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How to Start Grad School on the Right Financial Foot

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Starting a PhD program is, professionally and personally, one of the most exciting times of life. You’re meeting people who will be your peers and advisors in the coming years whose research interest align with yours, getting acclimated to a new university and city, and of course starting a fresh school year. However, many first-year PhD students, as they’re going to happy hours to get to know their cohorts and buying their textbooks, are thinking to themselves: “Am I going to make it until my first paycheck arrives?” Financially speaking, starting a PhD program is one of the most challenging times of life as well.

The financial challenges of the transition into a PhD program are myriad and the resources are likely to be few. Moving to a new place and starting the school year are expensive endeavors, and sub-optimal decisions around housing and transportation may reverberate in your finances for years to come.

I present this article not to discourage you in what should be an invigorating and hopeful experience, but so that you have time to prepare for its unique financial demands. Starting grad school on the right financial foot means that you are poised for financial success throughout your PhD instead of reeling from the initial financial blow and playing catch-up for months and years to come. Here is what you can do in the months leading up to your transition into grad school to start in a place of financial strength.

grad school right financial foot

Draft a Budget ASAP

It’s vital to put your stipend offer in context as early as possible. The number may strike you as generous-for-a-stipend or meager, but until you know something about the local cost of living it is rather meaningless.

The best way to get an idea of how far your stipend will go is to start drafting a budget and use approximate numbers until you lock in various aspects of your living expenses. Two starting points are the Living Wage Calculator and the estimated room and board from your university’s financial aid office. Neither one of these numbers will prove to be totally accurate (I hope they are both overestimates of what you will pay) but it’s a start for the triangulation.

Your draft budget should include:

  • The income tax you expect to pay,
  • Your necessary expenses, i.e., housing, transportation, utilities, groceries, household consumables, clothing, etc.
  • Your discretionary expenses, i.e., restaurant and bar spending, travel, entertainment, etc.), and
  • Your education expenses, i.e., tuition and fees required to be paid out of pocket, course supplies, etc.

Further reading: How to Read Your PhD Program Offer Letter

To a degree, you can use your current expenses (if you track them) to estimate what your future expenses will be, possibly with an adjustment for the shift in the cost of living.

It’s quite difficult to drill down into the specifics of what you will spend in a job/life that you’re not yet in, especially if you are not currently tracking your expenses. Therefore, you can use placeholder percentages to help you estimate your expenses and guide your decisions. For example, the Balanced Money Formula states that you should not spend more than 50% of your net (after tax) income on all of your necessities together (including minimum debt payments). This is a challenging benchmark for grad students to adhere to, especially in high cost of living areas, but it illustrates how important it is to keep your necessary expenses in check to the greatest degree possible.

Further reading:

Thoroughly Research Your Housing Options

Housing is by far the largest expense in virtually every grad student’s budget, and first-year PhD students are expected to make this enormous financial decision with little to no insight into the local area. The result is that graduate students often overextend themselves in their housing costs, which are financially, logistically, and emotionally difficult to change.

Starting grad school on the right financial foot means locking in your fixed housing and transportation costs at a reasonable level for your stipend. The general rule of thumb is to spend no more than 25-30% of your net (after tax) income on housing. This guideline proves impossible for many if not most PhD students, who may be paid too little, live in an expensive area, or both.

Further reading: How Much of Your Stipend Should You Spend on Rent?

Particularly in those challenging housing markets, the best course of action to find the most suitable housing (even if you spend more than the guidelines) is to start your search early and thoroughly research your options. I recommend starting your research with a housing survey conducted by your university or graduate student association (if one exists) and senior grad students who are paid a similar stipend to what you will be (e.g., 3rd years and up). From these sources you can ascertain the price range you can expect for housing and potentially tips on the best locations, housing types, and even specific complexes or landlords to pursue.

