Resident Retirement Contributions and PSLF: Pretax or Roth?

Saving for retirement, even as a resident, is a good thing. The absolute amount of money you can likely contribute is relatively small, but it does add up and over time it will compound to a larger amount. However, the most important reason to do so as soon as possible is to start the saving habit.

It’s important to make saving an automatic deeply-ingrained habit. It will serve you well when you make more money and help you make faster progress toward your savings goals of financial flexibility and a healthy retirement. If you think you should wait until you earn more money, the problem is that you can always spend more money, and some folks will simply need higher spending in order to make ends meet based on the decisions they’ve already made with regards to prior spending and borrowing, family planning, and the results of the match. So the most meaningful answer to the question of resident retirement savings is simply yes.

But if you can, let’s discuss the age-old question of pretax vs Roth.

The Options

In a traditional pretax account like the standard option for your work 401k or 403b, money is subtracted from your income in the year of the contribution. So you pay fewer taxes upfront. It then grows tax-free while in the account, and you’ll pay taxes on the distribution when you use it in retirement as if it were income.

Roth accounts are the opposite. You put after-tax money in, meaning you pay regular taxes on that money in the contribution year. The money also grows tax-free while in the account but then is also tax-free when you withdraw it.

Which contribution type is mathematically best has to do with your marginal tax rate during the contribution year while working vs during the withdrawal year in retirement. What’s important to realize is that mathematically, the two choices are equivalent when the tax rates are the same if the amounts contributed are adjusted on a tax-basis (ie, at a 10% marginal tax rate, $1000 pretax contribution is equivalent to $900 Roth, because the Roth has the taxes paid upfront).

The reason behind the idea that a resident should generally use a Roth option is because it’s assumed that you will earn less as a resident than you will want to spend in retirement (potentially true), not that you will simply earn less than you would as an attending (almost universally true).

Retirement Contributions and Student Loans

When it comes to student loans on an income-driven repayment plan, pretax contributions reduce your adjustable gross income, which reduces your discretionary income, which reduces your monthly payments the following year. Because PAYE/REPAYE uses a ten percent discretionary income calculation, every dollar you contribute reduces your payment by ten cents the following year (fifteen cents in the old IBR). If you achieve loan forgiveness via PSLF, then that bonus contribution match is truly extra free money on top of the PSLF windfall.

Additionally, if you are in REPAYE, the lower payments can result in more unpaid interest and thus a slightly better unpaid interest subsidy and lower your effective rate. Conversely, this would only matter if you did not get PSLF. Outside of this rate reduction, remember that lower monthly payments are really a good thing financially: they just mean less progress on your loans and more interest paid over time.

The impact here depends on how much you can contribute. If you have a high-earning spouse and can therefore max out a $19,000 contribution, for example, you’d save an extra $1,900 in payments the following year. That’s not chump change. But if you put $5k away? Just $500, or about $40 a month. Not necessarily anything life-changing there.

In contrast, Roth contributions have no impact.

How Taxes Work

2019 tax bracketsSingleMarried Filing Jointly
10%$0 – $9,875$0 – $19,750
12%$9,876 – $40,125$19,751 – $80,250
22%$40,126 – $85,525$80,251 – $171,050
24%$85,526 – $163,300$171,051 – $326,600
32%$163,301 – $207,350$326,601 – $414,700
35%$207,351 – $518,400$414,701 – $622,050
37%$518,401+$622,051+

Taxes are progressive. You don’t simply pay your marginal rate on all your earnings based on your total income. You pay the rate on each bucket of money as it fills up. But since pretax contributions are a deduction, they do reduce your taxes at the marginal rate.

So, looking at the chart, a single resident making $55k would be in the 22% bracket, and with the standard deduction their effective tax rate about 12%. Let’s say you then as a married couple wanted to retire on $100k a year? Well, with a $24k standard deduction that would actually get you a marginal tax rate of 12% and an effective rate of about 11% (using 2019 tax brackets as a guide). In this scenario, therefore, pretax could win right off the bat (the marginal rate is what matters here).

There are three important nuances here:

  1. We don’t know what taxes will look like in the future.
  2. Distributions are taxed as income, so not every dollar is taxed the same.
  3. You may need less money in retirement than you think.

