Traditional IRA + REPAYE?

[Tungsten5]

I'm struggling to wrap my head around REPAYE and how to maximize my investments with it. Everyone seems to talk about Roth IRAs, but from my understanding this is not beneficial with REPAYE.

As I understand it, REPAYE payments are calculated at 10% of discretionary, defined as (post-tax income-150% poverty limit). If these payments do not cover the monthly interest, the government pays half of it.

To maximize Uncle Sam paying your interest, you therefore want to minimize your monthly payment. Easy PGY1 if you had zero income as an M4 as your monthly payment is zero. PGY2 you want to decrease your discretionary income. Looking at the equation above, you can't change the poverty line, but you can decrease post-tax income... by using a pre-tax investment vehicle, right?

So why don't people use a traditional IRA to maximize this interest subsidy during residency? The only argument I can think of is that the tax benefits of using a Roth IRA outweigh the interest subsidy. I'm not sure how to run the numbers here, but given the fact you're likely putting in chump change as a resident into the Roth IRA during residency, it doesn't seem like the tax benefit decades from now outweighs today's interest subsidy.

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[Raryn]

I'm struggling to wrap my head around REPAYE and how to maximize my investments with it. Everyone seems to talk about Roth IRAs, but from my understanding this is not beneficial with REPAYE.

As I understand it, REPAYE payments are calculated at 10% of discretionary, defined as (post-tax income-150% poverty limit). If these payments do not cover the monthly interest, the government pays half of it.

To maximize Uncle Sam paying your interest, you therefore want to minimize your monthly payment. Easy PGY1 if you had zero income as an M4 as your monthly payment is zero. PGY2 you want to decrease your discretionary income. Looking at the equation above, you can't change the poverty line, but you can decrease post-tax income... by using a pre-tax investment vehicle, right?

So why don't people use a traditional IRA to maximize this interest subsidy during residency? The only argument I can think of is that the tax benefits of using a Roth IRA outweigh the interest subsidy. I'm not sure how to run the numbers here, but given the fact you're likely putting in chump change as a resident into the Roth IRA during residency, it doesn't seem like the tax benefit decades from now outweighs today's interest subsidy.

Most residents save zero for retirement, so just by asking this question you're already far ahead of the game here. The typical argument in favor of Roth during residency goes as such:

1) Your income now is lower than it will ever be for the rest of your life, almost certainly including after retirement
2) As a corollary to 1), your marginal tax rate is lower now than it will likely ever be (significant changes in tax law notwithstanding)
3) If your marginal tax rate is the same in retirement as it is today, it's a wash investing in Roth vs traditional (Roth may come out ahead if you're maxing contributions). If your marginal tax rate is significantly lower today than it will be in retirement, you absolutely come out ahead with Roth. The converse is true as well, hence why for most people who aren't expecting their incomes to quintuple soon, the traditional comes out ahead.

So you can see that by investing in the Roth, you pay taxes in the 15-25% tax bracket today (depending on if you're single/married with or without a working spouse) but save yourself from the 28++% tax brackets in retirement (most physicians not retiring quite young plan on having at least six figures in retirement income). In fact, barring your program offering a match for a traditional 401k/403b, that makes Roth vs Traditional a no-brainer in favor of Roth when looking purely at saving for retirement.

You do bring up a good point though: For those with student loan debt pursuing IBR/REPAYE/etc, payments depend on your AGI... and traditional contributions are one of the only ways you can lower your AGI. This makes the math significantly more complicated. Just looking at it, every dollar you can take off your AGI now saves you 10% in IBR payments the next year, so that potentially wipes out most if not all of the marginal benefit discussed above. There's a lot of moving parts here though, that depend on the size of your debt (and the interest thereof), whether you'll end up having to pay that money anyway (due to plans to refinance vs go the whole 10-20 years with IBR/PSLF/whatever), and actual current vs expected tax brackets (which is impossible to predict 100% anyway).

It gives me a headache just trying to run all the math for the above, but looking at it in general? I think that the difference ends up being negligible. A few % either way depending on how favorable you make your assumptions for one side or the other. In the end, it is more important that you're saving anything at all rather than sweating the details.

 

[NITRAS]

You mess up your back door roths later by having substantial pretax IRAs.

