By far, the most common question from physicians at my talks and meetings is: “What should I be saving to retire comfortably at close to my current lifestyle?” In this installment of Financial Focus, I will highlight some general principles on retirement saving, and then look at how to allot your savings in various pre-tax and post-tax options.

Variables and Budget Analysis

There is no one-size-fits-all answer to this question. A retirement analysis can be done by using an equation that takes into account the following variables: your (and your spouse’s) age; your monthly retirement savings; dollars needed (present value) for your current lifestyle; annual inflation (currently 3.43 percent per year, according to; your current retirement portfolio’s value; and the potential rate of return.

What you are looking for is whether the potential expected return on your current retirement savings, combined with your monthly additions to retirement accounts, equal what you need to keep your current lifestyle with inflation up until (and beyond) your life expectancy. 

A key error to avoid is underestimating the power of inflation. For example, to replace the purchasing power of $10,000 a month in today’s dollars using the current inflation rate, you would need $13,546 a month in 10 years; $18,979 a month in 20 years; and $26,592 a month in 30 years.

Take a good look at your budget and begin to identify: the expenses that will remain in your budget as you make the transition from your career to retirement (property taxes, insurance, groceries, utilities, etc.); those that will leave the budget (mortgage, student loans, kids, saving for retirement, etc.); and the expenses that will be added (increased travel, more golf, classes). This will yield a good starting figure to multiply by an estimated inflation number to serve as a goal. 

As with any equation, if you tweak just one variable you may have quite a different outcome. Also, since many variables are not guaranteed, actual results will generally differ. This may seem complicated, but most financial advisors should have a tool that they use to help narrow this down.

If you find that you are behind on your current retirement effort, you may need to do one or several of the following: increase your monthly savings; push back your retirement age; lower your lifestyle expectations for retirement; or seek a higher rate of return on your invested assets. However, note that investments with a higher rate of return potential will generally be accompanied by higher risk.

Due to the fluctuation of this equation, I suggest that this should be calculated at least once per year to make sure you are on track with your personal retirement goal.

Pre-Tax vs. Post-Tax Savings

There are two major buckets for retirees to withdraw income from at retirement: pre-tax and post-tax buckets. To give you the most options and choices at retirement, you should consider stashing your nest egg in both buckets. A rough guideline, which can vary immensely from family to family depending on their specific savings patterns and goals, is to put roughly two-thirds of your money into a pre-tax account and one-third of your intended retirement money into a post-tax vehicle.

Pre-tax accounts (401k, 403b, 457 plans, traditional IRAs, etc.) are advantageous because you get a tax break in the year that you contribute to these accounts. (You do not have to pay tax on the income you put into these accounts in the year that you contribute, and the growth is completely tax-deferred, meaning you are not taxed on any growth as it accrues in the accounts. The disadvantage is that you are taxed at 100 percent on all withdrawals past age 59 and a half as ordinary income. 

Post-Tax accounts (Roth IRAs, Roth 403bs, Roth 401ks) are advantageous because you are not taxed on a single penny that comes out of these accounts when you withdraw, as long as the withdrawal is qualified. For a withdrawal to be qualified, funds must be in the Roth IRA for five years and the account owner must be 59 and a half. Roth IRAs also grow on a tax-deferred basis. The disadvantage is that you do not get a tax break in the year that you contribute. 

The big-picture thinking on a retirement strategy and the tax issues that surround them is that you want to defer taxes when you are at a higher bracket and pay the taxes at a lower bracket. Of course, we don’t know where tax brackets will be in five, 10 and 20-plus years from now, and we cannot predict exactly how much we will have to pay Uncle Sam out of our nest egg.

Because of the progressive nature of our tax system, we want to pull money from pre-tax accounts in the lower brackets (currently the 10 percent and 15 percent brackets) and then avoid paying a quarter (or more) in taxes on every dollar we pull out by taking out the money needed in retirement above the lower tax bracket thresholds from our Roth vehicles.

The complicated part of this strategy is that there are income phase-out ranges and limits that exclude many physicians from putting money directly into a Roth IRA. (You cannot contribute to these accounts at all when your adjusted gross income is more than $183,000 if you are married, filing jointly, and more than $125,000 if you are single; and the contribution is limited to $5,000 per person annually). Most physicians are over these limits.

But on January 1, 2010 income limits on who could convert money into a Roth IRA were lifted. So, almost every physician can do a non-deductible IRA, and then convert it to a Roth IRA the next day. You should plan to convert it the next day because that minimizes the growth on that account that you would be liable to pay taxes on, as the conversion creates a taxable event on any earnings. This can be a bit of a paperwork nightmare for some, but there are many financial advisors who can help navigate these steps efficiently on your behalf, and this may be well worth the hassle when you have tax-favored accounts.

Also, more and more employers (currently about a third) are offering Roth versions of their 401k and 403b options, so you can put post-tax contributions away under the current limits of $17,000 per year as well.

For a Roth IRA, earnings withdrawn prior to reaching age 59 and a half and/or not meeting the five-year holding period may be subject to a 10-percent penalty in addition to income tax. After-tax contribution amounts are generally returned income-tax free; however, for Roth conversions, if converted amounts are not held for the five-year period, distributions may be subject to a 10-percent penalty.

Investors’ anticipated tax bracket in retirement will determine whether or not a Roth IRA versus a traditional one will provide more money in retirement. Generally, investors who are in a higher tax bracket at retirement relative to their current tax bracket while making contributions to a Roth IRA benefit more than an investor who is in a lower tax bracket at retirement.

If you do not have access to a Roth account through an employer and you want to supplement your retirement assets, another option to consider is the cash value of a life insurance policy. These types of vehicles are very complicated and should be carefully contemplated. Talk with your advisor. And, keep in mind that the primary reason to purchase a life insurance product is the death benefit, not for tax benefits. Life insurance products contain fees, such as mortality and expense charges, and may contain restrictions, such as surrender charges. Policy loans and withdrawals may create an adverse tax result in the event of a lapse or policy surrender, and will reduce both the cash value and death benefit.  REVIEW

This should not be considered as tax or legal advice. Please consult a tax or legal professional for information regarding your specific situation.

Mr. Ylinen is a financial advisor with North Star Resource Group. He co-authored the book Real Life Financial Planning for Physicians. He maintains a national comprehensive financial planning practice that caters almost exclusively to physicians. 

For information on this topic or any other financial matter, direct your inquiries to his website,