Do you ever get confused with all the different terms when reviewing retirement options? If so, rest assured, as this article will break down retirement planning for new optometrists in simple terms.
Optometrists are uniquely positioned as high-income earners for saving toward retirement. Although there is typically a sizable debt associated with the degree, optometrists can leverage their income and employment situation to maximize their savings through different retirement vehicles.
Estimating your savings rate
Your savings rate is highly individualized and is based on several factors, primarily driven by your desired retirement age and projected expenses in your retirement lifestyle after adjusting for inflation. Retirement savings for a simple retirement compared to a very extravagant retirement lifestyle require completely different savings strategies.
You need to first define what lifestyle and target age, at which, you would like to retire. From there, you can use the following basic retirement savings formula as a rough starting point to identify your target savings amount and create an estimated annual savings rate.
How to calculate your unique retirement savings formula:
- Estimate your annual retirement expenses.
- Current Annual Expenses × (1.03)^Years to Retirement
- Determine your retirement duration. The standard estimate is typically around 20 to 30 years, but adjust accordingly, especially if you decide to retire early.
- Total Retirement Needs = Annual Retirement Expenses × Retirement Duration.
- Annual Savings Rate = Total Retirement Needs / Years Until Retirement Age.
You could also incorporate Social Security income, but I recommend playing it safe and treating that income as a bonus, so you do not have to rely on it. You also need to adjust your calculations for investment returns; otherwise, this formula will likely overestimate the necessary savings rate.
There are many free calculators online that provide good starting points and allow you to visualize different savings strategies over time. I recommend plugging in numbers in a couple different calculators, such as this Bankrate or Pay Down calculator, to get a rough estimate. Although simple and not extremely accurate, they will give you a general idea if you are heading in the right direction.
A good rule of thumb is to try to save at least 20 to 30% of your gross income. The more you can save and invest, especially earlier on in your career, the more influential compound interest will be over time to grow your net worth. I recommend treating your annual savings rate as a non-negotiable “expense” and then adjusting your lifestyle around that, which is typically the opposite of what people tend to do.
For the motivated, there is even a whole community oriented around “FIRE,” or Financially Independent Retire Early, which is retirement at any age lower than the traditional retirement age in your 60s.
Check out the Average Optometrist Salary & Calculator to compare your salary to other optometrists!
Debt repayment: Snowball or avalanche?
As stated in my other article on investing, it may be challenging to know what to prioritize, especially if you have thousands of dollars of educational debt accrued. There is no one-size answer for everyone, but if the debt has a very high interest rate, then it is most likely advisable to get rid of this debt sooner, as the high rate will cost you more money over time.
It is not a bad idea to simultaneously invest toward your retirement accounts while also paying off debt. There are two philosophies for debt repayment: snowball and avalanche.
Snowball method
The snowball method focuses on paying off the smallest balance and working your way to the largest balance, ignoring interest rates. First, remember to continue to make minimum payments on all debts except the smallest balance. Put all extra money toward paying off the smallest debt as quickly as possible.
Once that debt is eliminated, move on to the next smallest debt until all debts are paid off. Mathematically, this is suboptimal and technically results in paying more interest over time than necessary.1 However, there is a psychological boost with the “quick wins” by reducing the list of debt to help motivate good habits.
Avalanche method
In contrast, the avalanche method is better oriented for those who are cost-conscious and motivated to become debt-free as efficiently as possible. The avalanche method is systematic in prioritizing debt with the highest interest rate, regardless of balance.
While you may not receive gratification as quickly, this method will minimize the amount of interest paid.1
Let’s look at different retirement options for optometrists
Your retirement options will differ drastically if you are a practice owner compared to an employee or an independent contractor. We will review each category’s options below.
