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Retirement Planning Basics

Retirement Planning Basics

During our working years the objective is to accumulate diverse appreciating assets. In retirement our objective shifts to ensuring we have adequate monthly income to meet our various needs. These two objectives are related but not identical

If you’ve mastered budgeting and time value of money and you know the exact date at which you’ll die, retirement planning is a simple exercise: Simply build up a nest egg during your working years, draw it down in retirement, and die exactly when your net wealth equals zero. Economically, that represents blissful perfection. The problem, of course, is that we don’t know when we’ll die!

 

Golden Goose Principal

A Golden Goose Principal (GGP) is a nest egg large enough that you can live off the income it generates without drawing down the underlying principal. Not only does this allow you to avoid the anxiety associated with watching your nest egg dwindle, you can bequeath that principal to your children, grandchildren, or favorite charitable cause.

In my personal finance lectures I show that a responsibly managed annual household income of $200,000 can realistically lead to a nest egg of over $4 million. (See the Hypothetical Wealth Accumulation template under Resources on this site.) As most physician households command higher gross earnings than the $200,000 figure, nest eggs in the four to six million dollar range are attainable. The assumptions required to reach the $4 million threshold are:

  1. A thirty-year investment horizon. Assume you are 37 years old and planning to retire at 67
  2. Retirement plan contributions of $33,000 annually. This includes your contributions and the employer match
  3. Compounded annual returns of 8% on retirement investments
  4. 30-year fixed mortgage payments on a home initially valued at $300,000 with average annual property value growth of 3%
  5. Your budget allows you to service student debt and mortgage payments

The key with retirement planning is to begin early. Make sure you contribute the maximum allowable from each paycheck to your employer's retirement plan. That plan is likely to be: a 401(k), 403(b), or 457(b). These contributions will be deducted from your taxable income, thereby reducing your tax bill for that year. Your contributions and gains or earnings grow tax deferred, which means you don't pay taxes until you begin to withdraw money from the acocunts, presumably in retirement, when your tax rates will be lower. In addition to your retirement plan contributions, most employers will offer matching funds up to certain limits. Make choices that allow you to receive the maximum employer match--it's free money! 

If your employer doesn't offer a retirement plan you can set up your own Individual Retirement Account (IRA). IRAs come in two flavors or types: Traditional and Roth. The Traditional IRS works much like the 401(k) and 403(b)s. Contributions you make may be deducted from your income for that tax year, and gains in the account are tax-deferred until you begin withdrawing funds. Roth IRAs are different: the contributions you make each year are not deducted from your income so you don't get any tax benefits upfront. Your investments are still tax-deferred, but the main benefit is that any distributions you take from the account (once eligible) are tax-free. 

There are various limitations and constraints on retirement accounts, including maximum annual contribution limits, income-limits, mandatory withdrawal requirements after a certain age (currently 72), etc.

There are many other aspects to retirement accounts. For example, There are also Solo 401(k) accounts that private practitioners can set up for their own private practices, as well as Roth-401(k) and Roth-403(b) accounts from employers. Some retirement plans may be rolled over into IRAs. Traditional IRAs may be converted into Roth IRAs. Some consumers are able to take advantage of a strategy referred to as a Backdoor Roth IRA, in which contributions are made into Traditional IRAs and then converted into Roth accounts (this is discussed in e-Book 1 under the Individual Retirement Accounts section). Finally, you can also invest in a regular brokerage or investment account that doesn't offer any specific retirement benefits. Instead, any gains in the account are taxed annually but the remainder is yours.  

Much of retirement investment planning is about considering taxes. I recommend hiring a competent accountant. This may not be as important when you are a low-earning resident with meager income and no assets, but it becomes increasingly important as your income increases and you accumulate more assets. 

Setting up retirement accounts is a necessary but not sufficient condition for retirement planning. Proper preparation includes increasing contributions to accounts over time, monitoring progress toward Golden Goose Principal (GGP), drafting estate planning documents, budgeting, and managing debt.

Many medical households face the following conundrum: If we have extra cash, should we: fund our children’s college plans, pay down our own debt, or invest in our own retirement plan? The reflexive emotional response is to pay for our children’s college education. The response may be partly motivated by guilt; we feel that paying off our own debt or investing in our retirement are selfish choices. But the mathematically correct answer is often to invest in yourself first. You can read more about this logic in the "Don't Succumb to Guilt" section of the Prepare for Retirement article.