Traditional vs. Roth IRA- A Real World Comparison

*The information contained in this post is not meant to be specific for you or your situation and is not meant to be financial advice, as I am not licensed as a financial planner. Before making any decisions, I strongly recommend speaking to someone licensed in this area to consider your unique situation. My recommendation in this area would be Will Butler.*

In my last post I talked about the difference between a Traditional and a Roth IRA and factors you should consider when deciding which account is best for you. That was my first 2,000+ word post, and since it was getting pretty long, I didn’t have room to add in an example comparing the two accounts. If you haven’t read that post yet, I encourage you to so that you have some context on the factors I’ll present in this post. I think using a real world scenario with two people in the exact same financial situation and the only difference being which account they choose should help to shed some additional light on the differences. There are so many different details in each individuals financial situations that will change things, so in order to avoid as much of that as possible, I’m going to do my best to look at an average situation for a single individual to avoid making this comparison more difficult than it needs to be. Keep in mind that just because this is a single person and your situation may be different, the majority of the considerations should still apply to your situation, but the numbers will be different.

The Subjects 

Bill and Jim are identical twins. Everything about their lives are exactly the same including: age, job, income, expenses, family situation (single with no kids), and retirement age. Let’s look at the specifics for them:

  • Living in Texas with no state income taxes
  • Standard deduction on taxes each year
  • Income: $52,000/year gross ($41,975/year net after federal taxes and FICA taxes)
  • Expenses: $38,975/year after taxes
  • Age: 28
  • Anticipated retirement age: 60

The employer that Bill and Jim work for does not offer a 401k, so they have to create their own individual retirement account (IRA). Bill decides that he wants to invest for his retirement in a Roth IRA, while Jim decides that he believes a Traditional IRA would be better. Bill invests $3,000/year (the difference between his income and expenses after taxes) into his Roth IRA. He knows that he will pay taxes on his contributions now but will get to withdrawal his contributions and earnings later without taxes. Since Bill and Jim are both in the 25% marginal federal income tax rate while working, Jim is able to contribute $4,000 to his traditional IRA due to not having to pay the 25% upfront tax on the $4,000 that resulted in Bill only having $3,000 to invest per year. Jim understands that he is getting a tax break on his contributions right now but that he will have to pay taxes on his contributions and earnings in retirement when he withdrawals the money.

They each contribute the same amount each year (Bill- $3,000 and Jim- $4,000) for 32 years until they reach age 60 and are ready to retire. For the sake of simplicity, lets assume that their income and expenses both remain the same throughout their working careers. Since their financial situations are identical besides the retirement accounts chosen, most of the inflation related increase would negate each other anyway and wouldn’t have a meaningful impact on the example. They each invest their funds inside their IRA’s in a mixture of stocks and bonds that results in a 8% return each year. Let’s check out how their accounts grow over the 32 year period.

IRA comparison- earnings

As you can see here, Jim ends up with a much larger ending balance, despite investment returns being the same, which is to be expected since he had the advantage of an additional $1,000/year invested due to his contributions being tax free. He also was able to experience compounding interest over the 32 year period on the additional $1,000/year. That leads to a total of $135,000 difference between the two at retirement.

A Closer Look at the Taxes

Now you’re probably thinking, of course Jim has a higher balance at retirement but that doesn’t matter because now he has to pay the piper and is taxed on all of his withdrawals from this point forward, while Bill gets to withdraw from his account tax free. You’re right, from this point on, Bill will be able to withdraw $38,975/year tax free to support his living expenses. So let’s look at exactly how much Jim will have to pay in taxes in order to be able to support his continuing $38,975/year of expenses. This is where marginal vs. effective tax rates come into play which I spoke about in the previous post. While working, when Jim contributed to his Traditional IRA while in the 25% marginal tax bracket, he saved that full 25% since each dollar he contributed was subtracted off the top of his total income which landed in the 25% bracket. This is not the case in retirement since any withdrawals have to fill up the lower tax brackets first before ever making it to the 25% bracket. Here are the current tax brackets with standard deduction and personal exemption to illustrate this point.

2017 taxes brackets.png

As you can see, Bill and Jim making $52,000/year puts them solidly in the 25% marginal tax bracket while working. When Jim subtracts $4,000 from his taxable income by contributing to his Traditional IRA while working, his taxable income goes from $52,000 to $48,000. Since that entire amount is in the 25% bracket, he saves exactly 25% in taxes on that $4,000.

Now we know the marginal tax rate they are in, but what is their effective federal tax rate while working? To figure this out, first we would take their gross income ($52,000) then subtract the standard deduction and personal exemption ($52,000 – $6,350 – $4,050 = $41,600). From there we use the info from the chart above to determine their total tax burden for the effective rate of the 25% tax bracket which is: $5,226.25 + (.25*($41,600-37,950)) = $6,138.75. Now that we know that the total tax burden for them while making $52,000 is $6,138.75, we can determine the effective federal tax rate by dividing the tax owed by the total income earned: $6138.75/$52,000 = 11.8% effective tax rate. This is a lot less than the marginal rate of 25% and why it’s so important to understand the difference.

Withdrawals in Retirement

As I stated earlier, Bill will be able to withdraw the exact amount he needs to live on during retirement which is $38,975 since he doesn’t have to worry about being taxed on his withdrawal. Jim’s situation is a little more complicated since he also needs $38,975 but he needs that amount after paying federal taxes which means he’ll actually have withdraw more than that each year to account for the tax bill. Exactly how much more you ask? It turns out he would need to withdraw $43,470 each year to have $38,975 after taxes. Let’s go through the calculation to see how I got this number using the total tax due calculations from above. Let’s take his gross income ($43,470) in this situation then subtract the standard deduction and personal exemption ($43,470 – $6,350 – $4,050 = $33,070). You’ll notice that since Jim only has to withdraw enough to cover his living expenses from this point forward instead of being taxed on his old $52,000/year income, this drops him down into the 15% effective tax rate after the standard deduction and personal exemption are accounted for. From there we use the info from the chart above to determine his total tax burden for the effective rate of the 15% tax bracket which is: $932.50 + (.15*($33,070-$9,325)) = $4,494.25. Now we take his gross income and subtract his federal taxes due: $43,470 – $4,494.25 = $38,975.75.

