Five solid steps you can take this year to better understand and maximize your financial health.
It’s only the second month of 2014 and already most Americans have abandoned their New Year’s resolutions. Lose weight, get organized, sleep more – the euphoria of creating a “new you” has passed, and now all that remains is hard work and discipline. Whether you keep that gym membership or not, there’s one resolution which is highly worth the effort: getting your financial affairs in order. A great way to start is to look at the five critical components of your finances over the past year.
Step #1: What income did you make?
On the surface this seems pretty easy, but we’re talking about more than just your emergency medicine income. We all have an idea of our gross income from working shifts, whether you are an employee or an independent contractor. But to figure out your total income in 2013, you have to look at all sources of income including the following:
- 1099 independent contractor income
- Employer matches for your 401k, 403b or other retirement plan accounts (yes, this is income because it’s money handed to you)
- Dividends from all investments (individual stocks and mutual funds) in every investment account, including taxable accounts and all retirement accounts
- Interest from all bank accounts, savings accounts, money market accounts, CDs, individual bonds and bond funds in all investment accounts
- All other income such as: rental income from real estate holdings, limited partnership income, income from the sale of your home for a gain, Social Security benefits
- Calculate the above for both you and your spouse to get your total combined income.
Step #2: How much did you spend?
Most physicians I speak to have little clue about what they’re spending and where the money is going. Kind of odd if you ask me. We spent a lot of time and money to get where we are, but without knowing what you’re spending, there’s no way to project what you can save.
You need to come up with an approximate number of your personal monthly expenses. This number doesn’t have to be down to the penny. On the other hand it shouldn’t be thousands of dollars off the mark either. To make it easy, go through your bank statements and credit card statements for the past 3 months (one year is better but if you’re like most physicians, you’ll never accomplish that task).
Then break down your expenses into big broad categories such as: home expenses (mortgage, utilities), vehicle expenses (like car loans and gas), personal expenses (food, healthcare, vacations), and insurance expenses (auto, disability). Multiply those expenses by 4 to annualize the numbers and you’ve got an estimate of your annual personal expenses.
You might get dismayed when doing this because you’ll realize how much you’re spending in certain categories. Take that as a wake up call.
Step #3: What was your total tax bill?
A bigger wake up call is realizing how much the government is legally seizing from your wallet every year. We all know the federal income tax, which is the largest tax you’re paying (not counting EMTALA) but there are lots of other taxes you’re paying which seriously damage your purchasing power.
To figure out your total tax bill, start with your federal income tax return, flip to page 2 of Form 1040, and go to line 61. That’s your total federal income tax. Embedded in that is capital gains tax, dividend tax, and self employment tax if you’re an independent contractor. Next turn to your state income tax return and find the equivalent line on that return for your total state income tax.
You’re not done. If you’re an employee, take out your year end pay stub through December and add the Social Security and Medicare taxes. If you’re married each of you gets taxed separately for Social Security and Medicare. If you’re incorporated don’t forget to add your federal and state unemployment insurance taxes.
Finally lump all of that together to get your total tax bill. You should now be livid.
Step #4: How much did you save?
When I review physician’s personal finances, I usually find a big disconnect between what you think you’ve saved and what I think you’ve saved.
Here’s a good example. Recently one physician told me that he’s 10 years past his emergency medicine residency training, works as an independent contractor, and has been making over $400,000 in gross income every year. The value of his SEP IRA is around $400,000. About 10 years ago the maximum SEP IRA contribution allowed was around $35,000 and now it’s over $50,000. So if we take the middle ground ($40,000) as an estimate of average annual SEP IRA contributions, then either his rate of return sucked (0% rate of return), or he has no clue how much he’s saving.
Look at deposits made into all of the following accounts across you and your spouse over the past year: 401k, 403b, 457, nonqualified deferred compensation accounts, annuities, IRAs, Roth IRAs, individual and joint investment accounts, employer matches (but don’t double dip and include this if you’ve included it as income already), investments into real estate holdings, land, limited partnerships or other investments.
Step #5: What investment returns did you get?
You might think you’ve generated great investment returns, but it’s likely you don’t know how to calculate them. Your mind fools you by ignoring your losses and blocking out investment mistakes, but that’s cheating. It will lead to poor investment decisions.
Here’s an example: You bought a stock in a brokerage account in 2007 that became worthless after the 2008 financial crisis. You then transferred your account to a different brokerage firm. Poof! You just mentally wiped the slate clean as if the event never happened and you likely won’t account for the 100% loss on the investment when calculating your investment return.
Calculate your returns for every account you own across both you and your spouse over the past 1 year, 5 years, and 10 years. Then calculate your overall portfolio returns across all accounts over those time frames.
One of the keys to taking control of your finances is to hold yourself accountable for your actions. Doing the exercises above every year will keep you grounded in reality. You’ll know exactly how much you make, what you spend, how much you’re taxed, how much you save, and what your investment returns really are.
Setu Mazumdar, MD, CFP is board certified in emergency medicine and is the president of Physician Wealth Solutions.