We don’t know what taxes will look like in the future

I suspect tax rates will overall be higher in the future, at least at the top marginal rates. The current rates are at historic lows, deficits are rising, and income inequality is reaching a tipping point. That doesn’t necessarily mean they’ll be higher at the level you end up retiring at, but it’s certainly a notch in the Roth column.

Distributions are taxed as income, so not every dollar is taxed the same

As we just discussed, taxes are progressive and each bracket is filled sequentially with rising income. So the first dollar pays almost nothing while the final dollar pays the full marginal rate. In retirement, you can utilize a combination of social security, Roth, and pretax money to minimize your tax burden. You do not need to pay taxes on an income of $100,000 in order to spend $70k after taxes in retirement like you would have during your working years if you have money in both types to utilize. You can use pretax at the lower tax brackets and Roth to fill in the rest to prevent paying the higher rates.

That’s one good reason to do a Backdoor Roth as an attending, even when you earn too much to contribute directly.

You may need less money in retirement than you think.

In retirement, you should have no debt and significantly decreased monthly expenses. No student loans. Real estate taxes, sure, but no mortgage. Probably no car payments, at least for a while. Maintaining a similar quality of life in terms of discretionary spending will be significantly less expensive even with some increased leisure spending.

The Fuzziness and Flexibility of Extra Money

The 10% PSLF “match” has nothing to do with tax savings. It’s extra after-tax money you get to play with the following year due to lower required monthly loan payments. So it’s letting you hold on to money you would have spent. That makes it fuzzy. But it also makes it valuable, because it’s money that you can do whatever you want with. You can certainly invest it by increasing your contribution to your retirement. You could even do that pretax again, getting a token 10% of that amount back the following year. But regardless, the money is a good reason to understand the idea of the time value of money.

The time value of money is the finance principle that money now is worth more than the same amount of money later due to its earning potential (ie it can be invested and earn interest). So while it’s possible, like in our above example, for this extra money to merely improve the tax inefficiency of using a pretax account when you hope to spend more in retirement, if it ends up a wash it still may be better to have that money now than later.

One thing to consider, outside of math, is simply where the extra money will help you more. If you do a good job saving for retirement, the few thousand bucks in changes related to tax optimization may not be meaningful because you’ll have more than enough anyway. On the flip side, having smaller IDR payments frees up money now on a monthly basis in these leaner years at the start of your career.

That’s putting money in your pocket to get rid of high-interest debt like credit cards, build up an emergency fund, save a little for an important purchase, make life and disability insurance affordable, or pay for your own HBO subscription (speaking of, have you priced out your options for own-occupation disability insurance yet? Because you need to).  My point is here is that it’s not always prudent to let the tax tail wag the living your life dog.

You can, of course, split the difference and invest some of your contribution in your work pretax account (say up to the match) and then whatever else you can afford into a Roth IRA.

Conclusion

it’s literally impossible to know what the correct choice is mathematically. Any calculation involves a ton of assumptions. It’s possible the machines will have taken over and everyone will be on a universal basic income and most tax revenues will come from the immortal cyborg of Jeff Bezos. It’s also absolutely possible that future tax rates will be sufficiently high that Roth becomes the optimal strategy regardless of the extra money pretax contributions can give you right now.

However, that doesn’t necessarily make it the right choice for you. Personal finance is personal. The increased cash flow now may be more valuable in practical life impact than more money later that you may not need or get to utilize.

Personally, if you’re really planning for PSLF, I think pretax makes a lot of sense (though Roth is never bad!). If you’re not planning for PSLF, then, by all means, these are almost certainly some of the best years of your career for Roth contributions. And lastly, if you’re struggling to make your IDR payments and don’t see how you could contribute to your retirement at all, then pretax may make it slightly more feasible for you.

47 Comments

  1. Great post! My friends and I were waiting for this one!!!

    Dr. White, do you mind explaining the effective tax rates listed and how the calculations were done surrounding the 100K retirement example?

    Reply
    • You can just use an effective tax rate calculator, like this one: https://smartasset.com/taxes/income-taxes or this one: https://equitable.com/retirement/products/variable-annuities/investment-edge-annuity/estimate_your_effective_tax_rate. Note you need to use your taxable income and not your total income, so for simplicity, subtracting the standard deduction is a good starting point. Your tax software will also tell you this after the fact when you actually file taxes.