This reduces Jim’s effective tax rate in retirement to: $4,494.25/$43,470 = 10.3%! Jim is paying much less in taxes after retirement on his withdrawals than the 25% marginal tax savings he got in the beginning with his contributions. Let’s see how this plays out over the life of his retirement compared to his brother Bill assuming they continue to earn 8% on their investments throughout retirement while Bill withdraws $38,975/year to pay for his expenses and while Jim withdraws $43,470/year which after taxes equals $38,975 to pay for his expenses.

IRA comparision- retirement

Conclusion

As you can see, Bill only makes it 19 years into retirement before he runs out of money while Jim can continue to support his current expenses for 32 years! That’s a 13 year difference in retirement with the only difference being that Bill chose a Roth IRA and Jim chose a Traditional IRA. I hope that this illustrates not only how, for the majority of people, a Traditional IRA is likely the better option but also how big of a difference even small adjustments to your finances can make over a lifetime. Bill had no idea his retirement would be cut short by 13 years when he made that simple choice at 28 years of age.

There are a few things to keep in mind from this example.

  • This is not including social security benefits that they may get in the future. Social security benefits would increase Jim’s effective tax rate in retirement but no where near the 25% marginal tax rate he was able to defer when making the contributions to his Traditional IRA.
  • Jim and Bill would likely receive raises throughout their career pushing them into the upper range of the 25% tax bracket and likely even the 28% tax bracket by the end of their career which would further improve the case for the Traditional IRA but the calculations would be much more difficult accounts for promotions and raises.
  • Jim and Bill would both have increased expenses throughout their lifetime due to inflation but if the tax brackets also increase with inflation, which makes sense, then these two should balance each other out as far as effective tax rate on withdrawals in retirement is concerned.
  • Although Jim and Bill were single throughout their lives, the same math would apply for two similar families trying to decide between a Traditional and a Roth IRA just with different tax brackets, two standard deductions, and more personal exemptions.

What do you guys think? Does a real world example with the calculations make the differences between the accounts easier to see? When considering marginal versus effective tax rates and tax deferred compounding, what scenario can you think of where a Roth would actually come out ahead? The primary factor that most financial advisors site as the reason to choose a Roth over a Traditional is the possibility of increased taxes in the future, but is it worth it to bank on an increase and pass up such a powerful difference as illustrated here?

Traditional vs. Roth IRA- Which is Best for You as a Therapist?

*The information contained in this post is not meant to be specific for you or your situation and is not meant to be financial advice, as I am not licensed as a financial planner. Before making any decisions, I strongly recommend speaking to someone licensed in this area to consider your unique situation. My recommendation in this area would be Will Butler.*

A couple of weeks ago I wrote my favorite post to date on the best student loan repayment option for those seeking financial independence. If you haven’t read that post yet and have student loans, I would encourage you to do so! The response I got from that post was interesting. Many people enjoyed how in depth I went with the calculations; some said that it was intriguing but wouldn’t  work for their personal situation; others said that they had been searching for a post like that for a long time and it was very helpful; and several people said I was a moron for ever thinking about keeping debt for 25 years despite the numbers making sense in my favor. To each their own, I guess. There was another common response that surprised me though, and that was, “Why would you choose a traditional IRA over a Roth IRA?” That was only a very tiny portion of that post yet it drew quite a bit of attention. After explaining my reasoning and hearing rebuttals, I realized that many people don’t understand the difference between the two at all and blindly choose based on what their financial guru of choice tells them to choose. The guru’s advice (cough, Dave Ramsey, cough) is often very general in order to fit a wide audience and very rarely the best advice for each individual’s situation.

Sometimes I have a hard time deciding what to write on this blog because my audience seems to be split pretty much 50/50. Half of the readers are physical therapists and student physical therapists that are reading because they are interested in travel therapy. The other half are die hard members of the financial independence/early retirement crowd. There is a small subset of readers that fall into both of these groups, but that is not very common. Since I want this post to appeal to all of my readers, I’m going to look at each group separately when determining what is best.

The Differences

Lets start with the basics in case there is some confusion on the difference between the two. It’s important to note that things change for people with higher incomes, but in this post I’ll just stick with how it works for the majority of the population.

  • Traditional IRA – Contributions go in pre-tax, meaning that you don’t pay taxes on the money when the contribution is made. The money then grows in the account (using whatever investments you choose) tax free. Your contributions and the growth made while in the account are taxed as ordinary income when withdrawn. Any money withdrawn before the age of 59.5 years of age is assessed an additional 10% penalty on top of your tax rate. A Traditional IRA is very similar to a 401k.
  • Roth IRA – Contributions are made with after-tax dollars, meaning that you pay taxes on the money before it ever gets put into the account. The money grows tax free (using whatever investments you choose) and is able to be withdrawn tax free. Contributions to the account can be withdrawn at any time without penalty, but any earnings made on your investments in the account cannot be withdrawn before age 59.5 without you being assessed a 10% penalty.
  • The current yearly maximum contribution is $5,500 ($6,500 if over age 50) regardless of the type of account chosen. Contributions can also be split between the two accounts if you wish as long as the total doesn’t exceed $5,500.

In summary, with a Roth IRA you pay taxes on the money before it goes into the account, but can withdraw contributions and earnings without taxes at retirement age. With a Traditional IRA, you don’t pay taxes on the money when it is put into the accoun,t but you do pay taxes on the contributions and earnings when you withdraw it at retirement age.

How to Decide

The easiest way to determine the right account for you is to look at your marginal tax rate now and compare that to what you believe your marginal tax rate will be in the future. Since none of us (unless you believe in psychics) can predict what the tax brackets will look like when we retire, there is some educated guessing that goes into this. A very good indicator of whether you taxes will be higher now or later is to look at your current savings rate.

If you’re making $60,000/year, yet spending only $30,000, which is the case for many in the FIRE (Financially Independent Retired Early) crowd is doing, it is extremely likely that you will have a lower tax rate after retirement since you will only need to withdraw $30,000/year (inflation adjusted of course) to live on in retirement. Having a lower tax bracket after retirement compared to your current tax bracket is the ideal reason for choosing a Traditional IRA over a Roth IRA.

