Financial First Steps for Graduating Physicians
Hey, what's up everyone, Henry here from Disruptive Money Management, and we are back with another episode on five critical things. I started doing something similar to this in the past, beginning with the most critical things you need before passing away.
If you haven't checked it out yet, please hit the episode notes for that link; it is the Five Most Critical Things You Need Before You Pass. I know it seems absurd to think about what you need to do before you pass away, but the fact of the matter is we never think about our untimely moments. To date, that is one of my most popular episodes. I think a lot of it has to do with it being simple and easy actions that you can take to protect your family if something happens to you.
I followed that episode up with the Financial Heart-to-Heart For Couples before tying the knot. In actuality, it was about having a financial heart to heart for couples who want to get on the same page when it comes to financial matters. I do want to say that while the episode is trending well, my wife brought to my attention that I really should not be giving relationship advice. "Stay in your lane, Henry!" is what she told me.
So with her advice taken to heart, I thought I better pivot back to where I'm more comfortable with and that it is practical financial advice for the everyday person. In this episode, we're going to be talking about the Financial First Steps for Graduating Physicians.
In working with numerous millennial physicians, many are coming out of medical school and starting their careers without a solid foundation for managing their finances. There is so much disinformation out there targeting physicians and those in the health care industry. As a US healthcare professional, you spend a ridiculous number of years in school. You go from four years of undergrad to four years of medical school before being allowed to devote another three to seven years as a resident. With everything is said and done, it's not uncommon to have gone through ten to fourteen years of education.
Yet, wherein our educational system did they provide financial mentorship? Every healthcare professional I have worked with knew they were going to be undergoing a rigorous educational procedure. I mean, it's healthcare. Just about everyone knew that they would be taking on an excessive amount of student debt to get to where they wanted to be. But then what happens? You're given the white coat; they hand you the stethoscope and start asking for payments on $400,000 of student debt!
And here you are, left scrambling trying to figure your financial life. A financial life that was never explained to you nor provided guidance. You've spent years hitting the books, memorizing critical components of medical knowledge, honing your practical skills, and off you go working sixty to eighty-hour workweeks.
Many of our healthcare professionals go from eating ramen throughout their college and residency years to figuring out how best to tackle their mountain of debt, how to save, and how to get their financial life to become less chaotic and more a pathway to financial independence instead.
Of course, our financial industry doesn't make it easier. Workplace financial wellness is nonexistent because healthcare systems are too busy to provide that for their employees. The best information you get is most often from the attendings and more senior colleagues. However, what they did for themselves may not be the most practical solution for you. In addition to that, you have hundreds of thousands of insurance salespeople and sales brokers who are throwing expensive commissionable products at you without regard to your holistic financial needs.
So what do you do? What do you need when you don't know what you need, and the information out there is murky at best? How do you sift through the mountain of data sent to you to determine what steps you need to take to secure financial independence?
Now I'm not saying that the five things I'm recommending are the end-all, be-all's; no, instead, it is the foundation upon which you should use to build. These five financial first steps for graduating health care professionals should be the base upon which you build your financial independence. For each five of these items, I'll explain what they are, why they are essential, and how to understand what's out there available for you to choose from.
Financial First Step Number One: Setting up a Roth IRA
Setting up a Roth IRA is one of the first things you should be looking to do when you have earned income. You cannot contribute to a Roth IRA until you have earned income which typically doesn't occur until your residency years. At that point, it most likely isn't a significant earnings amount, but at the very least, you can put up to the IRS maximum of $6000 a year into this account.
The Roth IRA is the best starting investing account for individuals with an earned income. The money you put in is after-tax, which means you have already paid taxes on it. Still, the growth is non-taxable, and withdrawals at retirement are entirely tax-free. If you need more information on this, please be sure to check out my episode, the Traditional IRA versus the Roth IRA.
Starting this early and creating this young means you have the potential to allow for many years of compound growth. Compound growth is what builds financial independence.
Compound growth is why individuals who start investing early on are more likely to experience high returns and more comfortable retirement later.
