I’m a recently graduated medical student who is about to begin my new job as a resident physician. Along with creating a monthly budget, getting disability insurance, and making a plan for my student loans, I also need to start saving money for retirement. Several of my friends and co-workers wanted me to help them get their finances in order as well. Here are my answers to some of their most common questions about retirement accounts.
1.What are the different types of retirement accounts? Technically speaking, there are two main types of retirement accounts: Employer-sponsored plans and non-employer sponsored plans. Employer-sponsored plans are things like a 401K (offered by for-profit organizations), 403b (offered by non-profits), and a 457 (offered by government institutions). Non-employer sponsored plans are called Individual Retirement Accounts (aka IRAs). Through traditional IRAs or Roth IRAs, you can choose to save earned income for retirement in a way that is not dependent on your employer.
2.What is the difference between a Roth account and a regular retirement account? Many people have the option of contributing to “Roth” accounts like a Roth 403b or a Roth IRA. While Roth accounts may have different contribution rules, the main difference between Roth and non-Roth retirement accounts is the timing on when you pay taxes on the money. Roth accounts are considered “post-tax” because you contribute to them AFTER you’ve already paid taxes. Employer-sponsored accounts are considered “pre-tax” because you contribute to them BEFORE you pay taxes.
For example, with a Roth IRA you pay income taxes on money you make now, then you contribute to the account with “post-tax” dollars. Your money builds and accumulates interest over time. In retirement, you WILL NOT have to pay taxes on the money you withdraw or on any profits you made in the account. Non-roth accounts like a 401K are different. You contribute to these accounts with “pre-tax” dollars and your money builds and accumulates interest over time. In retirement, you WILL have to pay taxes on the money you withdraw and on any profits you made in the account.
3.Should I contribute to a Roth account? It depends. If you feel your salary is going to increase in the future, then consider paying taxes now (while you are in a lower tax bracket) and thus opt for a Roth account. In contrast, if you are already near your peak earnings or may experience a decrease in salary in the coming years (due to working part time or opting for a lower paying job with more lifestyle balance) then you may want to postpone paying taxes now and opt for the non-roth retirement account.
The goal is to pay taxes on the money when you are in the lowest tax bracket. The average person will want to do Roth retirement accounts (like a Roth IRA) when they are young and just starting out in their careers (unless they have other competing expenses that make them want to defer the taxes). As they earn a higher salary, they will want to do non-roth accounts (like their employer sponsored 401K, 403b or 457 plan) to avoid paying so much in taxes on those earnings.
4.How much should I contribute? It depends. You have to figure out how much money you need to retire and contribute enough money each year into retirement accounts to meet that goal. Of note, different types of accounts have different rules about how much money you can contribute each year. As of 2019, the max a single person can contribute to employer-sponsored plans like 401K, 403b, or 457 is $19,000 a year. The max you can contribute to traditional IRAs and Roth IRAs is $6,000 a year.
5. What happens to the money I put into these accounts? Once you put money into a retirement account, you can choose to invest that money in a way that will earn a profit. Employer-sponsored plans like 401Ks may offer a variety of options with different ways you can safely invest into the stock market, purchase bonds, or do a combination of both to earn a profit on your money. Non-employer sponsored plans like IRAs tend to be more flexible and can be used to invest in things like individual stocks, index mutual funds, commodities (like gold), or real estate. Regardless of the type of plan you choose, most people use the money in these accounts to invest in the stock market by purchasing index mutual funds. These are large, diversified funds that invest in hundreds of different stocks (or bonds) and earn a profit ranging from 7-10% each year.
6. What if I own my own business, do contract work, or earn money from a side gig? Once you set aside money for taxes, you can choose to save and invest that money for retirement. Depending on your income level, you may be able to put that money into a Roth IRA (provided you have not already contributed the yearly limit of $6,000). You may also choose to open a SEP-IRA or a solo 401K through a company like Vanguard, Fidelity, TD Ameritrade, etc. These accounts allow business owners and self-employed individuals to contribute up to 25% of their earned income (or $56,000, whichever is lower) into those accounts each year.
7. Are there any special caveats I should be aware of? Yes. Oftentimes employer-sponsored plans will “match” your retirement contribution by placing an identical amount of their money into your retirement account, alongside your original contribution, up to a certain percentage of your salary. This is basically “free” money given by your employer.
Of note, people with really high incomes (i.e. physicians) are phased out of a traditional Roth IRA when their income gets to a certain level. They can try to work around this rule (legally) by doing something called a “backdoor Roth IRA” which is explained here. Some high-income earners may also be able to contribute to a 403b plan in addition to a 457 plan, which allows them to save even more money for retirement.
To summarize, there are many different types of accounts that help you save and invest money for retirement. Determine which employer-sponsored plans you have at your job and compare to them to an IRA. Traditional and Roth IRAs tend to have lower contribution limits but offer more flexibility in the types of investments you can make. Employer-sponsored plans have higher contribution limits and may even offer a “match,” but may be limited in the types of investments you can make.
Tell me, was this helpful? Do you have a better understanding of the different types of retirement accounts?