If you’re making $60,000/year and spending $55,000/year currently and you expect that you will be spending even more after retirement due to wanting to live on the beach and travel the world, then a Traditional IRA wouldn’t make sense for you. You will likely be in a higher tax bracket after retirement and would be better off paying taxes now and withdrawing the money tax free later.

Which is Best for You?

For the physical therapist readers, you could go either way here depending on your spending habits. If you save a decent proportion of your income (15-25%+) currently and plan to have a similar costing lifestyle once you reach retirement age, then a traditional IRA would probably be best for you since your tax rate will likely be lower in retirement than it is now. If you are mostly living paycheck to paycheck and aren’t able to save very much and plan for your retirement expenses to be similar to what they are now, then putting as much as possible into a Roth IRA is probably going to be better for you. If you’re somewhere in between these two scenarios, it might be a good idea to split your contributions 50/50 between the two in order to hedge your bets.

For the FIRE readers, it is very hard to argue against fully funding a Traditional IRA since, in order to achieve FIRE, your savings rate is obviously pretty high meaning that your tax rate will likely be lower after retirement than it is now. There is also a very good chance that by keeping your expenses low in retirement, you’ll be able to access the money in your Traditional IRA early without penalty and at a low tax rate. I don’t want to try to reinvent the wheel when the Mad Fientist has already done such an awesome job at explaining how this is possible in his article. This is personally the route that I am choosing to take with my financial plan.

Common Arguments on the Topic

It seems that many financial advisers as well as individuals knowledgeable on the topic have their own opinion on what is best. Here are some things that I’ve heard mentioned when discussing which account is best.

  • “Do you trust the government to not increase taxes over the next 40 years? No way would I gamble with what future tax brackets and rates might be, it’s better to pay the taxes now with a Roth IRA and not have to worry about future tax hikes.”
    • On the surface this seems like a valid argument. The future is definitely uncertain. It seems like taxes have increased over the years, right? Actually that incorrect. The reason it seems like taxes have increased is because of inflation. In reality, the effective tax rate for the median household income (~$56,000/year) has decreased over the past 70 years in inflation adjusted dollars. Anything is possible, but if the past 70 years are any indicator, we shouldn’t count on taxes increasing significantly in the future at the median household income. (Here’s a cool site a found where you can enter your current income and see what your tax rate would have been throughout history).
  • “Since Roth IRA contributions can be withdrawn at any time without penalty, a Roth is best since you can use your contributions in case of emergency.”
    • This is an absurd argument in my opinion. Instead of taking money out of a retirement account where it can grow tax free, you should have a big enough emergency fund or a plan to cover unexpected expenses so that you don’t have to touch your retirement savings regardless of the type of accounts it’s in.
  • “Reducing tax liability today using a Traditional IRA saves you money at your marginal tax rate today, since it’s being subtracted off the top of your current income, while being taxed at your effective tax rate later since the money withdrawn from the account will first be used to fill up the lower tax brackets.”
    • This is true and a solid point in favor of a traditional IRA in my opinion. Let’s look at an example to illustrate this using a single individual with a gross income of $65,000/year (a fairly common starting PT wage). At $65,000/year you would be firmly in the 25% tax bracket. That means that by contributing to a traditional IRA now, you would reduce your federal tax liability by 25% of the amount you contribute since it’s taken off the top. Now fast forward to retirement age and say you still want to live off of $65,000/year (in inflation adjusted dollars). Since we can’t predict the future, let’s assume the tax brackets are the same in the future as they are now. Now when you withdraw that $65,000 from your Traditional IRA (still assuming being single to not complicate things), the first $10,400 of that amount would be tax free due to the $6,350 standard deduction and $4,050 personal exemption. The next $9,325 would be taxed at 10% to fully fill that bracket. The next $28,625 would be taxed at 15% to fill that bracket. And only the last $16,650 would be taxed at the 25% marginal rate. This leads to an effective tax rate of only 14.15%. You would reduce your current tax liability at an effective 25% tax rate while paying only a 14.15% effective tax rate on the same amount at retirement. If this seems like gibberish to you, don’t worry, it took me a long time to realize the difference between marginal and effective tax rates as well. Check out this article that should hopefully give you a little better understanding of the difference between the two. **Keep in mind that this scenario is assuming that there is no other earned income in retirement which may or may not be the case for you depending on your situation. Having earned income could change things by a little or by a lot depending on how much it is.**
  • “You expect to make more money throughout your career, don’t you? Then a Roth IRA makes sense because it’s taxed now.”
    • When I was in PT school I went to the Virginia Student Conclave one year, and this is an almost word for word quote from a financial advisor speaking there on Roth vs. Traditional IRA. This seemed to make sense to me and I wrote in the notes I was taking, “Always use a Roth.” The problem is that whether or not your income increases during your career doesn’t matter, what matters is what your income will be in retirement which is directly related to your expenses. It would be foolish to start making IRA withdrawals while you’re still working and in a high tax bracket later in your career, so that is a foolish argument.

The last tid bit I want to add on IRAs (regardless of which type you choose), is that it is important to remember to contribute to your 401k up to the employer match before contributing to either a Traditional IRA or a Roth IRA. The employer match is free money and is always going to be your best return on investment.

Summary

Deciding between a Roth IRA and a Traditional IRA is not as simple as choosing a Roth IRA because Dave Ramsey says it’s best. I believe that for the majority of people, a Traditional IRA is the superior option unless you expect huge lifestyle inflation after retirement. If your tax rate is higher now than it will be in retirement, a Traditional IRA is right for you. If your tax rate is lower now than it will be in retirement, a Roth IRA is right for you. You should sit down and think critically about your own situation and what your life looks like now and what it will likely look like after retirement, otherwise you’re shooting blindly. And remember, always take advantage of the employer match in your 401k if available.

Were you aware of the difference between these two accounts? Which account do you currently contribute to and why? Did you think about your current and future tax bracket when making your decision or did you just take the advice of someone else who told you it was the right thing to do? Thanks for reading!

 

Is Travel Therapy Really Worth It?

This blog post was inspired by some questions I’ve gotten recently regarding the financial implications that accompany being a travel therapist. In this post I want to talk about not only the financial factors but also the lifestyle factors that play into the decision to become a travel therapist. What would a post on this blog be without talking about finances, am I right?! After all, that is the most common reason leading someone to pursue travel therapy in my experience.