So, where do you go to set up a Roth IRA? Practically anywhere. Just about all of the central banks and even local credit unions offer a Roth IRA, as do all major brokerage houses like Fidelity and Schwab. You can set up a Roth IRA with a mutual fund company directly, too, if you want. So what's the difference? Let's dive in and find out!
When I say walking into a bank, I mean opening up our banking apps because who steps into a bank these days, amirite? As I said, all major banks and credit unions generally offer Roth IRAs these days. You can practically open one and do an instant transfer from your checking or savings account directly to their Roth IRA if you want, which means there's a lot of convenience to it.
However, bank and credit union retirement accounts are tricky. While they may be easy to establish and transfer into, the accounts are generally designed only to provide CD-like returns. If you're not familiar with it, a CD is a contractual agreement between you and the bank whereby you leave your account with them for a predetermined period, like, say, 12 months. In exchange, they would credit you with a stated interest, say one percent.
So, while bank and credit unions may make it easy for you to set up a Roth IRA, you have to be careful with the underlying investment. Remember, a Roth IRA isn't an investment; it is an investment vehicle. The underlying investment with most banks and credit unions is generally only CDs, which means your rate of return is in the one to two percent range.
Yes, it's convenient, but with abysmally low-interest rates that cannot even keep up with inflation, you are better off steering clear of these places for your Roth IRA accounts.
Mutual fund companies also provide Roth IRA options. An example of a mutual fund company that is direct to the consumer would be American Funds, JP Morgan Funds, or T Rowe Price. These companies package the process neatly for you in that you can set up an account with them, select your investment from an extensive list of options, fund it by linking it to your checking account, and even set up recurring deposits so that you're automatically contributing into the account throughout the year.
Mutual fund companies are easy to use, and they provide a better diversification than bank and credit union products. However, mutual funds can be expensive. Most of the mutual funds out there charge you a buy-in commission of upwards of 5 to 6% of your deposit. This can very quickly eat up your investing power and become very costly over a long period if you're constantly paying a commission per deposit.
Setting up a brokerage account would be your best option if low rates of returns and high commissionable products are not something you want to deal with.
You can easily set up brokerage accounts at major firms like Charles Schwab, Fidelity, and Vanguard. All three provide a super intuitive phone app that allows you to see your balance, transfer funds quickly, and invest.
Just about all brokerage houses will allow you to purchase stocks for practically nothing. They'll even give you access to their institutional mutual funds for almost zero expense. Unless you're buying options, you pretty much pay zero in commissions.
The drawback is that they require a little bit more work on your behalf. Setting up a bank link will generally take a few more days than instantaneous. You also typically have to tell the system how you want it to invest. What I mean is this, if you're transferring money into that account, you'll have to manually enter in how you want that money to be invested. If you don't do that, your money can sit idle.
So if you're OK with a little bit more work on your part, the brokerage account is right for you.
Financial First Step Number Two: Refinance your student debt
With student debt now being the second largest form of debt obligation here in the United States, taking charge of your debt situation is of utmost importance. Yes, the number you have accumulated may seem daunting. Considering how you might be graduating with 8x the average student debt obligation, it's easy to become overwhelmed and put it off for a rainy day.
However, some straightforward and practical steps can help you not only get financial peace of mind surrounding student debt but also set you up on the path to demolishing that financial burden.
Refinancing your student debt from government and private lenders can save you thousands of dollars in interest. Lowering your interest rate not only saves you money, but it could be the smart move to help you pay off that debt faster.
Let's break this down into two components: interest rate and payments.
Suppose your student debt is accruing interest at 7%, and you can refinance your debt to 5.70% (which is on the higher end of the private sector right now). In that case, that is a savings of 1.30% over the life of the loan.
1.30% may not seem like much, but on $400,000 and spread out over 15 years, that is almost $140,000 of interest saved.
Suppose your current monthly student loan payments are too high, and you want some extra breathing room. In that case, you could also potentially refinance it to a slightly longer duration. You can stretch the payments longer by extending the loan term, thus effectively decreasing your monthly obligation.
While stretching out the loan may not be the soundest financial decision ever, if you do so by decreasing the interest rate, you could still effectively save yourself money in the long run compared to keeping your student loans at a higher rate institution like the Fed or brick and mortar banks.
