Welcome to residency, new interns! Your formal schooling is complete, and you are now working for a real paycheck. While you will be supervised by your attendings during residency, you now have “adult” money things to worry about, like managing a paycheck and investing for retirement. As part of the Intern Financial Survival Series, let’s talk about how to invest in a 401(k) plan.
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There are several types of accounts where you can invest your money. The 401(k) is a type of investment account that is run through your employer. You can allocate a portion of your paycheck to your 401(k) account, and your employer may match a portion of your contribution to encourage you to save for retirement. In the 401(k), you choose your investments from a list of mutual funds provided by your hospital. The money is designed to be withdrawn when you retire.
The 403(b) plan is essentially the non-profit (including non-profit hospitals) version of a 401(k) plan. Everything we talk about 401(k)s in this article applies to 403(b)s as well.
Why invest in a 401(k)
Matching contribution by employer
Many hospitals will match your contributions dollar for dollar. On average, the hospital offers a matching contribution on 2-3% of your pay. This is free money; hospitals give these matching contributions to encourage their employees to save for retirement. Take advantage.
There are two types of 401(k), traditional 401(k)s and Roth 401(k)s. All hospitals offer a traditional 401(k) option, but some offer both traditional and Roth 401(k) options. For a traditional 401(k), you get a tax deduction when you contribute to the account. Your money then grows tax-deferred (usually you pay a capital gains tax whenever you sell investments for a profit). When you withdraw your money, the money is taxed as ordinary income. For a Roth 401(k), your money grows tax-free, and you don’t have to pay taxes on the income when you make a qualified withdrawal when you retire. However, you don’t get a tax deduction when you contribute to a 401(k) like you do for a Roth 401(k).
Some residents (typically married residents with a non-working spouse) will be eligible for a tax credit when you make retirement contributions, including 401(k) contributions.
How much to invest in 401(k)
A lot of residents want to know how much they “should” be investing in a 401(k). Most residents have student loans that are accruing interest. But if the stock market goes up more than the interest rate on your student loans, investing in a 401(k) would be preferable.
If your hospital offers matching contributions to 401(k) contribution, you should contribute enough to max out your hospital’s matching contributions. Matching contributions are free money (an instant 100% return), so it is a no-brainer to contribute to the 401(k) when you will get a matching contribution.
After that, the amount to contribute to your 401(k) is up to you. The maximum you can contribute to a 401(k) is $18,000 a year, and some super-saving residents like my fellow blogger Future Proof, MD are doing just that.
Contributing to a 401(k)
Traditional vs. Roth
The first decision you have to make is whether to contribute to a traditional or Roth 401(k). For most residents, I recommend a Roth 401(k). When you do the math, Roth 401(k)s have larger tax benefits than traditional 401(k)s during residency (the reverse is true when you become an attending, because your upfront tax deduction with a 401(k) is higher when you make attending salaries).
Related Article: The Traditional vs. Roth Decision for Medical Residents
Percentage of paycheck vs. dollar amount
You can choose to contribute a percentage of your paycheck each pay period to your 401(k), or select a fixed dollar amount to contribute. You can change your selections at any time, but it may take 1-2 pay periods for your selections to get updated by your 401(k) plan provider.
Vesting only applies to matching contributions. Your contributions to a 401(k) is always 100% yours. When matching contributions have a vesting period, they are not officially deposited into your account immediately. They may be slowly deposited into your account over the vesting period (for example, 25% per year for a vesting period of four years), or all at the end of the vesting period. This is usually done to encourage employees to stay at the hospital, as if they leave the hospital, they lose out on the unvested money that has not yet been deposited into the 401(k). Residents are captive to their hospitals for their time in training, but possibly you may be incentivized to stay at your residency program’s hospital because of your unvested matching contributions. The dollar amounts for most residents is miniscule; I would not make any employment decisions based on unvested 401(k) money.
Choosing 401(k) investments
The number of 401(k) options can be very daunting for new residents, who may have never invested money in the stock market. Here is an easy step-by-step guide to selecting your 401k investment options for the first time; as you read and learn more about investing, you can make more nuanced investing decisions.
My recommendation for new residents is to focus on just one or two funds for your 401(k). Remember that each mutual fund has many stocks in it, so you are not putting all your eggs in one basket if you select the correct mutual fund. Also, the amount of money you are contributing during residency will probably be loose change compared to what you’ll be making after residency. There is no need to make investing more complicated than it needs to be.
Step 1: Look for an S&P 500 or Total Stock Market Index fund
When scanning through your investment options, look for an index fund that invests in the S&P 500 or Total Stock Market. If you find one, you are done. Put 100% of your money into that fund and you’re finished. Congratulations on working at a hospital with this investment option. If you want to add some bonds, skip ahead to Step 4 below.
Step 2: Look for a target-date fund
If your hospital doesn’t offer an S&P 500 or total stock market index fund, then look at whether it offers a target-date fund. These funds may have the words target-date or retirement in them.
Step 3: Sort by expense ratio, do not look at performance
Unfortunately, if you do not have a S&P 500, total stock market, or target-date fund among your investment options, then you will need to look at each individual fund. The first thing to do is sort the funds by expense ratio. Expense ratios are the percentage of your investment that you will pay in fees each year. Sort the list of mutual funds by expense ratio and start reading about the funds with the lowest expense ratios.
Read the mutual fund webpage and make sure that it is investing in the stock market. You don’t want to put all of your money in a bond fund or money market fund.
I warn you to not look at performance when comparing mutual funds. Past performance is not an indication of future results, and funds that do really well one year may do very poorly the next.
Related Article: The First Number I Look At When Choosing Mutual Funds
Step 4: Consider adding a bond fund
Some residents are uncomfortable putting all of their money in the stock market. For them, I would find a bond mutual fund (ideally an index fund with a low expense ratio). There are many rules of thumb for how much money to allocate in bonds versus stocks, but your age in bonds (e.g. a 30-year-old resident should invest 30% of their money in bonds) is a good starting point.
What happens to the 401(k) after you finish residency?
When you finish residency, your 401(k) does not disappear. You can leave it at your old hospital, or combine it with the 401(k) of your new job (this is called a rollover).
If you’re not sure where to start, shoot me an e-mail via the contact page and I’d be happy to look over your 401(k) options and let you know my thoughts.
What do you think? Did you invest in a 401(k) when you were a resident?