I’m sure if you’re in residency, you are spending countless hours thinking about how you will strategically reach your future retirement goals. Or not.
Between grueling shifts, research projects, studying for boards, and all the other tasks that eat up a resident’s time, you probably don’t have a spare minute to think about anything else. Because you have to sleep sometime.
That doesn’t mean you shouldn’t be taking advantage of a great retirement tool—one that you will regret not taking advantage of as you get older, knowing the difference it would have made. This great retirement tool is called a Roth IRA.
As opposed to giving you a tax deduction like a traditional IRA (essentially making the funds “pre-tax”), Roth IRA’s take after-tax dollars—meaning you pay income tax now. The benefit is, when you withdrawal these funds in retirement, all those contributions and the investment earnings you achieved over the years come back to you tax-free.
To be eligible to contribute to a Roth IRA, you must have earned income in the amount of your contribution for the year. Each person is limited to contributing $5,500 to a Roth IRA in 2015, with an additional $1,000 “catch up” contribution allowed for those 50 and older. Spouses are eligible for their own Roth IRA too, if you have enough earned income to cover their portion (assuming they don’t have earned income).
The only major restriction on Roth IRA’s is that if you make too much money, you can’t contribute. For 2015, single filers must have modified AGI (Adjusted Gross Income) of $116,000 or less to make the full contribution. Married filing-jointly filers must have modified AGI of $183,000 or less to make the full contribution. And that is where most physicians become ineligible to make a direct contribution.
So that is why it is so important to pay attention to these three key reasons for every medical resident should have a Roth IRA:
Pay Less Tax
The average resident makes $55,300 a year, according to Medscape’s Residents Salary & Debt Report for 2014. Throw in some deductions and exemptions, and chances are if you’re a resident, you’ll find yourself in the 15% income tax bracket, which will likely be the lowest tax bracket of the rest of your life. So by fully funding a Roth during your residency years, you are effectively guaranteeing that you pay the minimal possible income tax on those funds.
Also consider that our income tax rates in the U.S. are fairly low right now compared to historical rates. Our rates are especially low when compared to those of other countries. That means chances are pretty high that income taxes are going to creep up over the next 30 to 40 years (everything goes in cycles), likely causing you to pay higher income tax rates in retirement regardless. Deflect some of that tax burden by funding a Roth IRA during residency.
Traditional IRA’s, 401(k)’s, and other tax-deferred retirement plans make it very difficult to withdraw funds penalty free until you hit age 59 ½. However, Roth IRA's afford great flexibility. They allow you to withdrawal your contributions at any time without paying a 10% penalty, for whatever reason. You can’t do that with any tax-deferred retirement account.
Also, after turning 70 ½ the government requires you to start making required minimum distributions (RMDs) from your tax-deferred accounts, such as a traditional IRA. There is currently no such requirement for Roth accounts, proving another measure of flexibility, not restriction.
Lastly, too many physicians only fund tax-deferred accounts throughout their career. What they end up with is a huge deferred tax burden, with no Roth funds to draw from. By funding a Roth early on, you can give yourself a well-diversified mix of tax-deferred and tax-free accounts come retirement. This might keep from having to enter into those ridiculously painful higher income tax brackets.
Forming Good Habits
It will never be easier for anyone to form good savings habits than when they start their first full-time job. For aspiring physicians, that always comes during residency. You've never really made any substantial income up to this point in your life. You will do well to “pay yourself first”—or in other words, deduct savings from your paycheck before you can spend any of it. This will put you in an ideal position for the rest of your career as saving will come easier to you.
And every time you make a jump to a higher-earning position in the future, particularly your first contract after residency, it will be key to remember the benefits of “paying yourself first.” Your first raise to a full-time position will be a big one, and that makes for a perfect time to significantly increase your retirement plan contributions, as well as make bigger payments towards your student loans if you have them.
The bottom line is that for medical residents, the Roth IRA is the ideal retirement account. The only retirement account you should fund before a Roth, is any portion of your employer’s retirement plan that provides you with a match, because that’s basically free money (unfortunately, many residents don’t have this benefit). Otherwise, go Roth. You’ll be so thankful in retirement that you did!