 

[Raryn]

You mess up your back door roths later by having substantial pretax IRAs.

True, unless you end up rolling them into an employer plan in the future.

You also can just use a traditional 401k/403b if offered by your program.

 

[SigmaFS]

The most common ways to reduce your AGI, subsequently REPAYE payment, is contributions to a Traditional IRA, your employer sponsored retirement plan and a HSA. Consider increasing your employee contributions to your employer retirement plan, backdoor a Roth, and contributed to a HSA if you have a qualify high deductible health plan. A lot to ask on limited resources.

 

[ThoracicGuy]

The most common ways to reduce your AGI, subsequently REPAYE payment, is contributions to a Traditional IRA, your employer sponsored retirement plan and a HSA. Consider increasing your employee contributions to your employer retirement plan, backdoor a Roth, and contributed to a HSA if you have a qualify high deductible health plan. A lot to ask on limited resources.

Unless they have a spouse that is a high earner, there is no need to backdoor a Roth when they can just go through the front door.

 

[Tungsten5]

whether you'll end up having to pay that money anyway (due to plans to refinance vs go the whole 10-20 years with IBR/PSLF/whatever)

Can you explain this? I want to refinance and pay it all of ASAP as an attending. I figure the marketm isn't likely to beat my 6.6% loans. Does doing this somehow negate the interest subsidy?

 

[Raryn]

Can you explain this? I want to refinance and pay it all of ASAP as an attending. I figure the marketm isn't likely to beat my 6.6% loans. Does doing this somehow negate the interest subsidy?

No. It's just ask example of how this math can get complicated. Lets just run through the fake scenario:

1) You are currently in the 25% tax bracket, you plan on retiring in the 35% tax bracket. So, not taking into account student loans, Roth beats out traditional.

2) You're in REPAYE, so if you were to reduce your AGI by $1, your loan payments will go down by $0.10/year, mentally giving you an additional 10% "deduction" when you deduct a traditional payment now, negating #1 above. I would say at this point in the math we're in "it doesn't matter at all". But we can't stop here:

3) Your student loans are arbitrarily high that either way, you're not covering all the loan interest and you're qualifiying for the federal subsidy.

4) When your loan payments go down by $0.10, you don't continue to have $0.10 of actual benefit on your loan: the federal subsidy is only half the excess interest. So rather than your total balance going down by $0.10, it now goes down by $0.05. The other half of that money accrues and adds on to your balance.

5) Thus, that mental 10% "deduction" isn't real: The extra 10% loan payment was you paying yourself, and the marginal benefit is really just the 5% that the government is kicking in. You plan on paying back the balance in full eventually, rather than going for loan forgiveness, so you'll need to pay that other $0.05 back. That's money you wouldn't still owe on your loan if you had done the Roth route, tipping us back into "Roth is slightly better" territory (in my opinion). (That is, the 5% arbitrage you get from the loan subsidy is less than the 10% arbitrage you get with the tax bracket argument)

You can run real numbers on the amount of money available today vs the amount of money available in retirement, the expected growth rate of any investments vs your known interest rate on loans, what if you were in different tax brackets now/in the future (and who knows where tax brackets will be in 35 years?), what if you were seeking loan forgiveness (then I think traditional will win), etc. You're basically weighing "money saved on a high tax rate in retirement PLUS slightly higher loan payment now that pays down a little bit more of my debt" vs "money saved on a taxes and loan payments now, knowing that my debt may grow just a little bit more while I'm a resident".

But what I can again say is, that it truly won't make a huge difference. Depending on the assumptions above, you can probably make a case for a few percentage points marginal benefit on your savings if you do Roth or Traditional. My personal opinion is that Roth is probably slightly better for most people not doing PSLF, but traditional might be slightly better if you are getting loan forgiveness. Just the fact you're saving is more important than how much.

 

[NITRAS]

The faster you pay your loans off, the less interest matters.

Unless they have a spouse that is a high earner, there is no need to backdoor a Roth when they can just go through the front door.

Most attending will be above the income limits. I’m a big fan of the ROTH, and small advantages of paying a little less taxes now isn’t worth it in the long run. But that is my opinion.