      But the point is that each tax bracket is used for its corresponding income range, so the effective rate is a manifestation of the weighted average as you pay the cheaper brackets first. It will always be lower than the marginal rate because it’s usually calculated as the amount you pay in taxes divided by your taxable income. If you use total income, like those calculators do, then the numbers get even lower because of the deductions, which is how you can end up with sub-10% rates.

      Note that I was just including that to illustrate the taxes you actually pay (because people usually overestimate this); for the Roth vs pretax question, we actually are concerned with the marginal rate.

      Reply
  2. YO Ben. Awesome and timely!

    If we do traditional while in residency, do we need to rollover all of this and then do the backdoor Roth option? Any guidance would be great!

    Reply
    • 401k/403b contributions don’t matter for the Backdoor. If you use a traditional pretax IRA, however, then yes, you will need to transfer that to a 401k or similar account before making backdoor contributions due to what’s called the “pro rata rule.”

      The vast majority of residents have access to retirement accounts so there is usually no need to use a tIRA for very long, but if you do, it’s not hard to move the money over to future accounts when you gain access to one. (And you can also open your own individual 401k if you earn 1099-income from moonlighting, which I discuss in the book).

      Reply
      • Just found out my institution does not offer 401k/403b to its residents……
        Is it worth it still to do the traditional IRA, given that after 4 years, I would have to clear and pay taxes on all of this in order to do the backdoor Roth? Thanks Ben!

      • You will probably be to roll that pretax tIRA money into your future employer’s 401k instead of doing a Roth conversion.

      • What would be I guess, next steps, if I rollover the traditional IRA to 401k/403b? Continue contributing until retirement or do something with Roth eventually or some other hidden secret ninja moves? Thank you!

      • In the same boat as Quinn.
        So what’s the long term game plan for these traditional IRAs? Keep them around until retirement by rolling them into hopefully future employer’s 403b? Convert them to Roth upon residency graduation or retirement? Just want to know whether I should do traditional….or just stick with Roth IRAs…

      • Can definitely stick to a Roth IRA if it seems like a hassle. It’s always a solid choice.

        But yes you will likely be able to transfer to a future 401k/403b without issue. Additionally if you earn any 1099 income (moonlighting, surveys, etc) you can set yourself up with an EIN and then open up an individual 401k that can accept the transfer.

        A Roth conversion while still going for PSLF would just increase your income that year by the same amount, defeating the purpose.

      • is there a limit to the amount of money I can roll over to my individual 401k from an IRA??

        and what usually happens to that individual 401k? can it be rolled over to an employer’s 403b?

      • No limits. An individual 401k you can keep and manage forever, you have complete control making it a great versatile account.

  3. Basic question:

    Pretax account: taxes due only on what we contributed before taxes, or due on what we contributed plus anything we gained from investing?

    Is this different than Roth because nothing is ever taxed again, including anything we gained from investing?

    Reply
    • Taxes due on every dollar you take out in retirement (contribution + gains).

      Yes, that’s different from Roth. But remember with Roth that an equivalent contribution is smaller because you had to pay taxes on it before it’s invested. So yes if you put in 5k pretax and 5k in a Roth, you actually put *more* equivalent dollars in the Roth because that’s after-tax money.

      Reply
  4. Any good tips/books on how to start moonlighting, what insurance is have, 401k, etc.
    Thanks Dr. White! My friend just referred me over to this site. Don’t know why it isn’t more popular…

    Reply
    • Insurance depends on the gig, very common for it to be included with many opportunities. If you ever need your own, The Doctor’s Company and MedPro are good ones to look at. Individual 401ks are available from all the big players, Vanguard, Schwab, Fidelity, and E*Trade are the ones I would consider.

      I do plan to hopefully write more on these topics in the future.

      Reply
  5. Thoroughly enjoyed your book! After reading this post, I’m still confused as to what vehicle I should use when going PSLF. Is there a threshold of projected retirement income (crystal ball cloudy) that would cause a resident to lean one way or another?

    Reply
    • Unfortunately no easy answers here. If you look at historic tax rates, Roth sounds better for sure. In 1975, the $100k marginal rate I discussed above? 62%! So Roth is by far the more future proof choice, there’s no doubt about it from that perspective. The highest marginal rate right now is 37%, which was close to the rate for an income of $24k back then.

