"I am in the relatively typical position (for a physician) in that I have been in forbearance/deferment on all of my loans for many years, and I have not been contributing to a retirement fund. I am now faced with the question of how much money to use to aggressively pay down the loans, vs. how much to put in the retirement plan. Some of the loans are at relatively high fixed interest rates (4.5% - 7%), and the employer match for my retirement plan does not start immediately. What should I do?"
As a financial advisor, I have at least one thing in common with you and the physicians I serve: I hate debt too.
I know you worry about how to pay off your student loans, you wonder how you will ever be able to afford a home, and the thought of taking out a six-figure loan to buy into your practice makes you want to barf.
I get it… debt sucks.
But aggressively paying off all your debt right now--before you begin investing for the future--might be the first financial mistake you make. Here are a few things to consider before you take a sledge hammer to your debt:
- Leverage: Given that you're paying interest on student loans at up to 7% per year, it may be difficult to earn a greater rate of return by investing for retirement. But if you are an aggressive investor (which many young physicians either are, or could be) then you might be able to beat that interest rate with returns that are one or two percentage points higher. And many physicians can consolidate their student loans at much lower interest rates, making it easier to outpace the interest they pay with the returns they might earn. In the long run, using leverage means you give yourself a shot at having more money for retirement.
- Vanishing opportunities: Each year, you have a chance to set aside a chunk of money for retirement and if you don't use this opportunity, you lose it. For 2013, you can contribute up to $17,500 to your 401k/403b ($51K if you're self-employed) and you can contribute up to $5500 to a Traditional IRA (and maybe convert that contribution into a Roth IRA if you're in the right situation). Don't let this chance slip away. Even if your employer is not matching you yet, contributions to these accounts can defer taxes and provide a layer of asset protection. Later, when you are earning more and have more money to save, you will wish you had taken advantage of them.
- Tax Savings: While the tax savings on retirement vehicles may be temporary, most physicians have the opportunity for permanent tax savings by contributing to Health Savings Accounts (HSA's) and in-state Section 529 College Savings Plans. If you have kids or you are planning a family, you'll be saving for college some day anyway, so why not begin saving now? The annual tax savings that go with these vehicles are like free money, and these opportunities also expire on an annual basis.
Once you have considered all the angles and taken advantage of the no-brainer moves, then you might consider paying down your debt but until then, take a deep breath and think about making only the minimum monthly payments.