The majority of the more prominent student loan refinancing institutions also have no prepayment penalties, so even if you refinance to a longer-term for better cash flow purposes, that doesn't mean you can't keep your monthly payment at the higher amount to pay it off faster.
For instance, let's say you were making $3,000 monthly payments, and after refinancing your student loans, the new payment plans are set at $2,500 a month. If you haven't built up emergency savings yet, that extra $500 a month in freed-up cash flow could be a quick and easy way to get that out of the way. However, you can also still maintain $3,000 monthly payments if that number is comfortable for you. Having an additional $500 a month to principal goes a long way to paying off your debt faster!
Now, all of that may sound well and fine, so it's easy to think that student loan refinancing should be the very first thing you ought to do, right? Not quite so fast. Before pursuing student loan refinancing, please remember that the Federal benefits programs you may be automatically enrolled in would be phased out if you refinance your loans.
Currently, the payment programs like Income-Based Repayment (IBR), Pay As You Earn (PAYE), or Revised Pay As You Earn (REPAYE) are only available for student loan obligations held through the Federal government. Refinancing out of it means you would lose out on those benefits.
Additionally, PSLF, or Public Student Loan Forgiveness, is also only available for Federal debt obligations. PSLF would forgive outstanding federal student debt obligations if you were full-time employed for ten years with a US Federal, State, local, or tribal government or a not-for-profit organization.
To qualify, you have to have made 120 payments while employed in one of those criteria. Since these debt obligations are only forgiven if you maintain the student debt at that Federal Direct Loan service provider, you should take the time to think about whether it makes sense to refinance or not.
If the private sector currently employs you, and you do not have any intentions of working in the space I just mentioned above for PSLF, then you ought to consider refinancing your student debt.
However; if you are already in a not-for-profit hospital and believe you will be there for at least ten years, then you may want to keep your student loans at the Federal institution and work diligently to make sure all payments are counted towards the 120 payment plan system and seek loan forgiveness the moment you become eligible. If you are seeking PSLF, then, of course, by all means, you're better off utilizing IDR or the PAYE system instead.
Financial First Step Number Three: Disability Insurance
Your third order of action is to get disability insurance.
Disability insurance is essential for healthcare professionals for two reasons: debt ratio, income replacement needs, and physical exertion.
OK, that was three, but you get what I mean. As a healthcare professional, your level of education is vastly longer than most occupations which usually results in higher levels of student debt. This is further expanded upon if you are in a specialized practice.
Healthcare professionals are also one of the highest wage-earning professions, which generally allows you to afford more of what's out there. A higher-income means a higher borrowing potential which means a more expensive home or a more luxurious car. The higher salary could afford to send your children to private school or whatever it is that floats your boat.
Lastly, as a healthcare professional, so much of your daily work activities require physical labor. You're hustling all over the hospital, busy pushing and lifting weight that is frequently much more than what you weigh, and that's not even including the mental toll of working sixteen hours while constantly being on your feet.
These three criteria are the primary reason why you need disability insurance. God forbid an accident causes you to lose motion in your primary hand or the ability to maintain your work abilities; what would you do?
According to the American Medical Association, physicians have a greater statistical probability of suffering a severe disability that impedes their ability to work rather than die prematurely. Yet, physicians pay more attention to life insurance than they do to disability insurance.
We're often asked what would happen to our loved ones if we die prematurely. But very rarely are we asked what would happen to our lives if we suffered a severe disability. Ponder that for a moment, ask yourself how would that mortgage payment be covered if you are left unable to work? Would you be alright if your kids had to be pulled from private school or if you suddenly had to revert to non-organic produce? Can you imagine the horror of a life without Whole Foods? I mean, is life worth living if you can't afford Veganic Ancient Sprouted Maize Flakes for breakfast? Or what kind of party are you throwing if you don't have Pumpkin Spiced Latte Beer to go with your guac-kale mole?
All jokes aside on Whole Foods, the point I'm making is that instead of having a singular focus on life insurance, you need to make sure you are incorporating an adequate amount of disability insurance as that may be more important than the former.