      We just really have no way to know what the future holds from that perspective. There’s a reasonable argument to be made that you should always use Roth since we’re at historically low rates right now and we could conceivably return back to historic rates like that. But who knows?! The machines could take over and we could all have a UBI with low taxes as the corporate giants fund the economy. We do know that upfront pretax makes your life easier right now and helps with cash-flow in your leaner years, and that is definitely meaningful.

      It’s a personal choice. I do recommend that anyone doing pretax as attending also do a backdoor Roth, because it’s definitely good to have the flexibility of money in both pots.

      Reply
      • Hey Ben, I too am confused. After reading your blog, it seems that the above comment favors Roth, while the post favors traditional? Am I thinking about this correctly? I’m an intern going PSLF.

      • You are correct, the comment is fleshing out nuance #1 from the post. Who can say what taxes will be like when you retire? Given how low they are now, I would think it overall unlikely that they’ll be *lower* across the board. But that doesn’t mean they’ll be meaningfully different at “regular” income levels. Even if the rates for millionaires go up that doesn’t mean they’ll be different for everyone.

        My point in the comments and the post is that there are arguments in favor of both approaches. Roth now, essentially regardless of income, would be the mathematically right choice if tax rates were to revert back to historical highs. In many cases, pretax is actually a better choice if they don’t depending on how much you think you’ll realistically spend in retirement.

        I think for many people the choice that puts a little more money in your pocket now (or soon) and maximizes your PSLF benefit is a prudent approach for this particular question given the incredible uncertainly of what the world will look like 40 years from now. If not for PSLF, I would choose Roth. But both choices are absolutely good choices.

      • Thanks for pointing to those historic rates. How much consideration would you place on those rates vs state+federal income tax currently vs state+federal in retirement

      • We didn’t even cover the difference state residency can make. Certainly if you’re in a high tax state now but plan to retire in a low one, that’s a vote for pre-tax (and opposite for Roth).

        As for the future, I really don’t know. I think they’ll be higher, but I don’t know if they’ll ever return to those historic rates across the board as opposed to just for the “1%”–that seems relatively unlikely. I’d like to have a mix of both, since we can’t know the future. I’m planning on adding some more Roth contributions in the future via my individual 401k to increase my Roth holdings but it’s not something I’ve done yet.

  6. Dr. White, I’ve read both your student loan books and WCI. Any suggestions for further reading on investments and finances? Thanks, currently a resident and my partner is soon to be attending if two separate ideas would help.

    Reply
  7. You know, I’m impressed by your willingness to explain concepts that probably seem elementary to you. Hats off!

    I know you mentioned it before, but wanted to confirm. What’s the formula for calculating monthly student loan payment? Would it be recommended to contribute whatever needed amount to garner another year of close to $0 payments (ie. contribute x to traditional or HSA, the rest to Roth)??

    Reply
    • I do try! The best way for me to know how to help people is to listen to their questions.

      The formulas are in the book, for example: https://www.benwhite.com/studentloans/federal-repayment-options/

      That said, I would just use a calculator such as the one put together by the fine folks over at Doctored Money: https://www.doctoredmoney.org/tools-and-calculators.

      Re: $0 payments during PGY2. Yes, people definitely do that. One current wrinkle is that we’re experiencing $0 payments right now due to the Cares Act and we very well might see that extended well into 2021, making some of that work superfluous.

      But yes it’s pretty straightforward to do that for the PGY2 year. PGY1 will be $0 for lots of folks. PGY2 is usually based on a half-years income. The calculation is basically such that a single individual needs an income of about $19k to pay more than $0 (1.5x times the poverty line). So depending on your intern salary, cost of living/financial flexbility, and any other deductions, getting your discretionary income down to that level is potentially achievable for one more year.

      Reply
  8. Side question – I read that when choosing bonds it’s important to notice the year of maturity and interest rate. However, when investing in PIMCO or Vanguard total bond market, is it similar to VTSAX since its a fund of funds, so no real maturity date? Is that only for individual bond purchases?

    Reply
  9. Dr. White, no clear consensus after reading your post, these comments, and the Internet. Are there, if any, disadvantages to having both a traditional 403b AND a Roth 403b? Is there anything similar to having to clear out accounts to do the backdoor Roth IRA?

    Reply
    • Correct. No easy answers here, just considerations and approaches.

      No disadvantage to having both. 403b/401k accounts have no bearing on the backdoor Roth IRA. Usually if you want to make both types of contributions (and aren’t yet contributing to the annual maximum) people tend to do pretax in the 403b (at least the company match) and then separately fund a Roth IRA because you can often get access to better funds and pay lower fees on your own than with your employer account.

