By Mark Reiter, MD, MBA, University of North Carolina
Opening and fully funding a Roth IRA is the most important financial move you can make as a resident. You can open a Roth IRA in minutes with virtually any online broker. As you can see in Table 1, fully funding your Roth IRA each year is going to take quite a bit of cash, which won't be easy on your laughable salary. Still, do anything in your power to come up with the money: cut your expenses, defer your loans, check the hospital vending machines for loose change. Why the hurry? As you can see in Table 2, by the time you've earned your first full year's salary as a full-time attending, you'll be over the income threshold and will no longer be able to contribute to your Roth IRA. So, you only have about three or four years to plow a significant pile of money into your Roth IRA (Table 3)...for most physicians, it's a one-time chance. Note that you can fund your yearly contribution up until tax day (April 15th) of the following year.
|With initial investment of $15,000 and estimated 11% ARR
|30 year return with:
|Roth (0% tax):
|35% tax bracket:
|20% capital gains:
||Married w/ Joint Return
||$95,000 - $110,000
||$150,000 - $160,000
Now you're probably thinking, "Why should I live in squalor for several more years just to throw approximately $15,000 of my hard-earned cash into a Roth IRA?" The answer: an expected retirement nest egg of more than $340,000 30 years later for your troubles (assuming 11% annual rate of return or ARR), about triple the return you would have by investing the same amount of money if you were paying taxes on your profits each year. You'll likely never have as favorable an opportunity to safely make so much money on a small investment, so make sure you take the chance.
Roth IRAs became available for the first time a few years ago, and I consider them the best opportunity the government ever gave the American taxpayer. All profits (capital gains) made on investments held in a Roth IRA are not subject to any taxes. The lack of taxes allows you to earn much, much more money on your investments because a significant portion of your return is not being eroded by taxes every year (you'll likely be in the highest tax bracket). The tax-free rate of return becomes especially valuable when compounding interest is taken into account.
You can only withdraw money from a Roth IRA prior to retirement age without significant penalties for a few purposes, such as buying a home and certain educational expenses. However, you'd be a fool to tap into your Roth IRA even for such expenses. You want to use your normal taxable money to pay for your house; the last thing you'd want to do is use up the stash of tax-free money in your Roth IRA. Remember, your top financial goal during residency is to maximally fund your Roth IRA. You don't want to negate that important work by paying for anything with these tax-free funds. Even when you reach retirement age, you should always use normal, taxable dollars before using your tax-free Roth IRA dollars.
The Bush administration has a plan for a new type of retirement savings account that would replace and improve upon the Roth IRA. Overall, the taxpayer would be able to save up to $15,000 a year in a tax-free account, with fewer restrictions, and most importantly, no income thresholds. This would be a very beneficial for physicians, but only time will tell whether this proposal will become a reality.
Published in April/May 2004 EM Resident