roth vs 401k during residency

[gonogo]

I'm starting residency this coming summer and have about 5k in a 401k from a previous employer. Other than that I have no other savings. Fortunately I have no loans and will be probably able to save $300-400/month during residency. Here are my questions:

Should I start a Roth IRA? I've heard this is a good option for residents, however, what happens with the Roth once you finish residency and you no longer qualify for it? Do you have to start in zero a 401k and leave the Roth untouched until you retire? This doesn't seem too good to me.

In case I start a Roth, can I convert my previous 401k into a roth? What do I do with my 401K?

Finally, does it actually make sense to put the money in a retirement account, or would it be a wiser investment to put that money in a savings account with the idea to have a down payment for a mortgage by the time I finish residency?

I'd appreciate everyone's input.

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[dragonfly99]

Whether to save the $ for retirement or a down payment on a house just depends on your personal financial goals. I think you should do both - save for retirement and a down payment on a house.

With a Roth IRA, you pay taxes on the $ now, but don't have to later when you retire and take the money out. As a physician, you'll likely be in a higher tax bracket (hopefully) when you retire than you are now, so the Roth is a good deal. Also, the difference between Roth and traditional IRA is you can take money out of a Roth in certain circumstances without getting a penalty...buying a first home is one acceptable reason that you can take it out. I think the $ has to have been in the Roth for 5 years before you can take out any interest without a penalty, but the principle/$ you deposited I think you can take it out at any time without a penalty. Not sure...you should check on this. Much good info on the internet about Roth IRA's.

I don't know the answer to your question about converting 401k to Roth.

 

[Sol Rosenberg]

Should I start a Roth IRA? I've heard this is a good option for residents, however, what happens with the Roth once you finish residency and you no longer qualify for it? Do you have to start in zero a 401k and leave the Roth untouched until you retire? This doesn't seem too good to me.

(Bolded Question): Yes, you just leave it in your Roth. What else would you want to do with it?
(Underlined Question): Why? That is the purpose of a Roth IRA

In case I start a Roth, can I convert my previous 401k into a roth? What do I do with my 401K?

You can leave your 401k where it is or convert it to a Traditional (Rollover) IRA.

Under some circumstances, you can convert a Traditional IRA to a Roth IRA, but, regardless, you have to pay taxes on the money when you do so. Fortunately, if you do the conversion in 2010, you can spread it over 2 years to minimize to tax burden.

Finally, does it actually make sense to put the money in a retirement account, or would it be a wiser investment to put that money in a savings account with the idea to have a down payment for a mortgage by the time I finish residency?

Do you think you will have problems coming up with a 5% down payment when you finish residency such that you need to start saving now? I'm not sure what your concern is and/or how to help you with this one....

 

[The White Coat Investor]

Invest in your 401K just enough to get the entire match, if any.
Max out your Roth IRA.
Max out your spouse's IRA.
If you still have more to invest, go back to the IRA. If you max that out,
move to a taxable investing account.

If you have a 401K prior to med school, you should roll it over to an IRA, and convert that to a Roth IRA during med school, when you basically have a negative tax rate anyway.

 

[gonogo]

Thanks so much to everyone for the good advise. So as I see it the best would be to roll over my 401k into a Roth and max it out during residency.

The reason I thought it'd be better to max out a 401k during residency (and not a Roth) was so that after residency I'd be able to contribute to it and my capital will grow faster through compounding.

Under some circumstances, you can convert a Traditional IRA to a Roth IRA, but, regardless, you have to pay taxes on the money when you do so. Fortunately, if you do the conversion in 2010, you can spread it over 2 years to minimize to tax burden.

Where do I find out how to do this? Is it a DIY thing or can people in places like Vanguard or Fidelity help you out?

Thanks again!

 

[Wacaggie]

Gonogo,

If you have lets say 10,000 in just a Roth or 10,000 in a Roth and 401k combined the capital will grow just the same so it doesn't matter if you fill in the Roth while you can and then start at zero on your 401k. Capital is capital no matter where it is and will compound even if it is spread out between multiple accounts.

The benefits of both the Roth and 401k are that they compound without being taxed while they are in these programs. The benefit of the Roth is that even at dispersement you are not taxed because you paid tax already on the money. That is why it would be good to put money into a Roth when you have limited or no tax liability because you will basically never have to pay taxes on that money.

I agree with putting in the maximum to get a full match if possible for a 401k because that is a guaranteed positive return. This has saved me during this recent stock crash because I haven't lost any of "my" money yet and when it rebounds I have twice as many (or more because of it going in pretax) shares of each of the stocks than I would have had investing outside of the 401k.

