Question: “Last year I contributed the maximum allowed to my retirement plan and I’ve already done the same this year. Where should I invest extra money?”
First, congratulations on maxing out your tax deferred accounts. I know many physicians who can’t get close to the max despite making several hundred thousand dollars in gross annual income. Apparently saving takes a backseat to spending for a lot of physicians.
Unfortunately for many physicians maxing out tax deferred accounts may not be enough to achieve your retirement goals. This is primarily due to relatively low contributions limits in 401k plans. In 2018, the max is $18,500 (or $24,500 above age 50) out of your paycheck if you’re an employee.
So here are some avenues to invest beyond your current tax deferred accounts:
Open a second 401k
If your primary source of income is as an employee of a hospital or group, then you’ve already maxed out your group 401k or 403b plan. But let’s say you have a side job – perhaps you get paid for doing speaking engagements at CME conferences – and you generate some independent contractor income. You can set up an individual 401k for that income and invest some money in it. Be careful – you want to make sure you know the coordination rules between both of your 401k plans and you also want to make sure you know the limits for the second 401k.
Contribute after tax dollars to your current 401k
You’re probably making pretax contributions to your 401k out of your paycheck or you may have the option of designating these as Roth 401k contributions. If your plan allows it, you can contribute voluntary after tax contributions as well. These are separate from your regular or Roth 401k contributions. The combined regular/Roth 401k contributions, employer contributions and voluntary after tax contributions cannot exceed the combined 2018 annual maximum, which is $55,000 (or $61,000 above age 50). The advantage of the voluntary after tax contributions is that it gives you an indirect way of getting after tax (think Roth) money on a larger scale into your account.
Contribute to a traditional IRA or Roth IRA
Unless you are currently in residency training or have unusually low income, you won’t be able to contribute directly to a Roth IRA, but you can contribute to a traditional IRA regardless of how high your income. You won’t get a tax deduction, but gains will grow tax deferred. You also have the option of converting your traditional IRA to a Roth IRA without tax consequences as long you have only after tax contributions to the traditional IRA.
Open a dependent care FSA or healthcare FSA account
If you have a young child and you’re paying for before or after school care, babysitting or daycare, you can prefund some of these expenses by contributing pretax dollars from your paycheck (if your employer has this benefit) to a dependent care flexible spending account (FSA). If married, the max pretax contribution is $5,000. Assuming 30% combined federal and state income tax bracket, this saves you $1,500 in taxes. A similar healthcare FSA can also be set up to prefund medical expenses.
Contribute to an HSA
If you have a high deductible health insurance plan, you can set up a health savings account (HSA). You get multiple tax advantages: pretax contribution to save taxes this year, tax free growth and taw free withdrawals if used for health care expenses. What’s also nice is that like the FSAs described above and unlike many other tax deductions, even emergency physicians with high income can get the upfront tax deduction.
Open a 529 college savings plan
While you don’t get a federal income tax deduction for 529 contributions, you might eke out a small state income tax deduction if you use your state sponsored 529 plan for college savings. Plus you get tax free growth and withdrawals if used for college or grad school for your children. You can now even use 529 plans for K-12 private school. Just remember to use a 529 plan with well diversified mutual fund choices and preferably index funds and also weigh an out of state 529 plan (no state income tax benefit usually) vs. your in state 529 plan with tax benefits when deciding which 529 plan to use.
Invest in a good old fashioned taxable brokerage account
While tax deferral is all the rage, sometimes it’s best just to invest in a plain and simple brokerage account. Yes, I know you’ll have to pay some taxes on dividends annually and emergency medicine physicians are already in a higher tax bracket, but you gain tremendous flexibility. There aren’t annual contribution limits and penalties for early withdrawals unlike many of the other accounts I discussed. Plus you get some tax diversification during retirement. Having a combination of tax deferred and taxable accounts can give you flexibility in the order of withdrawals during retirement. Remember that when you sell investments in a taxable account, you only pay tax on the gains, not the whole amount.
And remember that with all of these accounts, keep the product costs low. You can do that by avoiding commission based products and instead use index funds.
I’ve met a number of physicians who feel restricted by low retirement plan contributions limits relative to your income. With the various ways outlined here, you can contribute far more than what you thought was possible.
A married 45-year-old emergency medicine physician who is an employee of a hospital system might be able to do all of the following:
- Contribute $18,500 to 401k
- Contribute $6,900 to HSA
- Contribute $11,000 to IRA (self and spouse)
- Contribute $5,000 to dependent care FSA
- Contribute $10,000 to 529 plans
- Contribute $20,000 to taxable brokerage account
TOTAL = $71,400
Your amount of type of contributions will vary depending on your specific situation, but you can see that making $300,000 income annually still gives you plenty of options.