What to do With Extra Money
As a resident, it's possible that you never feel like you have any extra money after paying for rent, food and student loans. But let's say that for one reason or another, either from cutting back on dining out or just by chance, you find you have some extra cash building up - what should you do with it?
Here at DOCTORED MONEY, we have some thoughts. Actually, we have tons and tons of thoughts, but we are only sharing a few of them with you today.
Pay Down All High-Interest Debt
This includes credit-card debt and any other high interest rate loans you may have (e.g. private residency/relocation loans). What’s high? It’s relative, but consider anything above 9% to be high, and debt that should be paid off as soon as possible. Credit cards often have teaser rates that quickly jump up to over 20%! Don’t get burned.
Are You Adequately Insured?
This includes health insurance, life insurance, disability insurance and renter’s/homeowner’s insurance. We’ll assume you already have health insurance covered. Life insurance is important if anyone depends on you financially. Disability insurance is insurance that will pay for part of your salary if you’re unable to work. Most employers offer group disability insurance, but it may have limitations and exceptions that make it hard to cash in on (such as excluding disability due to mental health, which is the most common cause of disability among young physicians). Ideally, by the time you’re done with training you should have your own disability policy.
Build an Emergency Fund
Most experts recommend an emergency fund that can cover at least 3 months of expenses. Although everyone’s needs are different, this is a reasonable goal for residents, especially if you already have long-term disability insurance (which usually does not kick in for the first 90 or 180 days of your disability). Aside from a personal disability, there are other emergencies to consider, such as an illness in your family that could require long-distance or expensive air travel, or an unforeseen medical procedure that isn’t fully covered by your insurance or if you have a high deductible.
A good place to stash your emergency fund is somewhere you can easily access it, such as an online savings account. But not too easily (so forget about stashing it in your underwear drawer). You can quickly make one-time deposits into a savings account from a checking account, but consider automatically transferring a few extra dollars every month directly into your savings account just after your paycheck gets deposited.
In fact, Richard Thaler and Schlomo Benartzi won a Nobel-Prize for their research on automatic contributions to retirement accounts, showing that employees who were automatically enrolled in 401k plans saved more than those who were not. The take-away: make it automatic, even if it’s just $50 a month.
Contribute to a Retirement Account
Exactly what type of retirement account to contribute to depends on what’s available to you. Certainly, if you have any kind of employer match, you should contribute up to the match because there are very few ways in life to get free money, and this is one of them. Always max out your match!
If you don’t have an employer match (which most residents don’t), then your next best option depends on your plan (or not) for Public Service Loan Forgiveness.
If you are on an income-driven repayment plan (required for PSLF), you know your payments depends on your income. The lower your income, the lower your payments which leads to increased forgiveness. Contributions to a tax-deductible 401k/403b will lower your income as counted by PSLF. In essence, tax-deductible retirement plan contributions will “earn” you a 10% “match” in the PSLF program (assuming you otherwise qualify in the future). You will likely never get a bigger match. So, if you are expecting PSLF, strongly consider putting extra savings into your 401k/403b.
But what if you are not shooting for PSLF and wish to save something for retirement? Then you have a choice: tax-deductible contributions to your 403b/401k or after-tax contributions to a Roth IRA. At a resident’s salary, it’s a toss-up which is better for you. Our suggestion is to invest in the Roth IRA. Roth IRAs have features which “break the tie” over the 401k/403b (assuming no match of course!).
A Roth IRA is an individual retirement account (e.g. independent of your employer) which has an annual contribution limit of $6000 (for 2019). There are several tax advantages. First, although you contribute post-tax dollars to your Roth IRA (i.e. no tax break today), you NEVER pay taxes again on money that you take out at age 59 ½ or later. That is, your contributions and (hopefully substantial) earnings will come out tax-free, forever.
The second big advantage to contributing to a Roth IRA is that it can also do double-duty as an emergency fund TODAY. That’s because your contributions (but not your earnings) can be withdrawn at any time for any reason without tax or penalty. For example, suppose you put $3000 in your Roth IRA. It’s now worth $3200. But oops, you have an unexpected major expense and need that money. The original $3000 can be taken out. Note however, that Roth dollars are very valuable and contributions are limited each year. So think VERY hard about any Roth withdrawals. Also keep in mind that your Roth IRA should be mostly invested in stock-heavy mutual funds, which means the value of your account will fluctuate, and could mean that the value of your account is lower than you started, perhaps exactly when you might need it as an emergency fund.
There is another key piece of information about Roth IRA contributions: there is an income limit, above which you cannot made a direct Roth IRA contribution. Post-training, you will likely be above this limit, or perhaps you already are if you are married and your spouse has significant income. If you file taxes separately from your spouse, you are also not eligible for a direct Roth contribution. Most people can still make Roth contributions when above the income limits or when filing separately, but most will have to do so via an indirect method colloquially referred to as a “Backdoor Roth” contribution. Go here to learn about backdoor Roths.
If you are one of the few residents who are able to max out your Roth IRA and still have more money to invest, then then next best option is to contribute to a tax-deductible 401k/403b. Not sure what investment to select? We suggest choosing a low-cost “target-date” fund. As we like to say here at DOCTORED MONEY “If you don’t know whether a Target Date fund is right for you, it is.” #Winky-emoji.
Pay Down Debt
Lastly, you can accelerate your debt payments. This advice is more likely to apply once you finish training and have a “real” salary. But let’s say you’ve got an adequate e-fund, maxed out a (probably “backdoor”) Roth IRA ($6000/year for 2019), maxed out your employer retirement account ($19,000/year for 2019), have all the insurance you need, and are making the minimum payments on your loans. What now? Do you save additional money for retirement in taxable accounts, or pay your loans down faster? The decision of whether to prioritize savings or debt can be difficult. There are psychological considerations which are valid to take into account, such as the emotional trauma which can occur when looking at large student loan balances.
Here at Doctored Money we have several resources to help you address your debt and the financial decisions around it. But in summary, it is never a “bad” idea to pay off student loans or other debt (for example, a mortgage) as fast as possible. However, there is sometimes a strong case to be made for not paying off debt faster than required, and putting any extra savings towards retirement. This is especially true early in your career, because most MDs are not already saving enough. In theory, retirement investments (which by definition are concentrated in mutual funds, which are mostly invested in the stock market) will earn more over the long term than the relatively low-interest you’ll save by paying down your debt. While it can depend somewhat on the the interest rate of your loans, our advice is to split the difference. Rob Lieber at the NYTimes wrote an article describing the benefits of such an approach. So even if your interest rate is 6% to 8%, you might consider putting half of your extra cash towards retirement and half towards paying down loans.
In Closing
This is the paragraph where we’d typically have a concise summary to end the post, and we’d insert a labored joke to lighten the mood. We’re still working on the joke because being funny is hard work (check back later!), but the summary is simply this: If you have any money left over after paying your necessities, make conscious and well thought-out plans for how to allocate your extra cash. Don’t spend it without thinking, but also don’t let it build up up in your checking account.
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