Investment Management

How to Maximize Your Roth Savings as a Resident or Fellow

Published September 16, 2022

“Compound interest is the 8th wonder of the world. Those who understand it, earn it. Those who don’t, pay it.”

This quote from Einstein appropriately marvels at the power of small, incremental beginnings persistently pursued.  Now imagine, if this “wonder” were allowed to accumulate tax-free for decades, then provide tax-free income to the account owner in retirement, all while retaining complete flexibility on the timing of that income to the owner and potentially their heirs.  What would you call that, other than a fantastic opportunity – a Roth IRA.

Consider this – a training physician starting a Roth IRA at age 25, maxing out contributions each year, earning a modest 7% return could see those contributions grow to over $1,400,000 by age 65.  Had they waited 10 years to start, the accumulated value can drop to just under $700,000. And, these would be tax free.

Among the many benefits of a Roth IRA, here are the ones that cause physicians the most smiles:

  • While the contributions to a Roth IRA are not deductible, they accumulate tax-free

  • If you are over age 59 ½ and the account is at least 5 years old, distributions are tax-free

  • No minimum distribution requirements or age.  While other qualified accounts such as 401(k)’s and Traditional IRA’s require distributions after reaching age 72, Roth IRA’s do not and may continue to accumulate tax-free

  • Inherited Roth IRA’s retain many of the same benefits depending on the beneficiary.

Do I earn enough as a resident?

You’re only “resident poor” for so long. Roth IRA’s have income maximums and let’s be real, you’ll be making more money soon. Soon you’ll exceed the income limits and will not be able to contribute to a Roth. Make lemonade from lemons. Put cash in a Roth now and watch it grow. You’ll never be taxed on it1. Established in 1998, Congress wanted to encourage people to save early. Take them up on the favorable terms of that offer! 

Roth IRA’s make a compelling case on the surface to earn a prominent part in your future plans, however, there are other often overlooked benefits that are particularly useful to physicians:

Tax diversification

Roth IRA’s, in conjunction with other qualified retirement plans, such as a 401(k) or 403(b), allow physicians to vary the taxability of the various streams of income they will utilize during retirement which provides for very powerful techniques in optimizing their taxes and managing their marginal tax bracket.  This is a substantial benefit to physicians who often find that their tax bracket has not gone down significantly in retirement.   

If the last decade has taught us anything, it is that Congress reserves the right to change the playing field whenever it has the ability to enact legislation.  Having accounts with varying taxability characteristics allows physicians to retain some measure of control and influence on how legislative changes impact their financial future. See our Infographic: Tax Diversification for more information.

When $1,000 isn’t $1,000

It is hard to understate just how big a benefit it is to have an account that is not taxed at all.  When a physician needs income or capital in retirement and is evaluating from where to pull those funds, it’s important to realize the tax consequences of that withdrawal.  Pulling $1,000 from a Roth IRA will net $1,000 after tax.  Pulling $1,000 from a 401(k) or Traditional IRA actually requires a larger withdrawal to net $1,000.  Why?  Taxes, of course.

Consider the following table illustrating the withdrawal needed to net $1,000 after-tax:

This also means that if you are in the 35% tax bracket and you have $1,000,000 in a Roth IRA, you would need over $1,500,000 in a 401(k) to have the same purchasing power after taxes in retirement.

Withdrawal Rates and Portfolio Longevity Risk

Conventional wisdom states that, depending on your assumptions, withdrawal rates in the 3-4% range of the overall portfolio balance may be where to start when setting income expectations.  Poorly managed tax optimization can take a withdrawal rate that may be sustainable for a physician’s lifetime and inflate it to a withdrawal rate that puts a physician in the position of possibly outlasting their portfolio.  Rather than leave this an unaddressed risk, financially successful physicians take advantage of Roth IRA’s and other strategies to maximize their tax flexibility and reduce the strain those taxes can have on the sustainability of the overall portfolio.

What should you do now?

Roth IRA’s are an indispensable part of planning for better financial outcomes for physicians. Whether you are a resident, fellow, or practicing physician, there are ways to make a Roth IRA work for you. Click one of the links below to learn more, to start today, or to contact us to discuss your specific circumstances.

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