An important factor, that those considering travel therapy are often unaware of is, the tax considerations. In order to be eligible for tax free stipends (the reason travel therapy is so lucrative) you have to meet certain criteria based on the tax laws. I have been promising to write a post on the tax implications of traveling for a while, and I’ve been working on it but want to make sure that I know as much as possible before telling you guys. In the meantime, the most important, and burdensome, of the criteria is to have duplicate expenses while traveling. This means that you have to be paying living expenses in both your “tax home” as well as in the area where you’re working. (I always recommend checking out Travel Tax as they have a great FAQ section that helped me a lot when I was first starting out).

Financial Implications

When prospective travelers find out about this, I often hear, “Is it even worth it to travel if you have to pay rent in two places? The extra pay isn’t enough to offset that, is it?”. Those are great questions, and I want to address them both. First lets start with a refresher on the pay difference between a travel job and a permanent job. We’ll use the example of a new grad here:

  • Average starting pay at a permanent job for a new grad PT is around $70,000 from what I’ve seen over the past couple of years. This will, of course, be higher in some areas and lower and others, but I’d say it’s a good estimate of the average.
  • Average weekly pay after taxes for a new grad traveler is around $1,550. My first contract paid $1,560, some make less, and some make significantly more (I just spoke to a new grad who accepted his first travel contract making $1,900/week after taxes!).

Let’s assume that the traveler works 50 weeks per year. As a traveler without vacation time, this just counts as two weeks of lost pay.

  • $1,560 * 50 = $78,000/year

Now you’re probably thinking, only $8,000 more AND I have to pay rent in two places?! That’s not a good deal at all. But wait, this is comparing apples to oranges. Don’t forget that I said the $1,550 figure is after taxes are taken out. What would this equate to before taxes? Using Pay Check City, I find that you would have to be making a salary of $124,000/year before taxes in order to bring home $78,000 a year (assuming Virginia taxes and no exemptions)!! Now with an apples to apples comparison, we have:

  • $70,000/year on average at a permanent full time PT job
  • $124,000/year on average taking travel assignments full time assuming two weeks off per year

For an even more crazy comparison, let’s look at the new grad I was talking about earlier who just signed a contract making $1,900/week after taxes. Assuming he works 50 weeks per year, he will be making the equivalent of $153,000/year!!

Duplicate Expenses

An average of an additional $54,000/year sounds pretty awesome, right? These calculations are the exact reason I chose to pursue the travel PT route. But all of that money doesn’t end up being profit, and the reason is what I talked about earlier, duplicate expenses. All travelers should be paying living expenses at both their “home” and at their travel assignment location. For some this can lead to a lot of extra monthly cost, but if you play it right, it doesn’t have to be. Ideally you want to keep your living expenses at your tax home as low as reasonably possible in order to keep as much of that difference as possible. For this reason, I recommend renting a room in someone’s house where you can keep your stuff while away and where you can stay while between assignments. Depending on the area of the country that your tax home is in, a reasonable amount for a rented room can be pretty low. I’d say the average country wide for a room is $500/month. Again this is keeping in mind that some places are ridiculously expensive and others are ridiculously cheap.

  • $500/month * 12 months = $6,000/year in additional housing costs

We also have to consider the fact that while on travel assignments, short term housing can be pretty expensive. I recently took a poll of 130 travel therapists and found that on average, short term housing costs about $1,055/month. Let’s assume that this is $255 more than you would normally pay for housing costs. After all, if you had a permanent job, in most parts of the country, finding decent housing for $800/month is more than reasonable. Let’s add this in.

  • $255 * 12 = $3,060 + $6,000 (calculated above) = $9,060/year

So what is the total difference between an average paying travel job while obeying the tax laws and working 50 weeks per year compared to a full time permanent job?

  • $124,000 (travel job)$70,000 (permanent job)$9,060 (additional cost of housing) =$44,940/year!!

I was terrible at statistics, but I’d call that a significant difference!

Lifestyle Considerations

If money was the only consideration, travel therapy would obviously be a no-brainer. An additional $45,000/year goes a long way toward whatever financial goals you’re shooting for, whether that be fast loan repayment, saving for a down payment on a house, or seeking financial independence. There are of course other factors to consider which differ significantly depending on the stage of life the potential traveler is in. Traveling with young kids, although possible, doesn’t seem like the ideal situation to me. Having a spouse who can’t travel for his or her job would make it tough. Traveling while having a close family member sick at home would also be difficult. For young people with no kids and no family issues, I believe traveling is a great choice. For those that are outgoing, it provides an opportunity to constantly meet new people and experience new things. For those that are more introverted (definitely me), it forces you to open up more and do things you would normally avoid. My personality and confidence have evolved significantly in the past two years of traveling.

I often have a conversation at some point with each patient about being a travel therapist. I’ve gotten many different reactions (especially once they find out we live in a camper…) but the most common reaction goes something like this: “Wow! That is so cool. I wish I had done something like that when I was younger. I’d love to have seen more of the country when I was in good health.”

If you’re on the fence about traveling and have a conducive family/social situation, I encourage you to give it a shot. Worst case scenario, you hate it and it’s over in three months, but best case scenario, you have the adventure of a lifetime over many years of travel and end up in a much better financial situation with no regrets about traveling later in life.

Please feel free to reach out to me if I can help you at all when starting out because it can definitely be scary. I have mentored many people and love to help those starting out by answering questions and providing recommendations for good companies and recruiters.

Thanks for reading, and I’d love for you to leave questions or comments down below. What is keeping you from traveling or, if you’re a current traveler, what do you love and hate most about travel therapy? Where would be your ideal place to visit on a travel contract? What goals are you saving money for?

Guest Post on “The Traveling Traveler” Blog: Achieving Financial Independence through Travel Therapy

I recently had the pleasure of writing a guest post for Julia on her blog “The Traveling Traveler.” She is an experienced traveling SLP, and she helped me a lot when I first began traveling. She is very well traveled and, in addition to stories about the awesome places she has visited, her blog is full of insightful information regarding travel therapy as well. I encourage you guys to check out her blog! You can see my post on her blog, which is primarily about my plan to achieve financial independence through the use of increased income that travel therapy affords. I’ll include the text from the article below for your convenience.