I recently have questioned completely filling in your 401k, after any match that is, because the investment tax after holding something for over a year is 15% and all of your earnings in your 401k when you retire will be taxed at the current income tax rate. This investment tax may end up changing and you do have to fight the detracting factor of the 15%, or possibly regular income tax levels if you sell before a year or on any dividends you earn. All in all you won't be dealing with that issue until you get out of residency unless you are single and have no debts or are VERY money conscious.

I agree with what Activeduty about the correct order of investing in different locations. Put it in the Roth while you can and if you can convert your 401k to a Roth do it as soon as possible during your half year of earning a salary.

EDIT: I was just looking at some numbers between a 15% long term investment tax and the 401k and realized that if you are taxed to begin with and then earn money tax free, with the same rate of return as a 401k that is only taxed at the end you will end up with the exact same amount of money in the end. That means that the 15% or more paid in taxes even just a few times will decrease your actual rate of return causing you to end up with less money than the 401k in the end. Now I definatly agree that after Roth and spouse Roth you should fill in your 401k and spouse 401k (if they have one) to the max before getting into taxable accounts, that is unless you want the liquididy of the taxable account despite the reduced possible earnings, or if your 401k has very poor options and high fees in its mutual funds.

 

[gonogo]

Wacaggie,

Thanks so much for your response. I think my plan will be to convert my 401k into a Roth and max it out every year during residency. If I still have money to put aside, I will put it into a 401k (the residency program I'll go to doesn't match 401k accounts).

Do you have any idea where I can find help how I can convert my 401k to a Roth? I read somewhere that it would usually require being converted into a rollover IRA and then into a Roth, but that if you do it this year or next you can just do it directly. Can anyone explain this or suggest me where to find info on this?

Finally, assuming I have both a Roth and a 401k, should I diversify each of them? Let's say I'd have a Vanguard target fund for my Roth (which is already diversified), can I have the same fund for the 401k? Or would that not be advisable?

Thanks so much!

 

[Sol Rosenberg]

gonogo, you might start with your broker, or just google "Roth IRA conversion." There is tons of info about this out there.

As far as I know, right NOW, you cannot convert directly from a 401k into a Roth IRA -- you must convert to a Traditional IRA first. I believe that within a year or two, legislation takes effect that eliminates this [minor annoyance.]

Wacaggie, you will only come out with the same numbers if you assume the same tax brackets before and after retirement. Depending on how you plan for your retirement, you may end up retiring into a lower or higher tax bracket than when you are working. It depends upon how much you earn, how much you save, how much your investments earn, etc. There are reasons for using a tax-deferred account, and then there are reasons for not using one. You have to weigh all of these different options and decide what works best for you. ActiveDutyMD's suggestions are great guidelines that will probably work for most people, but I encourage people to thoroughly research all of your options so that you can make the best decisions abotu what to do with your money.

 

[The White Coat Investor]

gonogo, you might start with your broker, or just google "Roth IRA conversion." There is tons of info about this out there.

As far as I know, right NOW, you cannot convert directly from a 401k into a Roth IRA -- you must convert to a Traditional IRA first. I believe that within a year or two, legislation takes effect that eliminates this [minor annoyance.]

Wacaggie, you will only come out with the same numbers if you assume the same tax brackets before and after retirement. Depending on how you plan for your retirement, you may end up retiring into a lower or higher tax bracket than when you are working. It depends upon how much you earn, how much you save, how much your investments earn, etc. There are reasons for using a tax-deferred account, and then there are reasons for not using one. You have to weigh all of these different options and decide what works best for you. ActiveDutyMD's suggestions are great guidelines that will probably work for most people, but I encourage people to thoroughly research all of your options so that you can make the best decisions abotu what to do with your money.

The guidelines I gave are for residents. Most docs will be in a higher bracket in retirement than they are in residency, but in a lower bracket in retirement than during most of their career. That's why the focus for residents should be on a Roth.

 

[AmyTam]

Maybe this will help:

http://www.rothirarules.net/roth-ira-investments.htm

http://www.rothirarules.net/roth-ira-conversion.htm

http://www.rothirarules.net/

Good Luck!

I'm starting residency this coming summer and have about 5k in a 401k from a previous employer. Other than that I have no other savings. Fortunately I have no loans and will be probably able to save $300-400/month during residency. Here are my questions:

Should I start a Roth IRA? I've heard this is a good option for residents, however, what happens with the Roth once you finish residency and you no longer qualify for it? Do you have to start in zero a 401k and leave the Roth untouched until you retire? This doesn't seem too good to me.

In case I start a Roth, can I convert my previous 401k into a roth? What do I do with my 401K?

Finally, does it actually make sense to put the money in a retirement account, or would it be a wiser investment to put that money in a savings account with the idea to have a down payment for a mortgage by the time I finish residency?

I'd appreciate everyone's input.