Is a 401k Worth It Anymore for Doctors?

Let’s just get this out of the way up front. A 401k is definitely still worth it for doctors…and anyone else. Unfortunately, I am hearing more and more chatter, even from financial experts, that investing in your 401k is some sort of a lost game and isn’t worth it anymore. And that we shouldn’t be doing it anymore. 

Quite frankly, this just doesn’t make sense to me. However, I do think it is important to discuss the pros and cons of your investing your retirement savings in your 401k. Especially given how prominent 401k detractors are becoming.

Why wouldn’t a 401k be worth it anymore?

The main arguments against a 401k are:

• Your money is “locked up” with an early withdrawal penalty until you reach the qualifying age of 59.5
• There is an annual contribution limit to a 401k
• Inflation 
• Tax deferred growth is not that important
• Money in a 401k can be better invested in other investment vehicles like real estate

These are all real downsides of a 401k to some respect. But the good news is they still don’t negate all of the benefits. Let’s talk about those first.

So, let’s examine why a 401k is still worth it for doctors…

…and why I still fully invest in mine. I obviously don’t believe that investing in a 401k isn’t worth it anymore.

Please note that I am using the term 401k in this post to represent really any primary employer-based tax-advantaged account. So if your employer has a 403b like mine instead of a 401k, same arguments apply.

1. Tax Advantages

Simple rules to build wealth:

• Make money
• Save money
• Invest money
• Minimize money parasites

And the biggest money parasites are taxes and fees. Minimizing fees is one of the big reasons that investing passively in broadly diversified index funds is the way to go.

That strategy also happens to minimizes taxes for the most part regardless of what account they are investing in. But, taxes will still take a big chunk of your money if you invest in a taxable account.

See, with a taxable account (like a regular account that you open up with a brokerage like Fidelity or Vanguard), your money is taxed when you put it in the account. And then it gets taxed again when you take it out of the account. So, double tax. And no tax-deferred growth.

With your 401k, the money is taxed when you take it out of the account. But not when you put it in. So you get taxed once. Still stinks. But better than twice. Especially if your tax bracket is lower when you plan to withdraw the money (likely in retirement) than it is now in your peak earning years. Your gains also will be taxed at lower long-term capital gains taxes assuming you held the investments for >1 year. This is a tax benefit. Unfortunately your withdrawals are taxed as income. This is another benefit assuming that your tax bracket is lower when you retire – but this is not always the case.

But even if that is not the case, it’s still worth it. I plan to remain in a high income tax bracket when I reach retirement age. I still fully fund my 403b. Why? It gives me options to diversify my withdrawal strategy in retirement.

But there is even another great opportunity for tax savings with a 401k

The money that you contribute is deducted from your ordinary income. This lowers your taxable income i.e. income taxes for that year. This means you are in a lower tax bracket and pay less taxes. It’s amazing how many physicians I speak with that are so interested in lowering their taxes but do not max out their 401k.

2. Diversification

I hope this is relatively self explanatory.

Don’t put all your eggs in one basket. Even if it is a good basket.

For example, I love real estate investing. A huge part of my net worth is in real estate as called for in my written financial plan. I encourage and teach others to invest in cash flowing real estate assets.

But I would never recommend that you should forgo your 401k to invest in real estate. I think that is bad advice. Investing in cash flowing real estate carries minimal risk. Similar to investing in the stock market via broadly diversified low cost index funds with yearly rebalancing. But the risk is decidedly not 0%.

So, create an asset allocation that allows you to reach your goals without unnecessary risk and follow it. That way, if something happens to one asset and it goes down, your others are there to keep you afloat until the other ones recover.

Related Posts:
Top 10 Ways That Doctors Should Invest Their Money
My Written Financial Plan Update: New Financial Goals and Priorities

And another way 401k’s help with diversification…

Your goal needs to be to save and invest at least 20% of your gross income. As a high income earner, you will likely exhaust all tax advantages accounts by investing this amount of money. This means you will need to invest some of your savings in a taxable investment account.

However, some investments are more tax friendly than others. Therefore, using your 401k means that you can hide your less tax friendly investments (like bonds) in a tax protected account. Meanwhile, your tax friendly options, like low cost, broadly diversified indexed mutual funds, in your taxable account.

That’s a big win and another way to reduce fees and taxes. This will keep so much money in your pockets, rather than someone else’s.

3. Asset Protection

The Employee Retirement Income Security Act of 1974 (or ERISA) protects assets in your 401k from creditors. So, your investments in there are safe if you have a (very unlikely) above policy limits malpractice or other judgement against you.

This is not the case with taxable investment accounts or even IRAs, whether Roth or traditional.

Most high new worth doctors that I talk to are very worried about asset protection for themselves and their heirs. This is a pretty big protection that would be silly not to take advantage of.

4. Behavioral Simplicity

Let’s use a story to help illustrate my point here…

Take Dr. YOLO

To his credit, he came up with a plan to invest $1,500 each month. But, his investment advisor tells him not to be a sucker.

“Don’t invest in your 401k. Invest with me and my proprietary algorithm. I’ll get your above-market returns,” she says.

Dr. YOLO can’t resist so he decides to fork over $1,500 each month to his advisor towards his retirement. But, each month it seems like there is a new fancy gadget that comes out that he can’t resist. So, maybe that comes out of his $1,500 retirement allocation.

And then, his car lease is up. And he only needs to budget $500 more per month to his lease to get the newest model with a self parking feature (even though his lives in the suburbs and parks in his driveway).

All of a sudden, those month retirement contributions are getting smaller.

No big deal right? Well, let’s see…What’s the difference between $1,000 and $1,500 invested each month for 30 years, even if his “advisor” can get 5% after tax returns?

Just $400,000!

