Case Study: A New Resident Gets Started on the Right Foot
Our client and her fiancé sought our help about six months after they each began the residency phase of their education. They had made it through the first two rigorous phases with a modest student loan amount ($180K). They were used to living lean, but admittedly had some pent-up spending desires as they watched their non-medical student peers begin to buy homes and nice cars.
Yet, they were thrilled to be earning a regular, albeit modest salary. They were wise to seek guidance and start planning at this stage of their careers. They knew they were “behind” their peers that were not on the medical student path because of time in school (a delayed start to saving), potentially higher student loan debt, and 3-5 years ahead of grueling schedules with non-pretentious income.
The decisions and lifestyle choices made during these years could dramatically change their lifestyle for years to come.
How Did We Help?
During our initial discussions, we shared our “Tips for Newlyweds” thought piece as a resource as well as our “Ten Tips for Grads.” As we looked at their priorities, we addressed these items front and center:
What is the appropriate amount we should set aside for an emergency fund?
- Since their greatest financial threat at the time was potential disability, we recommended their Emergency Fund be adequate to cover the waiting period of their disability policy.
What type(s) of insurance should we carry?
- In addition to the basic disability coverage offered through their respective employers, we encouraged them to purchase a large, specialty-specific, own occupation disability policy for each.
- As for life insurance, each could support him/herself if the other prematurely died. With no kids yet and no one else dependent upon them for financial support (their parents/siblings were financially stable), there was no actual need for life insurance. If there was residual cash flow after meeting their savings goals, or if they decided to start a family, we would consider seeking a 30 year guaranteed premium term insurance policy.
- In regard to liability exposure, malpractice premiums were paid by their residency programs. To cover events outside the workplace, we recommended an excess liability (“umbrella”) policy to provide protection beyond what their renters’ and vehicle coverage provided. [Note: Once you earn the privilege to be called “Doctor,” you become a more attractive lawsuit candidate.]
How do we prioritize saving our savings - Health Savings Accounts (HSAs), Employer-provided retirement plans, Traditional IRAs, and/or Roth IRAs?
- Since each had a high deductible health plan option as part of their employment benefits, we recommended they choose that option, coupled with an HSA (Health Savings Account). This enables them to use pre-tax dollars to meet deductible, co-pays, and other health-related items not covered by their plan. An additional benefit to this choice - the HSA account (to the extent it isn’t used) continues to grow over time. [Note: the HSA is not like the Flexible Spending Account - which has a use-it-or-lose-it attribute.]
- For their respective defined-contribution plans (she has a 401(k) and he a 403(b)), we recommended each select the Roth option and contribute at least 50% of the allowable maximum. While their contributions would not be deductible, they were in a low enough tax-bracket that the benefit of tax-free growth outweighed the benefit of tax-deferred growth. Contributing at that level would enable them to receive all their employer match funds (“free money”) and enable them to save outside their retirement plans for their Emergency Fund and their house down payment. As they earned raises, they could add to their retirement plan contributions until they hit the allowable limit. At that point, we could evaluate where additional funds should be directed.
- They were each offered a deferred compensation plan through their employers; however, we determined they needed all of their income at this point to meet their short- and medium-term needs until they could accrue additional savings, and prepare to pay off their student loans aggressively. We opted to revisit this benefit later for each.
Should we buy a home or rent?
- Typically, the break-even point in a rent-versus-own analysis is three to five years to offset the buying and selling transaction costs. While they anticipated that much time in their current community, they wanted to maintain flexibility should either have a promising job opportunity or a desirable fellowship elsewhere at the end of that period. A home they could afford now would likely not be the home they would want or could afford once they became attending physicians. And honestly, the time commitment devoted to the study of medicine during residency years would leave little time or energy for mowing the lawn, fixing the sink, and the other aspects of the pride of home ownership.
Our clients are newly married and feel confident they are on the right path with a financial plan in place. They are taking the advice to pay themselves first, live within their means, and protect their assets. Having this baseline plan coupled with their commendable self-discipline will serve as a solid foundation for their future financial freedom. As future HENRYs (High Earners Not Rich Yet), they are wisely on the path to translate high-income to wealth. Not all medical professionals succeed at this transition due to mistakes early on, or the on-going (sometimes insatiable) need for immediate gratification.
Posted on Mon, May 9, 2016
by Kimberly Pauley filed under