      Reply
  10. Where would Roth or traditional IRAs factor into this? Are IRAs preferred over 403bs if there is no employer match? Going the PSLF route. Thank you, KS

    Reply
    • If you have access to a work 403b or 401k, you will not be using a traditional pretax IRA. But otherwise a tIRA is pretax account and functions the same way with regards to lowering your taxable income.

      A Roth IRA, like the Roth-option on a 403b/401k that may (or may not) be available to you, is an after-tax account: a wonderful thing to have but totally irrelevant to helping you out with student loans.

      Reply
  11. Wanted to follow up on this:

    Realize that Roth 401k/403b can act as another retirement savings “bucket” but are there any advantages of that over a Roth IRA? Maybe some asset protection? Not sure…

    Reply
    • No, it’s the other way around. The Roth IRA is unique in that there is no required minimum distribution (RMD) in retirement. In a 401k/403b, you must start taking out a fraction of the account every year once you hit retirement age (currently age 72). This makes the Roth IRA more flexible during your lifetime and a better vehicle to pass on wealth to heirs.

      However, note that you can rollover Roth money from a 403b to a Roth IRA without fees, taxes, or other issues, so it’s not something that’s a huge deal in the short term.

      Reply
  12. Hi Dr. White,
    I’m planning to start moonlighting and was wondering if there were any good resources that cover this? Any books, article, posts, experiences, etc would be great.

    Also, since I’m applying for PSLF, does it make sense for me to moonlight. I know it’s a weird question but based on economics of time, total loan forgiveness, etc. Wanted to hear your input!

    Dave L

    Reply
    • I can’t think of any particularly good resources specifically about that offhand, though I’m sure it’s been covered in some Googleable capacity. It’s been on my personal list of things to cover for years. If you have any particular questions, perhaps I can get to them in a future post.

      As to the second question, it’s a bit of a personal choice if it’s worth it to you personally given how many hours are in the day. From a PSLF/student loans perspective, you will be paying an extra 10% in payments the following year, but you will obviously end up with more money in the bank if you work than if you don’t. It’s never going to hurt you financially to moonlight, if you’e talking $70-100/hr to moonlight, that can easily be life-changing money on a resident salary.
      If you were to moonlight a lot one year and then need to cut it out entirely the following year (such that your current IDR payments are hard to afford), that is conceivably a situation in which you could use pay stubs to certify your income instead of your tax returns.

      Also note that if you were to simply contribute every dollar you earn to a pretax account, then there would be zero tax or IDR consequence. So for those who feel like that they don’t have the cash flow to support saving for retirement, moonlighting can help provide that financial flexibility.

      Reply
  13. In an earlier post you mentioned Ally bank as your online saving account. Is there a particular reason why Ally over others? Want to put my PSLF side fund somewhere and have been looking at other banks such as First Foundation and Synchrony. Thank you!

    Reply
    • Ally is just an example of a popular (the most popular?) well-liked high-interest account. Mine is actually at HSBC, which is analogous (and which I opened back in college).

      Anything with a decent rate and FDIC insurance is fine.

      Reply
  14. Let’s hedge our bets here.
    1) Contribute maximum to HSA and some to traditional IRA (enough to lower AGI), and then Roth IRA
    2) HSA max, and then Roth IRA
    3) HSA max and traditional IRA

    Which one would you recommend? PSLF, intern, 450K student loans, not married, state income tax 4.9%

    Reply
    • If I didn’t have access to a 401k/403b, I’d probably personally split the difference and do max HSA followed by Roth IRA.

      Reply
  15. Question before thinking about retirement accounts, but still about PSLF so I apologize if this is the wrong blog to post this. I hear about needing to have ‘graduation’ status listed before I consolidate my loans for PSLF. Is there any reasoning for this?

    Reply
  16. Dr. White, some rather simple questions

    1. How do traditional IRAs work? Vanguard says an option is to transfer from a bank account, but wouldn’t that already be using post-tax/Roth funds since they’re in my account? Would I need to ask my employer to set this up even though it’s not a 401k/403b?

    2. Does contributing to an HSA qualify me for the Saver’s Credit?
    Any other potential tax deductions/credits for residents?

    Thanks,

    Sara

    Reply

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