Saving vs Debt Payback – Let’s Talk About The Future Value Of Your Money
The majority of residents make less than $50k/yr in residency and have sizable student loans. They are faced with investing their money into their 401k’s, saving it or paying down debt. Of course, some will use it to spend on their lifestyle. I’m writing this post to give a resident some ideas and better decide whether it’s better to put their money towards student loans, save it or create a more comfortable lifestyle.
Investing In Your Job’s Tax-Advantaged Retirement Account
By putting the money into a 401k (or other equivalent product such as 457b or 403b) you could lower your taxable income. If you gross $50k then you will owe taxes on that entire $50k minus any deductions and/or personal exemptions. Contributing $10k to your job-sponsored retirement account you will lower your taxable income by that $10k. Your take-home paycheck might be smaller but not by much and that money could grow if invested intelligently.
I ran some numbers to illustrate my point using $50k as the gross income, working and living in the state of Oregon which has relatively high state income tax rates. After deductions and personal exemptions (which every tax-payer gets) you would be left with $3,033 per month of take-home pay after all taxes are paid. That would equal an annual salary of $36,390.
If you contribute $10k to your 401k then you would be left with $2,482 per month or $29,780 for the year after taxes. However, you would have another $10k in your 401k which means you technical take-home is $39,780 for the year. Of course, you can’t spend that 401k unless you pay the 10% penalty along with any federal/state income taxes due.
If you feel that you could spare that $10k then I would lean towards letting your student loans ride out and building up a savings instead. If you decide to moonlight in residency you will have enough income that you can probably max out your 401k and that money could potentially grow annually, with the right investment. Giving your savings more time to grow will take advantage of the power of compounding. This is why people say that the first $100k is the hardest to save. And people say the same about the first $1,000,000… why? because of the power of compounding.
Once your annual taxable income goes past $80k then you can no longer benefit from taking a deduction for the interest you paid on your student loans. Therefore, while in residency with a relatively low income, it’s perhaps better to use the deduction to lower your taxable income and put the rest of the money towards your tax-advantaged investments.
Choice Between Lifestyle Or SL Debt Payoff
If you have to choose between living a better lifestyle vs investing or paying down debt then I would say figure out what your specific situation is like. If you are in a tough residency, such as general surgery, then it’s perhaps better to pay more for an apartment that’s closer to work, have a more reliable mode of transportation and less financial stress. If you are doing a family medicine residency then you can choose the cost saving option, trading off your comfort slightly. I’m writing this 7 years out of residency. I came out with nearly $60k in tax-deferred account savings (a 401k and a 457b). Unfortunately, I raided those because I didn’t know any better back then. I would much rather have had a higher savings balance than a lower student loan balance. Why? Because I could have lowered my student loans by maybe $50k, but then I would be stiffing myself and only ensuring that the student loan company is getting their slice of the pie. Fast-forwarding to when I’m an attending, my income is much higher, I am no longer eligible for many deductions (as beautifully illustrated by this table at the Tax Policy Center), but I can pick up more shifts and thereby drastically lower my student loan balances.
After your income increases you may be a better candidate for refinancing your debt. If you carry a lot of private loans with high interest rates you could save thousands by simply refinancing. With the advent of more savvy loan refinance companies your higher income will have a higher impact than the little bit of disposable income available to you in residency.
I hope this created a bit of perspective on the popular debate of saving vs paying off debt. I think this applies not only to residents but also someone who knows their income will go up in the near future. Let me know what you think in the comments.