kind of the blue states in the northeast, but every state's a little bit different. Most don't have an estate tax at all. Okay, here's a resident that's about to graduate. I'm currently graduating and planning life after residency and I plan to try to make some extra income from side gigs if possible. I've been reading about solo 401ks and I'm still a bit confused. I was hoping you can answer a few questions. According to NerdWallet, for people with side gig income, the elective contribution is per person and not planned. Does that mean I can't put any elective employee contributions into my solo 401k if I'm putting 18,500 into my employer 401k? Yes, that's true. You only get one employee contribution no matter how many 401s you have. And he asks if so, can I still make the $10,587 employer contribution to the solo 401k even with zero dollar employee contributions? Yes you can. So you're still eligible to make employer contributions or about 20% of your net income from that side gig into their into that solo 401k. So the typical pattern that people do is they put their employee contribution into their employer's 401k and they get whatever match the employee is offering. And then for their side gig they put 20% of their what they're making into their solo 401k as an employer contribution. The next question this doc asked is the $50,000 self employment income taxed at the self employment tax rate or at my marginal income tax bracket? Because of my physician income. Sounds like this doc's a little confused about how the tax system works. You have to pay federal income tax on all of your income and you have to pay payroll tax, Social Security and Medicare on all of your earned income. And so it's not like there's a separate self employment tax. What self employment tax is, is just your payroll tax. When you're self employed, you got to pay both the employee side and the employer side. So until you've maxed out your Social Security tax for the year, you're going to be paying, you know, that 12.4% towards Social Security if you're the employee and the employer. Although half of that is a tax deduction for the business, no matter how much money you make, you're still going to be paying the Medicare tax, which is 2.9% when you include both halves. And so you know you can have fairly significant tax rate on any money you make on a side gig, particularly as a resident or when you're in the military. I was appalled just how high my marginal tax rate was on my moonlighting income when I was in the military. I think I only had about $70,000 in taxable income that year, but my marginal tax rate was in the 40% range. It was really pretty terrible. Between paying both halves of the Social Security and the state income tax and the Medicare tax and the federal income tax, it was pretty brutal. Next question he had was, when calculating my solo 401 employer contribution of up to 20, 25%, can I only use the side hustle income of 50,000 or can I take 25% of my total income of 350,000? No. If you want to put it into the business's 401k, that solo 401k, you can only look at the income the business made so that 50,000. And as final question, if I have more than one unrelated side hustle, such as insurance consulting and writing fiction, can I combine all of those incomes to calculate my Solo 401 contributions? Yes, you can. Or do I have to create a separate solo 401k for each side hustle? You actually can create a separate solo 401k, but since the employers are all related, you're not going to get, you know, multiple maximum contributions. You can't put 55,000 into each of your 401ks because you're the only owner of all of those businesses. So they're all looked at together by the IRS, and you have one $55,000 contribution limit, no matter how many you have, so you might as well just have one. All right, that was a lot of questions from residents. Thanks for listening. I hope that was helpful to you.

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