Now take Dr. FIRE

Dr. FIRE also budgeted to invest $1,500 each month. But she decided to do it in her 401k with her employer. (Don’t worry, because she is Dr. FIRE, she invests way more than this towards her retirement, this is just for the sake of example).

Because she’s investing in her 401k, her money gets taken out take deferred from her monthly paycheck before she even sees it.

So she never dips into this money to satisfy unnecessary consumer needs wants.

The takeaway

Having money automatically deducted in a tax deferred manner to save, invest, and grow in a compounded fashion has huge behavioral advantages. Remember, the biggest enemy of our wealth is looking at us in the mirror. We have to protect ourselves from ourselves!

5. Employer Match

I put this last on purpose.

And the reason is that I can already hear the argument that people are making, “My employer doesn’t offer a match, so I shouldn’t invest in the 401k.”

Nope.

Regardless, the previous advantages listed above supersede this one. You should still invest in your 401k even without a company match.

But, if you do have an employer that will match employee’s contributions, this is a HUGE advantage.

This is free money. Don’t leave it on the table, please!

Actually, it’s like money that is included in your contract that you are leaving on the table and giving back to your employer.

Actually, it’s even better than money because it’s tax-deferred money that you can invest and grow, taking advantage of compound interest!

So, you see that there are a ton of benefits to a 401k, even for high income earners like physicians.

Addressing the elephants in the room

In fact, we covered and debunked most of the downsides of 401k investing in this discussion. However, there are a few downsides I’d like to address separately…

Inflation

Inflation is very real currently. And it is rightfully a concern of most people. The immediate reason is because inflation makes things cost more. The more longterm concern is that our savings and investments are losing relative value as inflation rises.

Not good.

However, not investing in your 401k is not the correct response to this reality. The goal of investing is always to have your money create more money. And your rate of return needs to outpace inflation or else your money didn’t really grow. At least in terms of purchasing power.

Therefore, as inflation rises, the goal remains to outpace the now higher inflation. To do so, we need to take every advantage that is available to us when we invest. We know that stock picking and trying to time the market don’t work.

So what are we to do?

Well, via a 401k, we can take advantage of important things like tax deferred growth, matching funds, and diversification.

More over, in response to inflation, the IRS recently announced that the contribution limits for 401(k)/403(b) retirement accounts is being raised from $20,500 in 2022 to $22,500 in 2023. They will likely adjust again for 2024. Further, catch-up contributions are allowed for those investing in a 401k above age 50.

So we can take even more advantage of this account.

Better ways to invest your money

This is one of the stickier arguments from those who say investing in your 401k isn’t worth it anymore. Especially when your 401k offers limited investment options.

The argument goes that you can take the money that would go in your 401k and invest it using other vehicles for higher returns and no limit on when it can be withdrawn.

The danger in this argument is that the logic sometimes checks out. And financial planners, a financial advisor, or any other entity may use this argument to pitch unique investment options that may not actually be so good for you. Thankfully, there are some serious holes in the argument that ultimately sink it in my opinion.

And while there are some cases where your employer-sponsored retirement plan will have severely limited options for diversified index funds with low fees, it is rare that there are none at all and the better option is not using the 401k at all.

Now, a metaphor…

Your 401k (or its equivalent) is a tool.

And it’s a good tool at doing the job it’s supposed to do. Which is to help you save and invest for your retirement. So use it to do its job.

Yes, you will need other tools to build your whole financial house. But that doesn’t mean you should ignore this one. 

Again, as a high income earner, you will need to do more than invest in your 401k to reach financial freedom. But, this is not an either/or decision. Your 401k is additive to your overall financial plan.

Use all of your tools. But build the foundation first. A 401k is a very good foundation for all of the reasons we have already discussed. 

And second, a comparison…

Most of the people who say it isn’t worth investing in a 401k anymore will cite real estate investing as the better alternative.

And don’t get me wrong, I love real estate investing and do it prominently. Investing as real estate has truly been a wealth accelerant for Selenid and me as you can see in this net worth update. That’s why we have 6 going on 7 rental properties. But I always hesitate to say it is a better investment. 

Related Post:
A Real Estate Investing Guide for Physicians

You see, I still invest using a hybrid investment strategy as my written personal financial plan calls for. Both Selenid and I max out our 401k to get am employer match. We aggressively pay down debt. And we invest heavily in cash flowing real estate.

Why do we use this hybrid plan?

It’s easy. For all of the reasons above. Asset protection, tax deferred growth, diversification, and so on.

In fact, here are 10 Reasons a Hybrid Investing Approach is Best.

Is a 401k worth it anymore for doctors?

Let’s end right where we started. As a bottom line, yes, a 401k or similar retirement fund remains a good option and good idea for everyone, including doctors…still and likely always.

Investing, retirement planning, reaching financial freedom should be boring. However, we often fall for the misconception that the opposite is true. 

I’m sure we have all come across situations in medicine where doing less actually ended up doing more. Maybe the decision not to operate was the right one. Maybe taking a step back and re-examining the whole picture led to a challenging patient’s diagnosis.

It’s similar with investing. Less tinkering equals better ability to capture and invest in the whole market with less taxes and fees. 

The formula for financial freedom is simple. Here are 6 Steps for Physicians to Attain Financial Freedom.

Using your 401k to its full advantage is not sexy. It is boring. But it will also play a huge role in your journey to financial well-being and freedom.

Here are additional helpful resources as you continue on your journey…

• 5 Easy Steps for Physicians Who Hate Personal Finance
• 5 Interesting (and Scary) Financial Facts
• Is There Such a Thing as a Poor Physician?

What do you think? Is it worth investing in a 401k anymore? Why or why not? Do you max out your 401k? Let me know in the comments below!