Link to the post on Julia’s Blog: The Traveling Traveler

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Achieving Financial Independence through Travel Therapy

Over the past two years as a traveling physical therapist, I have learned from my experiences and talking to others that there are many different reasons for why therapists choose to travel. The main motivations usually include: exploring new parts of the country, higher pay, meeting new people, experience in different settings, and the flexibility to be able to work when you want and take time off when you want. For me, my primary motive with travel has always been higher pay, with all the other perks being secondary. When I first learned that I could take a travel assignment as a new grad and make twice as much as some of my classmates who were taking permanent jobs, I was sold.

Setting a Goal

I have had a love for personal finance and investing from a very early age. Sometime in my readings prior to graduating from physical therapy school, I stumbled upon the concept of financial independence and early retirement. Prior to this, I had always assumed that working until a certain age was a given since that’s what everyone else did. Far too often, I’ve heard other adults in my life speak about retirement as if it’s some abstract concept that will one day “arrive” instead of having a realistic actionable plan to get there. I would imagine that the vast majority of people have no idea how much they actually need to save to retire, which is frightening. Learning that there was a whole community of people retiring in their 30’s and 40’s was an eye opening discovery for me. Since then, I’ve become somewhat obsessed with charting my own path towards financial independence and early retirement.

I usually choose to refer to this concept strictly as financial independence, as I feel that early retirement has some negative connotations. But, a combination of the two terms is probably the best descriptor of what I plan to do. To me, it means the ability to choose whether or not you want to work, exactly what your work will consist of, more time with family and friends, the ability to travel domestically and internationally, and more time to explore other hobbies and interests. A worthwhile thought experiment to engage in to determine what this would look like to you would be to ask yourself: how would I spend my days if all my current living expenses were covered and I didn’t have to work for a living? Everyone’s answer to this question will be different, but it should get you excited for the possibilities.

Taking Action

I came up with my plan for financial independence prior to graduating, and it has been adjusted many times as my income and expenses have changed. Currently, I’m on track to achieve financial independence a little over two years from now at my current level of expenses (with a margin for future increases built in) and my current savings rate. This means that with a career of less than five years, I will reach a point of financial independence where I can choose whether I want to work full time, part time, or not at all. To this point, I have achieved this by keeping my expenses as low as possible (traveling in a fifth wheel camper instead of finding expensive short term housing), working as many days as possible including overtime when given the opportunity, finding PRN jobs while on assignment when feasible, making smart investments, and making extra money on the side with credit card and bank account bonuses. While some travelers choose to take weeks or months off between assignments, I would rather work straight through, while still taking one week off per year for vacation and taking advantage of weekend trips without taking time off and then have unlimited time off once I reach my goal.

The method I used to determine my target net worth to declare myself financially independent is actually pretty simple. I added up all of my current yearly expenses and then multiplied that number by 25.   There is research to support this calculation,  or you can do your own research by looking up information on “the 4% rule.” Basically, in a well-diversified portfolio, you should be able to withdraw 4% of your net worth each year and have only an extremely small risk of running out of money based on research performed with regard to historical stock market performance. It is essential to determine this target number in order to formulate a savings plan that will allow achievement of the goal.

What Will You Do? 

The greatest things about travel therapy are the countless options and the flexibility. Those of us who choose to travel will undoubtedly have a leg up, financially, on others who choose permanent jobs in the same profession. There is no right or wrong decision as long as you are aware of all the possibilities and make an informed choice for your future. I believe that reaching financial independence as quickly as plausible while enjoying your lifestyle is ideal and that we should all take steps, by either reducing expenses or increasing income, to reach that milestone. But the first step is always devising a goal and a plan to achieve it. What is your plan and steps are you taking to achieve it?

Jared Casazza, DPT: Jared graduated from Radford University’s Doctor of Physical Therapy Program in May 2015. He has been working as a travel PT alongside his girlfriend, Whitney, who is also a PT, and together they travel in their fifth wheel travel trailer. He is a personal finance and investing nerd and is aggressively seeking financial independence, which he is on pace to achieve by age 30. Jared writes about travel PT and finance on his blog: www.fifthwheelpt.wordpress.com

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Travel PT: Headin’ back down South. But first, Jamai— repairs, then Jamaica!

-By Whitney-

Delayed post to update our Travel PT Chronicles… I’m perpetually several months behind on this! I blame staying busy all the time (which doesn’t stop Jared from writing, but I digress…)

Timeline: September 2016

So when I last updated, we were finishing our contracts in Massachusetts in September 2016 and planning to go on vacation to Jamaica!

We had it all planned out…

We had our next contracts set up in North Carolina for 2 weeks after our end date in Massachusetts, leaving about a week to go home to Virginia to visit family, a week for the vacation, and a couple days for the move. We had so far always done back to back to back contracts with only a weekend between (including the time we left VA on Friday and started work in MA on Monday). So this was the first time we actually took any time off between contracts, but we still were on somewhat of a time constraint. We planned during this time to drop our camper off in Concord, NC where we bought it at Camping World to have some repairs done. When we originally bought the camper, it was used (2009) and we noticed some wood damage under the slide-outs. We were told this was “cosmetic,” but it turned out to be potentially hazardous when we noticed the floor was basically rotting and could have fallen out beneath us. Therefore we were able to work out with Camping World to get this wood replaced at no cost to us. So we just had to get the camper there, and we arranged our flight to Jamaica out of Charlotte after we dropped it off.

In transit

So we were all set to leave Massachusetts and make the 13 hour drive back to Virginia. Things were going great… for about 30 minutes. Jared was driving the truck and camper and I was following in my SUV. Jared called me to say he was pulling over and something was wrong. So there we were on the side of the highway with a truck, a camper and an SUV. Jared climbed up in the hood and was able to visibly see the problem (thank goodness, because we were already wondering how the heck do you get a truck towed with a camper attached?? not to mention worrying what we would do about getting the camper home and make our repair appointment and flights on time). Now we really aren’t that mechanically savvy, but he was able to see that a hose that was supposed to be connected was not (turned out to be a Turbo hose). So fortunately with the second vehicle, we went to a nearby garage, got some advice, went to NAPA Auto Parts, got a new hose clamp, and Jared was able to fix it on the side of the road. Luckily the truck made it the rest of the way without any more problems. We planned to stop a couple hours short of home to sleep overnight at a Walmart parking lot in the camper (“boondocking”) and also visit friends. It had rained during the drive, and when we got to the Walmart to sleep, we discovered that the skylight in our bedroom had cracked and broken, letting water pour inside onto our bed! So it was late… we were in a Walmart parking lot… 3/4 of our bed was soaked. It was great, ha. So Jared slept on the sliver of dry bed, I slept on the couch. I just remember waking up being so hot and miserable because it was summer and we didn’t have any AC (no generator/electricity). (But I guess at least the couch was dry!) So we met up with our friends and had a good laugh about our luck and headed home safely the next day.

