Financial Planning for Young Physicians (Part I)

Imagine you have just finished residency and are finally starting your medical career. You may feel relieved to finally have those years of schooling and training behind you. But then reality sets in and you wonder how you are going to deal with the medical school debt that you’ve accrued.

According to the American Medical School Association, 86 percent of medical school graduate carry educational debt with a median debt burden of $155,000 for public school graduates and nearly $185,000 for private school graduates.

How can a young physician balance the financial stresses of overwhelming medical school debt with buying their first home, saving for retirement, buying a new car, and at the same time enjoying life?

Let’s approach this with a specific plan of action with some principles that can help any young physician. I have broken down the prioritization based upon two different case studies - one for a primary-care physician and the other for a specialty physician.

Specialist physicians on average, have more income than primary-care physicians. Due to the extra wiggle room, there are some significant differences between the two case studies. For example, we bump up retirement savings and a down payment for the purchase of a first home.

To develop a plan, you will need to take some time to ponder and reflect upon your situation. The best time to do that is now, early in your career. Here are some things to consider as you do that.

² Assumes married filing jointly, effective tax bracket based on 2012 tax brackets with standard deduction of $11,600, payroll taxes of 7.5 percent up to $110,000 of compensation

Addressing Debt and Establishing a 'Rainy Day' Fund

In my opinion, one of the most important things you need to do is to lower and eliminate your consumer and educational debts as well as to establish your "rainy day" fund.

Now that you have your first job as a physician, make sure for the first few months to set aside money for the "stuff happens" factors in life like the car breaking down or the furnace going out. I call this the "rainy day" fund.

For any physician, I suggest at a minimum saving $6,000 within the first few months. If you make over $200,000, double that. Continue to save that amount annually to keep building up for that rainy day.

Keep these funds in a money market or checking account until you have more than $15,000. Then, consider a low-risk investment account where you can pull out all of your money without any penalty, if necessary.

Beyond the cash cushion, focus on reducing your debt.

• First, make sure that you consolidate and lock in the interest rates for your student and consumer debt. We are at all-time lows for interest rates; and they are not likely to get any lower. As a matter of fact, interest rates are likely to rise within the next two years to three years.

Consider signing up for automatic payments to knock off 0.25 percent or more on your debts.

• Secondly, while in residency or fellowship, consider either deferring your loan (where interest will compound) or forebearing through an income-sensitive repayment plan or through an earnings-based repayment plan (EBR). Note that an EBR requires a lower monthly commitment than an IBR, but extends the life of the loan.

Next, consider debt-forgiveness programs that are available through federal or state sources. The Association of American Medical Colleges  and National Health Service Corps have more information

• Also, find out what it would take to pay back your student loan in 10 years or 15 years instead of 30 years. Consider that 30 years of interest on a 5 percent, $150,000 student loan amounts to nearly $140,000 worth of interest. If you pay back the loan over 30 years, you’ve just nearly doubled the total amount that you’ll have to pay. Whereas using only 15 years reduces the total interest to nearly $64,000. That $76,000 interest savings could buy you the cabin or RV (or five European vacations) you want in retirement.

 At a minimum, consider putting at least an extra $500/month to $1,000/month or more towards your debts.

• Lastly, your student loans are not likely to be tax deductible (since you will be making over $90,000). Pay them down before you pay down a mortgage. However, other consumer debt like credit cards and car loans typically have higher interest rates. Pay off consumer debt (or even better, don’t have consumer debt) before paying down student loans.

Focus on paying off one debt or another by balancing interest rates versus your cash flow. If you have a huge interest rate difference between debts - let’s say 4 percent or more - pay off the higher interest rate debt. Also, if you only have $5,000 or more left for a debt, consider focusing on that debt to have it paid off and increase your monthly cash flow.

Next week, we'll take a look at enjoying a reasonable lifestyle today, saving for retirement tomorrow, and review some guidance on big-ticket items.

Dave Denniston, CFA, is a professional wealth manager and financial advisor located in Bloomington, Minn. He is also the author of "5 Steps to Get out of Debt for Physicians and 45 Secrets to Financing a College Education." You can contact him here.