For employees
As an employee, you are typically eligible for a variety of employer-sponsored retirement plans, such as a 401(k). With a 401(k), employees can contribute a portion of their salary, typically on a traditional, pre-tax basis.2
Employers may also offer to match a portion of the employee contributions, which is effectively free money toward retirement. Of note, 403(b) plans are similar to 401(k) ones, but are offered by non-profit organizations, such as academic institutions and hospitals.3
Alternatively, a SIMPLE IRA may be offered by your employer, as the vast majority of optometry practices are considered “small businesses,” which is where these are more commonly found. SIMPLE IRA is a simplified version of a 401(k); employers are required to either match employee contributions up to 3% or make a non-elective contribution of 2% of each eligible employee’s salary.4
Health Savings Accounts (HSAs) are also excellent retirement tools. While they are intended to be used for current healthcare expenses, HSAs can also serve as a retirement savings vehicle if funds are not needed immediately for medical expenses. Contributions can be double tax-advantaged in specific circumstances where both the contribution and withdrawal are tax-free, which can be very powerful if allowed to compound over time.5
Some employers, such as the military, still offer defined benefit/pension plans where you are guaranteed a monthly benefit in retirement based on factors like salary and years of service.
Outside of work, you can also open an Individual Retirement Account (IRA) that falls under a traditional or Roth tax basis. This is an excellent, tax-advantaged tool to supplement your employer-sponsored retirement plan. Because of its strong tax benefits, it is highly encouraged to max out your traditional / Roth IRA after contributing enough to your employer-sponsored retirement plan to receive their full match.
For employers
Those who are practice owners have different retirement vehicles that offer great benefits. IRAs and HSAs are also available in the same manner as above. If you are self-employed with no employees, you can consider a solo 401(k), which allows you to contribute both 25% of net earnings as an employer and up to $23,000 as an employee, providing an advantageous avenue for maximizing tax-advantaged retirement savings.6
You can also consider utilizing a SIMPLE or SEP IRA for employees in your business. With SEP IRA, only the employer contributes, which is up to 25% of compensation and must be proportional for all employees.7 As an employer, this can be a significant cost for you if you have several employees, and is also less attractive for employees since they do not have the ability to contribute.
SEP IRA might be advantageous if you generate a high income and have very few employees in order to maximize contributions for yourself. In a lot of practices, SIMPLE IRAs are used to reduce the cost for the employer. For example, if you have a small practice, you could consider having your spouse work as an employee and receive a reasonable, earned income from the business.
Since SEP IRAs require equal contributions for all employees, your spouse would receive whatever percentage you contribute to yours. This allows you to maximize your household tax-advantaged contributions.
The when and how of investing
Now that we know the basics of the different tax-advantaged investment vehicles, we can discuss how frequently to invest in them. In a lot of cases, your account will be defaulted in a dollar-cost average (DCA) format, in which a fixed amount of money is invested at a consistent frequency regardless of the price of the asset.8
The big advantage is that it eliminates the emotions with investing since it is all automated. Too many times, individuals think they can figure out the “pattern” of the market and try to time it. Studies have shown that more times than not, humans cannot outperform the market.
If full-time financial professionals struggle to consistently beat the market, you most likely cannot either. In contrast, lump-sum investing involves investing a larger amount of money all in one transaction, rather spread out evenly over time (ex., DCA).
Technically, lump-sum investing statistically outperforms DCA; however, there is a psychological component of timing the market.9 Personally, I subscribe to the DCA strategy. I think there are too many emotions involved with timing the market, so I prefer a systematic contribution where I can set it and forget it.
Deciding the contribution distribution in the different available retirement vehicles (401[k] vs. Roth IRA vs. HSA) is a nuanced discussion that is beyond the scope of this article. If you contribute enough to meet any match offered and reach your annual savings rate, you are in better shape than a lot of people, who often have decision paralysis and delay in action until it is too late.
For more details on what to invest in, my other article discusses investing basics and the benefits of hiring a financial advisor.
Looking for more information on how to manage your money? Read Personal Finance Basics for Optometrists!
In conclusion
This article simplifies retirement planning for new optometrists by outlining key steps for retirement savings, debt repayment, and different retirement plan options based on employment type.
Estimating your savings rate via a basic retirement calculator will give you a good starting point for the contribution amount. Think about which debt repayment strategy works best for your personal case to eliminate your debt.
Most importantly, make decisions early on in your career, avoid “decision paralysis,” and stick to your plan once you make one.
