High School Flash Back Time!
I’m 17 years old in the back of my high school business class. A square-box class room with floor to ceiling single-pane windows along the rear wall that can barely bring themselves to hold the cold air out. The low rumbling of the 1950’s era room heater interrupts my count down until I can get home and get back GoldenEye on N64. As I re-start my daydreaming about which un-lockable achievement I was going to masochistically throw myself against that afternoon (some of those achievements were hard!), my teacher showed the class an example of saving money in a Roth IRA.
While this chart uses a pretty “rosy” market return of 12% (that I would not recommend using for your calculations). It does do a pretty clear job of demonstrating the effects of saving early versus saving late. The person represented by the column on the left only saved $16,000 total while compound returns did the heavy lifting; whereas the right saved $78,000 and ended up with significantly less.
As I grew older and more interested in finance – that chart continued to bother me – but I never forgot it. It needed a 12% return in order for the numbers to look dramatic and I thought it painted an unrealistic picture of likely investment returns, even at my naive knowledge level. It wouldn’t seem prudent to expect 12% market returns for the next 40 years and telling someone to only save $16,000 definitely seemed foolish to me. But the concept of early saving versus waiting is obviously a vitally important one to understand.
/end High School Flask Back Time
Recently, I came across an article from the very smart and well-respected Paul Merriman titled, “Save $1,000 a year. Retire with millions”. He demonstrates a similar concept to the above chart using the historical returns of ~11%, but mainly he is trying to show that staying consistent is the key (despite his clickbaity title).
But this got me thinking… how could a Pharmacist get to $1,000,000 today (and use less dramatic, more realistic future market estimates)?
The Path to Being a Pharmacist Millionaire Begins!
Saving any amount consistently, while minimizing expenses, is better than saving nothing. This is the vital concept to take from this post and others like it. If you can only spare $50/month to save for retirement today? Do it! Developing the habit of saving is far more important than amount you save, at least initially, (we are all going to need to increase our saving over time). This isn’t the only thing a new graduate should be concerned about either, so be sure to read my Top 6 things a pharmacist should do once they graduate.
Utilizing my proposed recent graduate pharmacist cash management plan, we can estimate what a new pharmacist could/should be saving toward retirement. If we assume we are saving $1,333 per month (or possibly less if you are getting a hefty 401k/403b matching contribution from your employer). And yes… $1,333/month is the minimum someone making $100,000/year should be targeting.
This is what happens:
So it only takes about 25 years with pretty reasonable investment return to get to $1 million dollars.
Example on how to get to $16,000/year ($1,333/month) with employer 401k matching
Let’s assume your employer offers something like:
“50% match on the first 5% contributed”
This means your employer will give you $0.50 for each $1 you put into your 401k until you reach 5% of your salary. Assuming we make $100,000/year, the employer would give us $2,500 (for free!) when we put in $5,000 ~ making the total amount $7,500 in our retirement account. If you save more than 5% of your salary (which you’ll need to long-term) you don’t get more than the first $2,500 of free money from your employer. To dive deeper into retirement saving – check about my post devoted to it here.
And things start to look even better if you keep investing through to age 65, rather than stop at age 50 like in the above example:
You don’t need to do anything fancy to get to a million dollars or more (simple passively-managed index funds will do it). This is absolutely within the realm of possible for anyone making over $100,000 per year. And the best part is it grows tax-deferred and it reduces your taxable income today (saving you money today in taxes owed).
Won’t having a seven-figure retirement account mean crazy taxes??!
I get asked this question frequently by my finance students and colleagues as I implore them to create healthy (read: large) 401k/403b retirement accounts. I had a couple crude calculations in my head about how taxes shouldn’t be too large a problem since we aren’t required to take any distributions (withdrawals) from our 401k accounts until age 70.5.
But, having a large tax-deferred retirement account will require significant taxable distributions in retirement, no doubt about it. Uncle Sam wants his taxes eventually! Social Security will also need to be included since we should earn between $20,000 – $30,000 per year just from the Social Security taxes we’ve paid in over our working life (assuming $100,000/year salary).
The required withdrawals amount to about 3.6% of our account balance at age 70.5 and increase each year. I had estimated you’d need tax-deferred accounts near $2 million before you’d have a taxable income of six-figures in retirement and possibly risk paying higher taxes in the future compared to now. But since professionals making six-figure salaries today pay marginal tax rates of 22-24% ~ we’ll have a lot of room to pay less tax in retirement.
Cue the true hero of this post, Mr. Grossman on HumbleDollar.com
This was all crudely estimated in my head, until I saw an article on the HumbleDollar website titled Six Figures, Tiny Taxes. It is as if Mr. Grossman knew I was writing this post and wanted to help! I’m going to walk through a hypothetical pharmacist who saved similar to my examples above and how our tax-burden could be far less than you’d expect (but definitely give Mr. Grossman’s link a click to see the inspiration for some of this content and an example of how you could have six-figure distributions and still be taxed less than 3% in retirement).
Let’s walk through our estimates and assumptions for our robust pharmacist saver at age 70:
- We’ll assume we have a Social Security benefit (we delayed it until age 70) of $22,000 per year, of which ~$19,000 counts as taxable income.
- Social Security payments are complicated. I’m making some assumptions and taking 70% of the projected benefit. Email me if you want more detail.
- Our Required Minimum Distribution on a ~$2,000,000 portfolio would be about $73,000 (all taxable)
- So we will get a total of $95,000 per year of income in our retirement
Now, ideally, we’d have some Roth IRA money (tax-free withdrawals) and some money in a taxable brokerage account (also would be tax-free to spend). As this would allow us some more tax flexibility (and would have likely decreased how much was in our tax-deferred accounts). But for this tax example, I want to make it as “bad” as possible by having all of our money tax-deferred initially and now fully-taxable.
Our Taxable Portion of Income:
- Social Security = $19,000 ($22,000 total, but only $19,000 is taxable)
- 401k distribution = $73,000 (fully-taxable)
- Total = $92,000 taxable income (Total Income of $95,000)
Time for some exciting estimated tax-preparation blogging!!
Starting in 2018, everyone gets the Standard Deduction of $12,000 ($24,000, if married) and people over 65 get a little more. We are over 65 in this example and will take a $13,600 deduction (Single) or $26,600 (Married)
For the Single Pharmacist Millionaire:
- $92,000 income minus $13,600 = $78,400 taxable income = ~$13,200 taxes owed
- Take Home Pay = $81,800 ($95,000 – $13,200; for an effective tax rate 14%)
For the Married Pharmacist Millionaire:
- $92,000 income minus $26,600 = $65,400 taxable income = ~$7,500 taxes owed
- Take Home Pay = $87,500 ($95,000 – $7,500; for an effective tax rate 8%)
Now those numbers are based on today’s tax rates, which probably will be higher 30 years from now, but I would posit that there is a lot of room between the 8% and 14% effective tax rates in this example and the 23% effective tax rate I have today. Our situation would have been even more favorable if we had a portion of our retirement in a Roth account or taxable account.
So I don’t feel bad stuffing my 401k full of pre-tax money and you shouldn’t either!
What do you think? Are you still afraid of stuffing your 401k/403b full? Do you have a different plan? Tell me below! I read every comment and email I receive.