Personal Finance
Financial Planning for New Physicians
A few key steps early in one’s career can generate benefits over a lifetime.
By Steve Finkelstein, C.F.P., and Joel Greenwald, M.D., C.F.P.
Adjusting to a practice setting. Having to make clinical decisions. Moving or starting a family. These are just a few of the changes and challenges for physicians new to clinical practice.
Often delayed or overlooked in the midst of these changes is making important financial decisions. Failing to consider investing in life insurance, disability insurance, your children’s education, and your own retirement can have a negative impact on your ability to realize your dreams and aspirations.
Using the following case, we’d like to examine financial-planning issues a young physician might face and suggest ways to deal with them.
Case Study
T.F. is 30 years old and in her third year of practice as a cardiologist. Her annual income is $400,000. Her husband is a stay-at-home dad, and they have two children, ages 4 and 2. T.F. has approximately $40,000 in savings and $85,000 of student debt at 2.7 percent interest. The practice’s retirement plan is a 401(k)/profit-sharing plan with 10 investment choices. T.F. has elected not to defer to the 401(k) at this time and has allocated all of her employer’s contribution to a money market fund.
T.F. has come to her financial advisor with a number of questions: Should she pay off her student loans or instead concentrate on building her investment portfolio? Should she be investing her 401(k) contributions differently? What’s the best way to start saving for her children’s education? Are the life and disability insurance policies provided by her employer sufficient?
Doctors new to practice typically have student debt and, therefore, one of the first questions they ask is how quickly they should pay off that debt. The answer to that question depends on the interest rate for the debt as well as the current market rates for savings and investment. When we first started working with physician-clients a decade ago, student loans were at an interest rate of 8 percent or higher. When rates were at those levels, it made sense for us to encourage new physicians to concentrate on paying back the debt. Paying off $1,000 of student debt was equal to getting a guaranteed, after-tax rate of return of 8%, which is a pretty attractive investment.
In this case, the interest rate on T.F.’s debt is 2.7 percent, so we would advise her to use her available cash to achieve other financial goals and to not to be in a rush to pay off this low-interest debt.
Although T.F.’s No. 1 concern may be her student loans, we’d suggest that she consider a number of other important issues at this stage of her career.
Formulating a Savings and Investment Plan
T.F. and all new physicians need to realize that the secret to achieving financial independence by a reasonable age and having the freedom to practice when and where they want to rather than when and where they have to is to live below their means. This is often difficult for a physician new to practice, who may have delayed gratification while in college, medical school, residency, and fellowship. T.F. may feel that now is the time to buy a new house and car, go on vacations, and eat out after having worked so hard and waited so long. Unfortunately, focusing on material comforts at the expense of savings can lead physicians to neglect saving and investing, and this delay can severely damage their chance of having enough money to one day be able to scale back practice, take a part-time academic position, or spend a year volunteering on a medical mission. For example, by failing to make the allowed $15,500 pre-tax deferral to her 401(k) for the first three years of practice, assuming a 9 percent rate of return during her working years, T.F. will have accumulated $951,000 less in her retirement plan ($46,500 of the shortfall would be due to the three years of missed contributions, the rest would be the result of lost earnings over time). T.F. will therefore need to work extra years to accumulate sufficient funds for retirement.
T.F.’s goal should be to save at least 10 percent of her income each year and ideally 20 percent or more, depending on what age she wishes to reduce her practice schedule and/or retire. This is the age-old trade-off between spending more now on luxuries versus living more frugally and being able to retire sooner.
How should she invest her contributions? The answer is complex and can’t be addressed in a short article. However, there are principles she can follow (see “Immutable Laws of Investing”).
Other Pieces of a Solid Financial Foundation
In addition to paying off her loans and investing for retirement, T.F. needs to put in place a few additional pieces in order to build a solid financial foundation:
♦ Saving for Emergencies
For one thing, T.F. should have an emergency or “rainy day” fund. This money should equal three to six months of living expenses and be used to pay the mortgage in case she loses her job, replace the roof on the house or fund other major repairs, or buy rather than finance a new car. It should be held in a savings account, money market fund, or other interest-bearing account and used for unanticipated expenses.
Immutable Laws of Investing
1. Clearly define your investment objectives (retirement, children’s college, new home)
2. Understand your risk tolerance
3. Make an investment blueprint and stick to it
4. Set up an automatic investing plan
5. Invest in a tax-efficient manner
6. Pay attention to the fees on your investments
7. Don’t pay too much attention to the fees on your investments
8. Diversify
9. Stay focused on the long term
10. Monitor investment results
11. Consolidate your holdings
12. Make sure your financial advisor acts in your best interest |
♦ Purchasing Life Insurance
It is vital that this physician, who is supporting her young family, have sufficient life insurance. But how much is enough? There are calculators that can help you arrive at a figure; but a good rule of thumb for life insurance is to purchase eight to 10 times your income. How can a new physician afford such a large amount of coverage when she has so many other ways to spend and save her money? The answer is term insurance. A 20- or 30-year term insurance policy is an affordable way to get the coverage she needs. Adding permanent coverage that has a cash value and can provide for her survivors may make sense in the future if T.F. finds she needs additional coverage for contingencies such as caring for a child with special needs.
♦ Purchasing Disability Insurance
The chance of T.F. becoming disabled during her working years is much greater than the chance of her passing away. Thus, a long-term disability package, often including individual coverage to supplement any group coverage provided by the practice, needs to be part of her financial plan. T.F. should discuss this with an independent disability insurance specialist who has experience helping physicians with disability coverage.
♦ Funding College Education
A significant concern for T.F. and many other physicians is funding a college education for their children or grandchildren. The preferred way to save for college on a tax-advantaged basis is through 529 plans. These are similar to Roth IRAs in that after-tax dollars are contributed to the plan. If those funds are used to pay qualified educational expenses, there are no taxes due on any gains. However, in T.F.’s case, fully funding her 401(k), having enough life and disability insurance, and having an adequate emergency fund should be her priorities.
Estate Planning
While making financial decisions, young physicians should also consider doing some estate planning. Although T.F. may not yet have an estate subject to estate taxes, the fact that she has dependent children means that she and her husband should at least consult with an estate-planning attorney to have them prepare the following: 1) a simple will with trusts for their children; 2) assignment of durable powers of attorney; and 3) a health care directive. Without these important documents, T.F. could leave her heirs vulnerable to estate laws that may not be in the family’s best financial interest.
Conclusion
Young physicians have many issues in their lives that compete for their attention. Unfortunately, planning their finances often takes a back seat to more pressing concerns such as starting a family or raising young children, adjusting to the demands of a new job, or getting settled in a community and neighborhood. But a few financial planning steps taken early in a career can help give a young physician control over his or her professional and financial life. Whether using a financial advisor or doing it on their own, young physicians who spend time on financial planning will find it bears fruit over their long medical career. MM
Joel Greenwald and Steve Finkelstein are Certified Financial Planners with Sterling Retirement Resources, Inc. in St. Louis Park, Minnesota. Registered Representatives offering securities and investment advisory services through Financial Network Investment Corporation: Full Service Broker Dealer, Member SIPC. Financial Network and Sterling Retirement Resources, Inc. are not affiliated. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. All economic and performance information is historical and not indicative of future results.