Back home

We enjoyed our time at home with family and friends, as we had not been back in almost 6 months. This was also the first time that we had the truck and camper without being at a campground, so we had to figure out where to put it while we were home for a week. Unfortunately we didn’t really know anyone with enough space to park it. So we rented a space at a storage unit for a week. We also wanted to take the truck in to have it looked at to make sure everything was okay. So we took it to the Ford dealership, and they ended up replacing the Turbo hose which was an unexpected cost, but we were glad to have it fixed and ready for the next adventure.

In transit again

We left Roanoke the night before our flights, planning to sleep in another Walmart parking lot, so we could drop the camper off first thing in the morning in NC for repairs and head to the airport. We got about 20 minutes down the road… this sounds familiar… and the truck started to mess up again. The hose/clamp had come undone again. This time Jared’s dad was able to come meet us and help out, again on the side of the road, this time in the dark. They got the clamp fixed and we were back on the road again.

Vacation time!

Luckily, things went smoothly for the rest of that trip. We dropped off the camper, made it to the airport, and were in vacation mode! We (…Jared) did some serious planning to make this trip one for the books! It was completely paid for with credit card reward points, from the flights to the all inclusive hotels. We took advantage of my American Express Platinum membership rewards perks and specifically planned our flights with a long layover in Miami, where they have an exclusive Centurion Lounge with free food and alcohol. So we got our All-Inclusive started early. We had fun being fancy and gluttonous at the lounge, and then enjoyed a nice snooze on our final flight to Montego Bay, Jamaica! Our trip was amazing. We split our stay between two all inclusive resorts based on points allocation. Our favorite was The Hyatt Zilara Rose Hall, which was Adult Only and was the fancier of the two resorts, and we were able to spend 4 nights there. We then moved down the road to the Holiday Inn Resort – Montego Bay All Inclusive, which wasn’t quite as fancy but was still great! We spent most of this vacation just relaxing and enjoying what was offered at the resorts. Unfortunately we did not take any excursions to really explore the area. I think after working continuously for over a year we were just ready for some R&R! The beaches were so beautiful and the people very hospitable! We made some vacation friends, and we got to experience the island life for a week!

Back to reality

We were of course sad to leave, but I don’t think our waistlines could’ve handled much more free food and drinks after 7 days! (But seriously, finding work clothes that fit the next week, a struggle…) So we headed back to the states. This time we stayed at an Airbnb overnight upon returning to Charlotte, because the camper was still at Camping World. We picked up our camper the next day, and they stayed true to their word and covered the wood repairs at 100%. We did have some additional cost to repair the broken skylight, and we left with some suggestions on how to help upkeep our camper to help prevent future water damage (more on this later…)

So we just had a short drive from Charlotte, NC to our next job assignments in Fayetteville, NC. Stay tuned and I’ll update on our adventures in Fayetteville (someday 😉 ha)!

The Best Student Debt Repayment Option for Those Seeking Financial Independence (FIRE)

*The information contained in this post is not meant to be specific for you or your situation and is not meant to be financial advice, as I am not licensed as a financial planner. Before making any decisions, I strongly recommend speaking to someone licensed in this area to consider your unique situation. My recommendations in this area would be Will Butler or Joseph Reinke. 

In previous posts I have put some numbers behind the different student debt repayment options as well as included some non-financial reasons why I have chosen to go the income driven repayment route. For some background, please start here and here. Also if you’re unfamiliar with the idea of financial independence/early retirement, read this for context on what it means to me.

When I wrote those posts, I tried to keep the information general so that it would apply to as many people with student loans as possible. I really enjoyed doing the calculations and going through the considerations necessary to arrive at a conclusion, as it further cemented my decision. By the end, I determined that Revised Pay As You Earn (REPAYE) is the best option for my situation and likely the best option for the majority of those with student debt, but it is very important for everyone to run the numbers for themselves. I have to admit that for a long time I wavered back and forth on whether I truly wanted to continue on an income driven repayment plan when I have the money in cash that I can make my student loans disappear today. The numbers don’t lie though, and I am in this for the optimal financial outcome and not what is most convenient. I also have additional reasoning now that I fall back on when I’m in doubt.

Why REPAYE?

Let’s look at my situation and consider the best and worst case scenarios.

Best case: I make minimal payments, likely less than $100/month and almost definitely $0/month once at financial independence, for 25 years. At the end of 25 years my, now inflated, loan balance is “forgiven,” but I’m on the hook for paying taxes on the unearned income produced. I estimate that at this point my $97,000 initial loan balance will have grown to a little over $200,000 (6% interest rate reduced to an effective rate of 3%/year due to only half of accumulated interest being capitalized under the REPAYE plan), and I’ll be taxed at around 30% between federal and state taxes. This means I will have a $60,000 tax bill at the end of 25 years, plus only minimal (tax deductible) payments made throughout the course of the 25 years. What would I have to invest today to have $60,000 to pay this bill in 25 years at an average market return of 7%? About $11,000! So basically I could decimate my savings to destroy my $100,000 in debt today, OR I could invest only $11,000 of it in an S&P 500 index fund earmarked for my future tax bill. Sign me up for option 2!