So how do you know if the disability insurance proposal you're reviewing is the right one for you? Well, first and foremost, know that disability insurance is not the same across the board. Just like your car insurance, shopping around will make a big difference in how much you pay versus how much coverage you get.
When purchasing disability insurance, you want to look for policies covering 50 to 60% of your income. Disability insurance, if purchased individually, is paid out tax-free, which is why you do not need an exorbitantly high amount of coverage. At the same time, you want to make sure that you have an own-occupation clause that would allow you to work in a similar field without losing the disability payout.
That clause is critical because specific disability policies, especially those not designed for physicians, can stop paying if you can work again. It doesn't matter if that work is nowhere close to what you previously paid, so be careful what type of policy you purchase.
When shopping for disability insurance, you must work with an independent insurance agent versus someone who represents a particular insurance company. An independent agent can help you look across multiple insurance companies to find the best coverage and rate for you. A captive agent may be able to provide you with one or two quotes. Still, they'll almost always recommend the insurance quote from the company that they represent directly.
What is even better is working with a licensed insurance agent who also can provide financial planning. While many insurance agents will masquerade as financial planners, you want to make sure they truly incorporate financial planning into their practice and not just insurance sales.
If the person you're talking to starts recommending many insurance products to you, then you should get a second opinion. It's hard sometimes, especially if the person was recommended to you by someone you trust. Still, when the salesperson starts saying that everything can be accomplished with an insurance product, you know you're probably better served with someone else.
Disability insurance can also be provided to you by your employer. Many employers offer benefits packages incorporating disability insurance. Perhaps it's prepaid by your employer, or you pay into the system and get it through their group coverage plan.
While those are not bad, you have to think about the worst-case scenario. The worst scenario is that most prepaid plans generally do not have a lot of coverage. They very rarely ever get close to the 50-60% income replacement that is typically recommended.
Additionally, most of these policies are only available if you are working with that employer. But what happens when you take on a new job somewhere else? Insurance policies are better purchased when you're young because insurance costs are less than older. If you switch jobs in your forties, you could wind up paying a lot more for disability insurance versus if you started in the thirties.
Remember that insurance policies that your employer pays for are generally tax-deductible to them, meaning it would be taxable income to you when you receive it. What would have been a decent benefit could suddenly become drastically reduced by taxes if that is the case.
Financial First Step Number Four: Get life insurance
Five words: term life for twenty years.
Term life is the cheapest form of life insurance you can buy, and twenty years is a reasonable enough time frame for you to build on your financial nest egg. If you want more security, opt for a thirty-year instead.
How do you know how much you need? I have a whole episode on calculating how much term life insurance you need, so be sure to check it out.
But the short answer is to calculate how much outstanding joint debt you have with your partner and any financial cushions you want to leave behind, like extra money for kids' college and all of that. You can always use the rule of 5x salary for a quick and easy ballpark figure if you don't want to go through all of that number crunching.
Life insurance is not a benefit for you but for your loved ones in the event you pass away before you have secured a well-funded financial nest egg. It's like your car insurance, it doesn't matter if you never get into a car accident, but it'll be there in the event you do. If the thought of paying into a system for something you may never use sucks, then consider a return of premium insurance.
Return of premium insurance is like term life with the added component of refunding your entire premium if you live past the policy duration. These policies cost a little more each month, but if you survive twenty years, the insurance company will give you back everything you paid them.
Not all insurance companies provide ROP insurance, since they are not as popular as straight term life, but it can be a solution if you want peace of mind but hate the thought of twenty years of insurance premiums being flushed down the toilet.
Financial First Step Number Five: Set up your 401(k)
Set up your 401(k) at the earliest opportunity that you can. If you're with an employer, that is most likely sixty to ninety days before you can be entered into the plan. I rarely see one-year eligibility for health care systems, but that can still be the case.
You'll probably be allowed to enroll in the Roth 401k. Still, at your salary level, you're best served with the Traditional 401(k). The Traditional is the Pre-tax option which means you're saving money on taxes now versus paying it upfront like the Roth IRA.
