A Case Study in Financial Planning
I frequent a number of personal finance forums, namely over at The White Coat Investor and Rockstar Finance. Every now and then a certain topic will tickle my fancy and break my bad case of writer’s block. I came across one such thread on the WCI forums and thought it would make an interesting thought experiment. At the very least it can give us an opportunity to play financial planner for the day.
Asking For Financial Advice
The person who started the topic is a physician who is a little over a year into their practice and is looking for advice regarding their specific situation. They provide their demographic and financial information, which is summarized below:
- Married filing jointly; family size of 4
- Base salary: $600,000 with an annual bonus of $100,000-$150,000
- Currently maxing out 403(b) ($18k per year) with employer match of 6% of income
- Roth IRA: $5,500
- Currently have $250,000 in cash/money market
- Need to open 529 accounts for children (projected 15-20 years)
- Expenses: about $8,000 per month including mortgage
- Direct subsidized loan: about $65,000 at 7.125%
- Direct unsubsidized loan: about $400,000 at 7.125%
- Currently enrolled in REPAYE with monthly payments of $2,250
- Not eligible for PSLF (Public Service Loan Forgiveness)
My first thought after reading the post was that this doc isn’t in a terrible financial situation. Did you see their salary? $600,000!! Add to that their annual bonus and you get $700-$750k a year!! Sure they have a mound of about $465k in student loan debt, but that income provides them with a mighty big shovel with which to attack it. And it’s unclear if the spouse is working or not. Who knows, there might be even more income that they can use to tackle this debt.
Another thing that stood out to me was the $250,000 sitting in cash. More on this later.
Finally, their student loans are still sitting at an interest rate of 7.125% even though they graduated from residency more than a year ago. This tells me that they haven’t refinanced these loans. Since they are not eligible for PSLF, it doesn’t make sense that they have not done so by now.
As I said before, this physician has a lot going for them… mainly their income. They are also maxing out retirement contributions and enjoying an employer match of 6% of income. Still, there are some things that could be done better. Let’s see if we can come up with a quick-and-dirty financial plan given their situation.
Continue To Max Out All Tax-Advantaged Retirement Accounts
This doc should have no problem maxing out their tax-advantaged accounts. In fact, I think all physicians should do so before tackling their debts. Also, it’s unclear who the Roth IRA belongs to and whether or not the spouse works. Either way, the maximum amount of Roth IRA contributions between the two is $11,000. If the spouse does not work, they can always do a spousal Roth IRA.
Put That Cash to Work!
There is SO MUCH opportunity cost in having that $250k sitting in cash, especially given the amount of their student loan debt. Perhaps it’s an emergency fund, a hefty one at that given their $8k of monthly expenses. Or maybe they don’t know what else to do with the money other than park it in a savings or money market account.
In my opinion, there are a few ways in which this person can put this cash to work. One thing they can do is actually invest the money. As I wrote about before, there is a difference between saving money and investing it. Keeping that much cash sitting in low-yield accounts won’t do much in terms of long-term growth.
Another thing they can do is use that cash to accelerate their student loan debt payoff. They can put $200k toward the student loans, knock the balance down to $265k, and still have $50,000 left as an emergency fund.
SRGO’s Plan for Student Loan Debt Elimination
Here is what I would do if it were me in this situation.
- Pay $200,000 towards the student loans using available cash. Like I said, this would bring down the balance from $465k to $265k in one single payment.
- Refinance the remaining balance. Since I’m not eligible for PSLF, there is no reason to keep those federal loans at 7.125%. Refinancing to a lower rate would save me money on interest payments over the life of the loan. Also, refinancing at a lower debt to income ratio could mean scoring a better interest rate on the new loan.
- Throw as much of my income as I can at the debt to pay it off ASAP. How quickly could I pay things off given a gross salary of $700k? I ran some numbers* and estimated that I would have $25,500 left per month after accounting for taxes and monthly expenses. If I applied ALL of this to student loan payments, I could have the loan paid in full in about a year (give or take).
- Commence working toward financial independence and early retirement.
Our physician friend had all of the right tools available from the start; they just needed a plan to be able to USE those tools effectively. But you can’t be too hard on them. Judging by the sizable cash balance and student loans that have yet to be refinanced, it’s likely that the good doctor just doesn’t have much knowledge when it comes to personal finance. This example highlights one of the most important steps in taking control of your finances: learning about the stuff. Without a basic foundation of knowledge, it’s hard to come up with a financial plan, let alone execute it.
Readers, what would you suggest as a financial plan? Would it be similar to mine, or something completely different? Share your thoughts in the comments section below! And as usual, thanks for read!!
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* I calculated estimated taxes using the information that was provided. I also had to make some assumptions and used the tax estimator on SmartAsset.com. Filing status was married filing jointly with a family of four taking the standard deduction. I used California as the state and came up with about $280k in total taxes owed. I subtracted that from $682k ($700k – $18k) and got $402k as after-tax income. Divide by twelve and you get $33,500 per month. Subtract monthly expenses of $8,000 to arrive at $25,500.