What to do with your first $50,000

Congrats to the third year residents and fellows who finish on June 30 and are out in the real world! This article was originally published by our friends at Ophthoquestions on December 5, 2017. There are some good articles on their site that everyone should read, here’s the link.

Hint: despite the photo above, the answer isn’t to go to Vegas and blow your $50,000.

This article applies to those of you who are employed as well as going solo. Here’s the full post, with an tax planning strategy addendum from a reader question:

So you’re an attending finally and in your first job.  That means you can finally afford a nice car maybe a Beamer or Mercedes, a luxury condo or to buy a house, and eat at fancy restaurants?

Wrong. You actually can’t afford to NOT continue to live like a resident.  Right now is the most important time to save lots of money.  First of all, the money you save now is worth more in terms of time growth.  $50,000 invested at age 25 at the assumed stock market return of 8% (the SP500 index fund has actually historically returned 10-12% with dividends) is $1.086 million dollars — and that’s even without contributing another penny after age 25!  But $50,000 invested at age 35 is only worth $503,000 at age 65. You’ll have to save twice as much if you start 8-10 years later.

Furthermore, the more fancy stuff you get the younger you are, the more used to it you’ll get and if you ever have to “go back” it’s no fun.  If you’re used to staying in the Super 8, the Courtyard by Marriott is a lap of luxury.  But if you’re used to the Park Hyatt, the Courtyard is ghetto.

Finally, as Ho Sun has so carefully discussed in our blog, a big reason why he had so much trouble starting up his practice from scratch straight out of residency was because he had nothing.  If he worked for a few years and spent all his money he’d still have nothing!  But if he had worked and saved up $50,000 for a few years it would’ve been easier to start up and get away from a tyrannical boss — FREEDOM is priceless!!

Definitely do NOT buy a house!  Because most of you reading this (80%) will be leaving your first job and relocating!  You pay commissions of 1-2% as closing costs When you buy, as well as the real estate agent 6% of what the house is worth when you sell it.  Housing prices usually go up parallel to inflation so you’d have to stay four years just to break even. How bad would it be if you stayed in a job you didn’t like because you bought a house and it’s too expensive to move? You’d be a prisoner in your own house!

If you earn a $170,000 salary, assuming you max out your 401k at $18,000, and get a 4% employer match of $6800, you’ll take home about $4200 per pay check or $109,200 per year.  If you live slightly better than a resident say on $50,000 post tax then you’re still saving $59,000 plus $24,600 in your 401k or $83,600 per year.  Even if you up your spending to $65,000 per year, you still save $68,600 per year.

Most financial experts recommend putting into your 401k at least the amount to get any employer match, but I highly advocate putting in the entire IRS limit of $18,000.  Not only is it a tax break, 401ks provide high asset protection.

You should also put $5500 into a non-deductible traditional IRA to do a backdoor Roth.  This can become complicated if you have other IRA accounts.  If your 401k plan allows for IRA transfers, this might be a good way to reduce your IRA basis to zero to be able to do a backdoor Roth.

Note to residents and YOs: leave the 401k plan from your residency and your first job open to potentially be able to do the above. Don’t roll it into a IRA.

So now you have $23,500 (or with a employer match $30,300) in tax-advantaged, asset-protected accounts that will grow on the average 8-12% per year.  If you are 30 when you’re done with training, the $30,300 will be worth $500,000 at age 65.  Would you rather buy a new car that depreciates, or have a half million dollars at retirement?

If you are in good health, sign up for a high-deductible health plan with a HSA (health savings account).  While you’re responsible for the first $5000 or so of your health care with these plans, if you’re healthy you can curbside colleagues.  That’s the good thing about being a MD!  You can contribute $3400 every year and invest the money in stocks while using post-tax money to pay for health care expenses.  There’s a triple tax advantage — the $3400 is tax deductible, all growth is tax-free, and no taxes on withdrawal as long as it’s used for health care!

So you’ve saved $26,900 to $33,700 so far.  The 401k, Roth, and HSA should be invested in low-expense ratio broad index funds like the SP500, total stock market, and total international stock market funds.

Note that I did NOT entertain buying individual stocks, gold, or bitcoin due to diversity risk. If the entire US stock market collapses Congress will issue a stimulus/ bailout; if one single company goes bankrupt no one may care.

The next thing I would do would be to pay off any high interest loans that accumulated during residency.  Some people would advocate doing this first even before maxing out a 401k, let alone the backdoor Roth and HSA.

But my argument is if you’re reading this and have enough discipline to follow what I say, your income will be high enough to pay off any high interest debts in a year or two.  But if you delay funding a 401k, backdoor Roth, or HSA since these accounts have annual contribution limits, you lose the opportunity forever.  By high interest I mean 6% or over.  The stock market averages a 8-10% return but is much more volatile, so I’d take a “guaranteed” 6% return any day.

Finally, I would save the rest in cash.  Everyone needs a six month emergency fund (most disability insurances will have a 90 or 180 day waiting period).  Don’t forget, the less you spend, the lower the emergency fund will be.  If you spend $50,000 a year, you only need to save $25,000 for your emergency fund; if you spend $80,000 then you need to save $40,000.  $40,000 takes longer than $25,000 to save. Since you’re spending more meaning you have less to save, in addition to the fact that the dollar amount is much higher.

Once your pay starts to increase, you have the six months saved, and high interest debts are paid off, then start saving for starting a practice, down payment for a house (I only recommend this once you enter partnership with your practice), or paying off student loans if you can’t consolidate to a lower rate.

Believe it or not, there are many attendings 10-15 years into practice that have zero net worth.  These are the same people who wind up pushing unnecessary procedures and treatments that line their own pockets rather than benefit the patient.  Don’t be one of them.  Start early, save your first $50,000 and take it from there.

June 2018 addendum: a current fellow finishing training this year emailed me to ask about his specific situation. If you’ve been saving in a 401k during residency or your first year as an attending, listen up! Your marginal tax rate is probably very low due to having a half year of attending income. Consider a Roth conversion.

If your 401k plan for your residency or new job allows in plan traditional 401k to Roth 401k conversions, or your new job allows Roth 401k contributions, this is the perfect year to do it. That’s because you’re still in a very low marginal tax rate due to just a half year of attending salary, yet are making enough money to be able to pay for the conversion!

For those of you that aren’t familiar, 401ks defer tax when you contribute, and are taxed upon withdrawal. This is great if you are earning a lot and have a high tax rate, and expect it to be lower during retirement.

Roth 401ks and Roth IRAs are taxed at the time of contribution (the backdoor Roth described above is with post tax money). But all growth in the account is tax free and there is no tax on withdrawal. So if you’re in a low tax bracket now (not earning much) this makes sense, especially when you’re young and have many years of potential growth. Putting some of your money in Roth accounts provides for tax diversification and is a hedge against higher rates in the future. 401ks also provide high asset protection, so you are using post tax dollars which aren’t asset protected to get a higher amount under your 401k limits ($18,500 Roth 401k post tax is worth more than $18,500 pretax in traditional 401k).