Worst case: say 5 years from now all income driven loan forgiveness is repealed and everyone counting on it is left out in the cold. This is highly unlikely to happen without the people currently enrolled being grandfathered in, but this is the worst case scenario so humor me. In this situation, likely the income driven payment plans would still exist, but now no forgiveness at the end. Is this a disaster for my financial future? Not in my estimation. In this case I would remain on REPAYE (at the effective 3% interest rate as mentioned above) for as long as possible. A large loan with a 3% interest rate when market returns will likely be at least 6%/year and hopefully much more over the next 25 years, sounds like a great situation to me. In fact, if someone reputable approached me today and offered to loan me $1,000,000 at a 3% interest rate for the next 20-25 years, I would take that any day of the week! The student loan scenario is even better than the hypothetical loan though because all interest paid is tax deductible, which actually further reduces the effective interest rate.

To summarize, in the best case scenario I pay ~$70,000 over a 25 year period for a $100,000 loan. In the worst case scenario, I get a large tax deductible loan at a low 3% interest rate. Even the worst case scenario seems pretty good to me. I’m happy to plan for the worst and hope for the best here.

Narrowing the Focus

Alright, I’m already 700+ words in here and I haven’t even gotten to what I really want to discuss, so this may end up being a long one. Instead of looking at broad, more generalized scenarios like in my previous posts on student loans, I want to zoom in on those specifically shooting for becoming Financially Independent, Retired Early (FIRE). If you have read my blog for any length of time, it should be apparent that FIRE is my goal and that I believe it should be the goal of everyone, although with respect to their own life situations.

For people in the FIRE community, one of the foremost objectives is to reduce taxes by as much as possible to maximize savings rate. The primary way this is achieved is with maximizing tax deferred accounts (401k, traditional IRA, and HSA). This is paramount because for those of us seeking early financial independence, our tax rate will be much lower, possibly zero, after FI than before. This goes hand in hand with choosing REPAYE for student loan repayment. Since only roughly 30-40% of the final loan balance will be paid in taxes at the end for most people, keeping monthly payments as low as possible to have the maximum amount forgiven is optimal. Monthly payments are based on Adjusted Gross Income (AGI), for income driven repayment plans, so the lower your AGI, the lower your payment. AGI is reduced using the same strategies as reducing current tax burden, so we’re essentially killing two birds with one stone.

How Low Can You Go?

Yesterday, being the finance nerd that I am, I decided to play around with the student loan repayment estimator for a while (great use of a Saturday afternoon, right?) to determine how high of an AGI I could have to keep my monthly payment at $0. It turns out that $18,685 is the magic number for me being single and living in VA. I know what you’re thinking, that is pretty low. I agree, but keep in mind AGI is determined after subtracting contributions to tax deferred accounts. So in reality, I could have a gross income of $18,685 (AGI) + $18,000 (401k contribution) + $5,500 (traditional IRA contribution) + $3,400 (HSA contribution) = $45,585. This number seems a little more realistic. Having an AGI that low may not be feasible or desirable for many, and that’s understandable. The good news is that for every $10,000 that my income goes over the $18,685 threshold, my payment only increases by ~$88/month. That is, an AGI of $28,685 = a monthly payment of $88/month. An AGI of $38,685 = a monthly payment of $172/month, and you can extrapolate from there. As mentioned above, since the accumulated interest is much higher than these monthly payment amounts, every dollar I would pay would be interest. Normally this would be bad thing, but student loan interest is tax deductible so I’ll get a portion of what I pay back at the end of the year.

Everyone’s situation will certainly not be in the same as mine so I encourage you to play with the estimator yourself to find the magic AGI for you depending on your family size and state.

A Little Deeper

So for those trying to reach FIRE, a low AGI is already desirable so that is a big benefit, but there is another benefit from choosing REPAYE in this population. After financial independence, we will have much more control over our taxable income each year. It should be no problem keeping my AGI at $18,685 or lower and no longer having a monthly student loan payment. In addition, I can strategize with my income as the loan forgiveness date closes in. Since the total forgiven loan balance is taxable income, it is in our best interest to have as close to zero taxable income as possible in the year that the tax bill hits for the forgiveness to avoid the additional taxable income being taxed in a higher bracket. After financial independence this should be fairly easy due to much more flexibility. I would simply withdraw twice as much from taxable accounts in the year before (or withdraw money from a Roth IRA that has been rolled over from a Traditional IRA previously tax free) to cover my expenses for the year in which the tax bill hits, so that my taxable income, besides the unearned income, is at or very close to zero. Using this strategy and my estimated loan balance ~23 years from now, I determined that I would pay only an effective federal tax rate of 25.9% or $52,602 (on my total forgiven balance.

Keep in mind that this is based on today’s tax brackets. It is definite that the tax brackets and percentages for those brackets will be different in 23 years when I reach forgiveness, but I’m optimistic that this will benefit me more than it will hurt me. This is due to the steady increase in the lower tax brackets with inflation each year as well as a larger standard deduction and personal exemption.

That is my case for why REPAYE is the optimal option for those seeking FIRE with student debt and especially those with large amounts of debt.

Thanks for reading. What is your opinion on this matter? Are there considerations that I missed? What is your plan for your student debt?

Progress to Financial Independence- June 2017

This month was very busy, not so much because of weekend trips this time, but because of overtime at work. Although we did go on an awesome weekend trip to Washington DC which was a lot of fun and very interesting. We got to stay at a beautiful Fairmont hotel suite there for free by using a free night and room upgrade Whitney had from a credit card sign up bonus. She also got a $50 meal voucher on that card to use at the hotel restaurant which was very good. On another weekend, we went on an amazing hike near where we are staying that overlooked the historic town of Harpers Ferry, WV. Harpers Ferry is somewhere I would recommend everyone visit because there is some incredible scenery.

I definitely made some significant progress toward financial independence in June. I had two 60+ hour work weeks, as well as quite a bit of overtime the other weeks this past month, which meant some big paychecks. June had five Fridays which meant five paychecks as well. I also updated my financial assumptions and goals which involved reducing my target net worth and increasing my average savings per month to make things a little more realistic. This has led to a drastic reduction in the time left to FI, which is now only a little over two years away!

Due to all of the overtime we’ve been working on this contract, I was able to negotiate a bonus with our travel company for each hour of overtime worked that will be back paid once we sign a contract for our next assignment. Whitney and I were extremely happy about this because it will likely be an extra $2,000 or so for each of us. Overtime pay for travelers is usually not very lucrative because it is only time and a half of our taxable wages with no additional stipends. This makes the hourly rate of overtime work only about half of our normal hourly wages due to the tax free stipends! Getting the extra $15/hour bonus I was able to secure has made the overtime work a lot more tolerable.

