Resident Physicians: How to Manage Debt
As an independent wealth management team that specializes in helping medical residents transition to practice, we often are asked to highlight the best thing residents can do when starting to practice in order to get ahead financially.
Our answer: “live like a resident”.
In this third blog post in our series called Live Like A Resident, we focus on debt.
As we wrote in our initial Live Like a Resident blog:
A few years ago, it was not unusual for a physician to have $200,000 on a line of credit when starting their practice. Now that number is closer to $300,000 or even $350,000.
Newly practicing physicians are often highly indebted and fall into three broad categories as it pertains to their debt:
- Those who want to pay down debt as quickly as possible,
- Those that have no concerns about carrying debt (given lower interest rates)
- Those who are in between
While it is easy to categorize attitudes in broad statements like these, the reality is, we should not. Each resident has unique attitudes and abilities to manage debt.
To start, taxes play an important part when considering paying down debt. The lower your tax bracket, the less you need to bill to pay off your debt. This applies to any personal debt you have or plan on acquiring in the near future – from student loans to mortgages. A retired physician client, whose perspectives we always appreciate, mentioned to us that she wished someone had shown her early on in her career the total cost of paying for a home. We now make it a point to share that perspective with newly practicing physicians looking at the affordability of buying a home. When you consider debt, you need to look at not just the cost of the interest that is being charged, but also the tax cost. It is helpful to think of debt in terms of how much you will need to bill in order to pay off that debt over its lifetime. For example, an $800,000 mortgage amortized over 25 years with a 3% interest will cost $338,107.15 in interest (assuming 3% throughout the loan with monthly payments). But if this physician is in a 50% tax bracket, they will need to bill $2.276 million in billings to pay off that loan. If in a 40% tax bracket, the billings required are $1.897 million over 25 years. There are strategies that help to reduce the overall tax paid, and this discussion always ties into a cash flow discussion (see our article Live Like A Resident Cash Flow ).
While we work with our clients to ensure they have a debt reduction strategy, we also help them determine whether it makes more sense to invest earlier or to pay down debt aggressively. As mentioned above, the answer to this question depends on an individual’s personal circumstances and debt preference.
At Tall Oak Private Wealth, we have developed a proprietary debt preference questionnaire. We weigh three main factors in helping our clients decide how best to allocate any extra cash flow:
- Balance Sheet Considerations
We look to see what an individual’s potential debt balance sheet and borrowing capacity might be based on their assets and liabilities. Think of a physician who has $240,000 of debt on a $250,000 line of credit. While they might be very comfortable having debt, they do not have much of a cushion for borrowing and might be advised to pay down debt to give them some breathing room.
- Cash Flow Considerations
We look to see what an individual’s cash flow capacity is based on their excess cash flow. Think of a situation where someone is uncomfortable holding debt, but taking advantage of lower interest rates, only a small portion of their after-tax discretionary cash flow is going to service debt. They may benefit significantly by managing their tax rates and spreading their debt repayment over multiple years rather than rushing to pay everything off as soon as possible.
- Personal Preferences
In this third section, we weigh a client’s preferences and outlook towards debt. Think of a newly practicing physician who has paid down a good portion of debt, and has only a small line of credit outstanding, but cannot sleep at night until it is paid off.
In order to decide whether to pay down debt more aggressively or to invest, we customize a Personal Debt Preference output for them and map out a 5 Year Wealth Plan. This allows for a clear understanding of cash flow and tax cost over the next five years.
Understanding cash flow and having a well thought out strategy to pay down debt is critical for newly practicing physicians to accelerate their ability to build their wealth. This is why we, at Tall Oak Private Wealth, are committed to making sure our clients have an articulated debt plan that can adapt as their needs do.
If you would like your Personal Debt Preference output as you contemplate paying down debt, we welcome you to reach out to us. There is no cost or obligation to have your personal plan created for you.
Tall Oak Private Wealth (Written by Mehendi Kamani, CFP®, CLU, CIM®
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This material is provided for general information and is subject to change without notice. Although every effort has been made to compile this material from reliable sources; no warranty can be made as to its accuracy or completeness, and we assume no responsibility for any reliance upon it. Before acting on any of the above, please contact Tall Oak Private Wealth of Raymond James Ltd., for individual financial advice based on your personal circumstances. Raymond James Ltd. - Member - Canadian Investor Protection Fund. Insurance offered through Raymond James Financial Planning Ltd., not a member - Canadian Investor Protection Fund.