I know it sounds counter-intuitive to the Roth IRA we just talked about but stay with me here. At your salary level, you want all of the tax breaks that you can, and there's nowhere that allows you to shelter $19,500 in earned income from taxation aside from the 401(k). It doesn't make sense to pay the taxes on that because it's a substantial number. Drop that into the pre-tax bucket, let it grow tax-deferred, and when you're ready to start withdrawals in retirement, you can work out a plan to control the taxation at that point. There's no sense in paying all of that tax now if you can avoid it.
I didn't recommend a Traditional IRA up above because the Roth IRA becomes a better complimentary account to someone who has a Traditional pre-tax 401(k). Additionally, as your income rises throughout your years, you'll be phased out of Traditional IRA deductions. You may use the backdoor Roth IRA which can become complicated if you have an outstanding Traditional IRA balance.
Confused? Yeah, but don't be afraid to pick up the phone and give me a call if you want a more hands-on walkthrough. I also have an episode on the backdoor Roth IRA which explains the concept in-depth.
For now, remember Roth IRA and Traditional pre-tax 401(k). Those are your foundational accounts.
Regarding investment selection, most 401(k)'s will automatically default you into a target-date fund that is age-based. The younger you are, the more exposure you have to growth-oriented investments. As you become older, the addition of bonds within the portfolio is designed to soften drastic market downturns.
While the easy button is OK for a short duration, it's still best if you elect for your mix of investments. For instance, most target-date funds have diversified domestic equity, international equity, and fixed income. When you're young and aggressive, you may not want to utilize any fixed-income alternatives.
Additionally, the average return on domestic equity is approximately two percent higher annually compared to international equity, so why sacrifice investment returns just for the sake of exposure to global equity and fixed income alternatives?
When it comes to investing, be aggressive where you can, and being aggressive at an early age is perfectly fine. When it comes to retirement accounts, the likelihood you'll need the funds during your working years is relatively slim to none. Does it matter if you see volatility during these early years? Most likely not.
Your fund menu line-up will probably have about fifteen to eighteen different options, and you can quickly narrow it down to four or five. Suppose you pick a mix of the S&P 500, mid-sized domestic equity, small-sized domestic equity, and a blend of value equity funds. In that case, you're in relatively good shape for a growth-oriented portfolio that is well diversified in domestic companies.
All right, ladies and gents, that rounds out the five things on my list of Financial First Steps for Graduating Physicians. However, suppose you've been a follower of my podcast series. In that case, you'll probably notice that I like to throw a couple more cause sometimes five isn't enough.
I intentionally omitted these following two items because they aren't precisely must-have to-do's that you need to get done early on. My list of five items is something that is best approached in the earliest years possible. Quite frankly, if you can do those five things in your residency years or early attending years when you're not making a whole lot of money yet, all the best to you.
The following two items are generally for you when you are more established and have a more complex financial situation. These two items are:
Fostering a CPA relationship;
And speaking with an estate planning attorney
When you're just starting, it's easy to jump onto TurboTax or TaxAct for simple filing of tax returns. As your income scales into the six figures, you're going to want to start working with a CPA to make sure you're taking all of the possible deductions available.
Yes, it's a little more costly, but a good CPA can save you hundreds if not thousands of dollars in proper tax planning strategies.
As you start a family and start accumulating assets, you will want to start working with an estate planning attorney to draft the necessary documents needed to protect your family in emergencies.
While all situations are different, at the very least, you want to ensure you have your proper documents in place. These documents are your:
Financial power of attorney
Healthcare directives
Will's
Setting up a trust if needed
Setting up LLC's if you own properties or outside businesses
While you may not necessarily need those very early on, as you build your net worth, you're going to want to ensure those are all properly drafted and established.
Whew, alright! I know I threw a lot at you. Still, as I have said numerous times in the past, it's a shame that financial wellness matters are not taught in our education systems because how to manage your money correctly and your financial life is just as important as every other aspect of your daily needs. By setting the proper foundation, you'll find that it becomes effortless to add additional layers of security to it without feeling overwhelmed.
Doing these simple things will set yourself and your family on the right path to financial independence.
And that's it for today, my friends. I hope you enjoyed this segment, and you know of someone who could benefit from this advice, please share a link to the podcast or my blog. Until next time, I wish you and your family the very best.