 

[redfish955]

Your going to retire with at least two million. You can safely take 6 percent out of that annually. The Roth will be tax free and worth a ton at 58. It's great for splurging on a dream home or motor home at retirement. Think of the Roth as your big investment money and the 401k as your annual return.

 

[Raryn]

Your going to retire with at least two million. You can safely take 6 percent out of that annually. The Roth will be tax free and worth a ton at 58. It's great for splurging on a dream home or motor home at retirement. Think of the Roth as your big investment money and the 401k as your annual return.

There is so much wrong with this post, I can't even begin to start. Literally every single statement is objectionable.

 

[ThoracicGuy]

The faster you pay your loans off, the less interest matters.



Most attending will be above the income limits. I’m a big fan of the ROTH, and small advantages of paying a little less taxes now isn’t worth it in the long run. But that is my opinion.

True, but few residents would be in that situation of needing the back door.

 

[Stroganoff]

Besides 401k/403b and HSA, there's another vehicle: student loan interest deduction.

Is the $2500 student loan interest deduction an above-the-line deduction? So as a resident, paying $2500 towards interest per year (both required and voluntary towards your highest interest rate loans), you could potentially lower your AGI even more, making REPAYE monthly payment even lower.

Double check me on this. I think it lowers AGI.

 

[apr27]

True, unless you end up rolling them into an employer plan in the future.

You also can just use a traditional 401k/403b if offered by your program.

My program offers a traditional 403b. I was planning on contributing up to the point where they start matching, but I was also considering opening up a Roth IRA after that. What do you think?

 

[Raryn]

My program offers a traditional 403b. I was planning on contributing up to the point where they start matching, but I was also considering opening up a Roth IRA after that. What do you think?

That's the general recommendation. Maximize the match then put any additional money you want to save in a Roth.

 

[apr27]

That's the general recommendation. Maximize the match then put any additional money you want to save in a Roth.

Thank you! Obviously, this is encouraged. If you know, are most residents able to max out their Roths or is the thought kind of "saving something is better than nothing?" I will definitely be living in a high cost of living area, so I was curious.

 

[Raryn]

Thank you! Obviously, this is encouraged. If you know, are most residents able to max out their Roths or is the thought kind of "saving something is better than nothing?" I will definitely be living in a high cost of living area, so I was curious.

I don't know of any official statistics, but I would say the majority of residents save jack diddly squat. I know a few that saved substantial retirement funds (mostly people who were married) and I know a few that managed to rack up substantial credit card debt while residents, but most were in between, close to zero overall net savings. I maxed my Roth each year and put a little bit aside in my 403b each month, but I also lived at home in residency and did moonlighting in fellowship.

 

[TMP-SMX]

Keep in mind the saver's credit as well is free money given back to you. Sometimes the feds do have programs available to help lower income people but unfortunately most can't or don't take advantage of these things because they are too busy maxing out credit cards. I was guilty of this during residency increasing credit card debt due to having three kids but due to saving and paying down equity in my home. In the end, I helped keep our financial sector healthy. The goal shouldn't be to be paying finance charges to people that don't care about your best interest and it should be to live within your means.

 

[Raryn]

Keep in mind the saver's credit as well is free money given back to you. Sometimes the feds do have programs available to help lower income people but unfortunately most can't or don't take advantage of these things because they are too busy maxing out credit cards. I was guilty of this during residency increasing credit card debt due to having three kids but due to saving and paying down equity in my home. In the end, I helped keep our financial sector healthy. The goal shouldn't be to be paying finance charges to people that don't care about your best interest and it should be to live within your means.

Savers credit is for truly low income people. No resident is earning <$31,500, and there's very few married residents with a spouse who doesn't work in that $41,001-$63,000 range.

 

[TMP-SMX]

Savers credit is for truly low income people. No resident is earning <$31,500, and there's very few married residents with a spouse who doesn't work in that $41,001-$63,000 range.

They certainly do make less than 31,500 their first year of residency.

 

[Raryn]

They certainly do make less than 31,500 their first year of residency.

I will concede that point.

I wonder if I would have qualified for that credit way back in my intern year. I don't remember adding it to my taxes and I certainly had some retirement savings then.

10% of the maximum of $2k would be a $200 credit.