You spent roughly two decades in school, plus a few years as a resident, working to become the doctor of your dreams. Congratulations, you made it! Your income has jumped from about $50,000 as a resident to anywhere from a low of $130,000 to upward of $500,000. So what now?
The car of your dreams? Children? A home in a gated community? Why not—you can afford it all, right?
It is at this point that many young doctors begin to make their first financial mistakes. The real question you should be asking is: How can I protect my decades-long investment in myself? In other words, what is the best way to go about repaying student loans, preserving newfound income streams and setting up your family for financial stability through retirement?
Such questions naturally lead many young doctors to consider professional assistance, but hiring someone itself isn’t so simple. For instance, do you start with a money manager, a product salesperson or a financial advisor? And is there a difference? You bet there is—and this distinction is critical moving forward. As a medical practitioner with a high level of disposable income, you are a prime target for every salesperson in your hometown and beyond. This is not to say that no salesperson can be trusted, but you always have to consider whose interest is ultimately being served.
My recommendation is to retain the services of a fee-only financial advisor. This is an advisor who has no licenses to sell products, and does not have any fee-sharing relationships that may pose a conflict of interest. The advisor’s sole source of income comes directly from you, the client. And if you can put a solid plan in place first, your product needs will become apparent, especially for young practitioners just getting started.
To illustrate this, let's consider a couple of examples that come directly from such a plan, disability insurance and life insurance, as starting points for a new doctor.
Suppose your gross income is $250,000 before taxes. How much disability income would you need if you lost your right arm? Let's assume you have little in the way of tax deductions (remembering you’re just getting started in life) and your tax obligation could be as high as $75,000. That means you’d net $175,000. Setting aside any inflation considerations for the moment, you would need a policy that pays $15,000 per month if you want to insure a net income of $175,000.
But what if the $15,000 a month were taxable, as it would be if the premiums were fully paid by your employer? In that case, you’d need significantly more to deliver a net of $15,000 per month. However, had you purchased this same policy with after-tax dollars (your own after-tax money), the entire $15,000 per month would be income-tax free.
This is not meant to suggest that you turn down the group disability insurance offered by an employer, such as a hospital. Rather, it means you need to work with someone who understands the differences at a time when your expertise may be lacking in this area of planning. Also, bear in mind that most group disability policies are not transferable if your leave your employer. For this reason, you should consider a personally owned disability policy as part of your protection plan, and be sure it is for your “Own Occupation” until age 65. It may be a little more expensive, but it is worth every penny.
Life insurance is purchased to cover a loss of income and/or the need for a lump sum to confront existing or foreseeable indebtedness, such as a mortgage, college loan or expenses related to the care of a "Special Needs" child. Life insurance needs can be calculated to a reasonable degree of accuracy, and you need to understand how that’s done.
Let's suppose you’d like to replace $175,000 in income and cover $300,000 in student loan payments. Would $2,000,000 in life insurance be enough to meet both goals? Well, it figures that you’ll have $1,700,000 left to generate income after paying off the student loans. One goal down and one to go. In today’s environment, if we invest the remaining funds at 3%, the annualized income would be $51,000, and may be fully taxable. In other words, we appear to have a shortfall of $124,000 per year.
One option is to dip into the $1,700,000 principal to make up the difference. But that would reduce the remaining interest-earning portion to $1,574,000, and if continued over the next few years, quickly deplete future earning potential.
Another option is to rethink your lifestyle expectations. Suppose you need only $80,000 per year to live on, exclusive of taxes. Furthermore, let’s imagine that you contributed the maximum $18,000 to your 403-B Plan as well as another $18,000 to your “non-profit” employer’s 457 plan.
Although such contributions would be expenses drawn against your income, they’re ultimately a form of saving, unlike a utility bill that once paid is gone forever. What’s more, these transfers of income to retirement plans allow for pre-tax deductions and create assets on your balance sheet. Run these contributions out over 25 or 35 years, with conservative investment returns of 5% to 6%, and the results are staggering.
These points may help you recognize the value of a “comprehensive financial plan” coming first. If so, it may be one of the best investments you will ever make.
Image: Er Ten Hong / iStock.