Monday, December 21, 2009

Retirement Investing in Medical School: Part 2 of 2

It's been over a year since the last post, and an internship has come and gone. On a wintry post-call day, I've finally decided to revisit our friends Jane and Jack.

I should preface this by saying that I have set up a bit of a straw-man argument here. The fiscal inequality between Jane and Jack has been accentuated a fair amount to make a point. And, one can't overlook the obvious issue of job security: a first-year associate at Lehman Bros making 80 grand with a healthy bonus sounds all well and good until there's that small matter of a financial system collapse. As a medical resident, chances are you aren't going to lose your job unless you show up drunk or do this.

All that aside, and taking the following with a small grain of salt, let's look at the numbers.

Read the previous post for a recap of where we stand. The long and short is that Jane is making money and fully investing in her two retirement account options (with employer-matching) while Jack has a bright red balance sheet during four years of medical school. What's worse, since Jack has no wage income nor an employer during med school, he's unable to invest in any tax-deferred instrument.

We'll look at Jane and Jack at age 30. We'll say that Jack came out of his internal medicine residency and took a job as a hospitalist where he's making $150,000 - during which year he's able to fully invest in his retirement accounts (and his employer even matches).

The other assumptions we'll make are A) an annual inflation rate of 3%, with contribution limits indexed to inflation; and B) an annual stock market growth rate of 8%.

We'll start with total gross income at age 30 (the sum of 9 years of earning):
  • Jane: $882,125
  • Jack: $365,506
I'm not even going to bother trying to figure out taxes, cost of living, etc. Certainly Jane will have a higher tax burden than Jack, but likely not enough to prohibit her from fully contributing to her retirement accounts.

So, that's a decent amount of income disparity. Perhaps Jack will catch up after a couple more years of working. Maybe he'll do a fellowship that will increase his earning potential. But, let's not forget the student loans.
For loans, we have assumed that the Stafford loans taken by Jane and Jack hold the fixed interest rate of 6.8%. That was the norm up to a recent legislative change; we'll get to that issue in a future post. We will also assume that Jane was able to defer interest on her loans during college, and that - for the sake of simplicity - Jack was able to defer interest on all of his loans during both college and med school. (Remember that this is not possible to do with unsubsidized Stafford loans).

Here's a sum of how much dough Jane and Jack have spent on loan payments by age 30:
  • Jane: $28,585 (she has only $3,062 remaining before she pays off her loan)
  • Jack: $111,513 (he has $94,308 remaining before he pays off his loan)
Mercy. That's a pretty healthy difference. Read here for more statistics on average national student debt as well some AMA advocacy positions.

If we take loan payments into account, the income disparity between Jane and Jack comes out to $599,546. That is to say, Jane's going to have $600K more in her pocket by age 30. That'll get you a nice Back Bay condo.

Now, here's the kicker. Remember that Jane has been steadily contributing to her Roth IRA, her 401(k), and her employer has been chipping in at 50 cents on the dollar (to her 401(k)). Remember also that Jack didn't start making retirement account contributions until age 26, and that because of the pesky need to eat, he couldn't contribute maximally. I would have said the chances of his residency program matching his 403(b) contributions were nil, but turns out at least one program does: UT Southwestern. Who knew?

By age 30, with the assumptions enumerated above, here are the values of Jane's and Jack's retirement accounts:
  • Jane: $328,230
  • Jack: $104,669
Well, that's a bummer for Jack. His retirement accounts have less than a third of the earning potential of his Ivy League peer's. And therein lies the heart of the problem. Successful retirement planning requires the tincture of time. Paraphrasing my uncle-in-law, if you have to work for every dollar you earn, you're going to either work yourself to death or retire poor. With that in mind, we're going to perform an admittedly simplistic exercise.

We're going to freeze Jane and Jack at age 30, and see what their retirement accounts do over the next 35 years. No more contributions, no more income, yada yada. By the time the pair are 65, retired, and running into one another at alumni events at what pass for Ivy League football games - here is what the balance sheet shows:
  • Jane: $4,852,998
  • Jack: $1,547,568
I would venture to guess that Jane and Jack's salaries have equalized to some degree, but the difference in the value of their retirement accounts is striking.

All of these numbers are based on back-of-the-envelope calculations, but they all speak to the same truth: any contributions you can make to tax-deferred investment vehicles while in med school, PA school, nursing school, etc will pay dividends. Literally.

We'll have a post on in-school retirement investment strategies in the future. In the meantime, save your nuts!