July will likely involve a lot of expenses. We are planning to get our camper worked on at the end of this month as well as our truck since it, again, isn’t starting. We’re hoping that the overtime pay will offset these costs, but we haven’t gotten quotes on either of them yet so we will see. We have been looking for our next contracts which we hope to start 30 days from now, but so far have been unsuccessful in Illinois. We’re hopeful that we will be able to find something there. But, if not, taking a week or two off wouldn’t be the end of the world considering how much we’ve worked during this contract. I could definitely use a vacation.

Speaking of vacations, my little brother graduated from high school in June, and I surprised him with a trip to Aruba that I have planned for December, with the majority of the cost paid for with credit card rewards. I’m hoping it will be an awesome trip and allow us some time to spend together since I haven’t seen him much while traveling over the past two years.

Overall June was very eventful. Let’s see what July brings!

Taking The Risk Out Of Your Early Retirement Plan

GUEST BLOG POST BY JOSEPH REINKECFA, CEO of FitBUX

Today I have a guest blog post for you guys from a finance professional and not someone that just plays one on the internet, like myself. Joe is a very intelligent guy who spoke way over my head in the conversation that we had so I was very excited when he offered to write a post for the blog. Anyone that has student loans should check out his site FitBUX because he has created a wonderful FREE resource for determining the best payment plan to choose for your situation. In this post he offers a conservative and foolproof approach to determining net worth needs for retirement. I hope you guys enjoy.

                                                                                                                                                                  

Recently, Jared Casazza published the article “Retiring Early on a Physical Therapist’s Salary” on his blog.  The article was a guest blog by Chris from Eat The Financial Elephant.  Chris discusses retiring early as a physical therapist and references his article “Our Ultra-Safe Early Retirement Plan”.  In the last section of the referenced article, Chris mentions a few of his fears in regards to his plan.

This article discusses the problem with using “traditional” ways to determine how much money you need to retire, how to reduce how much you need, and how to limit the risks you face.  Most importantly, this article highlights a phrase I often say, “Every financial product has their purpose. If used correctly, you can maximize the benefit.”

The Problem

“Traditional” ways to calculate how much you need for retirement have three large problems (note: there are many mathematical problems with the traditional approach but I will spare you the boring details and state the high level problems):

  • They make a lot of assumptions. When it comes to money, the more assumptions you make the more risk your plan has.
  • The calculations dramatically underestimate how much you actually need to retire.
  • A “safe withdrawal rate” is often stated by financial professionals when planning retirement. However, most of this research drastically underestimates how much money you will actually withdrawal in retirement thus underestimating how much you need.  The main flaw in this research is again, a lot of assumptions.

Financial professionals continue to use the “traditional” way because the actual number would demoralize many individuals.  Non-financial professionals continue to use this approach because the materials they read reference it….but where did this type of analysis come from?  Many pensions used to use the same models so that is where we will look for answers.

A Conservative Approach

For years pension funds used similar calculations to predict future liabilities, withdrawal rates, and asset allocations.  Overtime, pension funds became seriously underfunded and ultimately have gone bankrupt.  The solution they have begun implementing is a portfolio management approach called Asset Liability Matching (ALM).  Pensions, banks, and insurance companies use this approach in managing their portfolio of assets.

The most basic form of this approach for personal finance looks at a liability in the future and then invests in a risk-free asset that will grow in value to match the liability in the future.  In the case of retirement, the liability his our annual expenses we will have to pay for while we are in retirement.

For example, say you have a $40,000 expense in a year from now and you can earn 1% on a risk-free investment today.  You would invest $39,604 today and it would be worth $40,000 next year when you need it to meet your expense.

This approach removes stock market risk because there is no market risk.  It also removes the risk around a “safe withdrawal rate” because you have an asset to directly match the liability (the liability in this case is your annual expenses.)  Although there is risk in this modeling approach, such as predicting expenses and reinvestment risk, it removes many assumptions.  In short, it is the most conservative way of predicting how much you need in retirement.  So why doesn’t everyone use it…the results…

Chris’ Example

Using Chris’ scenario, assume he has retired at age 40 and estimates his expenses each year are going to be $40,000 with inflation at 2%.  At todays risk-free rates, if he were to use the ALM approach and he wants enough money to last him until he is 100 years old, he would need $2.2 million to retire (for those that are wondering, if he wanted enough money to last till 87 years old he would need $1.7 million).  Having this amount and using the ALM approach would greatly reduce Chris’ risk of running out of money.  However, there are ways to reduce the amount needed to retire.

For example, most financial professionals agree that you should have between 10% and 30% (depending on your age) of your investable assets in an annuity.  This greatly reduces what is referred to as longevity risk, i.e. you will outlive your retirement income.  Let’s make the assumption that Chris puts $200,000 into a variable annuity.  This annuity has a guaranteed withdrawal benefit of 5% per year with a rider that increases the withdrawal base by 10% per year regardless of stock market performance.

At age 60, Chris begins to withdrawal the income each year from the annuity to meet a percentage of his required expenses. Based on these assumptions, Chris would need an additional total of $874,000 invested using the ALM approach to meet his retirement needs until he reaches 100 years old.  Therefore, the total amount he would need today to retire is $1.074 million.

One of Chris’ fears was related to health expenses.  Most people will spend more on long-term care than actual medical expenses in retirement.  Therefore, Chris could hedge this risk with a long-term care insurance policy and since he is relatively young he could do so cheaply.  For our example, we’ll assume he spends an extra $5,000 per year for he and his wife to be covered, thus, upping his annual expenses to $45,000.

Adding long-term care insurance would increase the total amount Chris needs to retire today to $1.32 million.

For his investment portfolio, instead of using all risk-free assets such as treasuries, he could put some of the longer term investments into other secured products such as structured CDs.  These investments are FDIC insured, have a minimum annual return (most of the time between 0% – 2%) and the actual returns are based on the performance of the stock market.

                                                                                                                                                                  

I would again like to thank Joseph for taking the time to write this post for the blog. Leave any questions or comments for him below and check out his site, FitBUX as he is helping a lot of people with their student debt burden.