Further reading: Your Most Important Budget Line Item in Graduate School and Why You Need to Re-Evaluate It

A note on on-campus or university-affiliated housing: On-campus housing is attractive for students moving from a distance because it short-circuits this whole decision-making process. But this type of housing was not all created equal. At some universities, the university housing is subsidized, which means there is likely fierce competition to live in it. At other universities, the university housing is more expensive than comparable non-affiliated housing. You won’t know whether university housing is a good deal and worth pursuing until you talk with current grad students.

Further reading and listening:

Go Frugal on Transportation

Alongside figuring out your housing options and eventually committing to something, you need to decide how you will get around town. If you don’t own a car, you might need to buy one. If you already own a car, you have to decide whether to bring it with you or sell it.

Owning a car, even without a car loan, is a very expensive undertaking. Beyond the cost of the car itself, you typically have to pay for insurance, parking, gas, registration fees, inspection fees, taxes, maintenance, and repairs.

If it is feasible to live car-free in your new city and you don’t currently own a car, I recommend trying to live car-free for your first year. You can always reassess and buy a car at a later time if you decide you want one.

If you decide to buy a car or keep the car you already own, make sure you globally assess your expected costs (not just the best-case scenario!) and write them into your budget. An expensive or newer car costs you more not just in the purchase price but in your insurance premiums as well.

Your transportation and housing expenses are necessary to fix in concert to a degree. If you decide to live car-free, you might choose to pay more to live closer to campus or on a convenient bus route. If you decide to buy or keep a car, you can offset some of those costs by finding less expensive and less convenient housing.

Create a Transition Budget

Most graduate students experience what I call the long and expensive first month of grad school, though I have noticed some universities are working to change this pattern. You must prepare for this long and expensive first month prior to starting your transition to grad school.

The expense of the first month comes from your move. First, the moving expenses themselves: your and your possessions’ transportation to your new city plus the cost of feeding yourself and so forth during that time. Second, the start-up expenses for your new place: first (and last) month’s rent and security deposit, deposits for your utilities, furniture, and stocking your pantry. Third, the expenses of a new school year/term: any money that you must pay to your university in a lump sum and the expenses associated with your coursework.

The long first month refers to the length of time from when you move to your new city until you receive your first paycheck. Personally, I showed up for orientation in mid-August and didn’t receive my first paycheck until the last day of September. Of course, that time includes all your regular living expenses, on the back of your moving expenses.

You want to be sure going into the long first month that you can come out the other side without racking up debt. Saving cash in advance to pay for the transition is the best solution, and a transition budget will help you estimate the total cost.

Build Your Financial Foundation Now

Because you have several months between now and your matriculation into your PhD program, you have the opportunity to establish your financial foundation prior to the challenges of this transition. By financial foundation I am referring to saving cash for the transition, saving an emergency fund, paying off debt, and/or investing – whatever is most appropriate for you right now.

If you currently have a full-time job, you have the most opportunity to shore up this foundation, but even as a student or part-time/gig economy worker, it is still possible to a degree. It will be well worth a few months of sacrifice, either in terms of earning more through a side hustle or spending less through frugality, to start grad school on the right financial foot instead of a few steps behind.

Further reading: Financial Reasons to Work Before Starting Your PhD

After you save the money you need for your transition into grad school, consider whether you can pay off any of your current consumer debt completely (e.g., credit cards, car loan, medical debt, IRS debt). While you can defer student loans while you are in grad school, these other kinds of debts will still require minimum payments even while you receive your stipend, so it’s worthwhile to attempt to knock them out completely.

Further reading:

If you spend the time and effort now on planning out your expenses and saving money, once you matriculate you will be able to focus solely on the stimulating new people and experiences you encounter instead of experiencing financial stress. Starting grad school on the right financial foot by locking in a good deal on housing and not allowing yourself to fall into credit card debt also sets you up for financial success throughout your PhD. An ounce of prevention is worth a pound of cure.

If you would like to me to work with you on navigating your financial transition to graduate school, please check out my financial coaching program exclusively for rising grad students.

Rising Grad Students: Start Grad School on the Right Financial Foot

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Start Grad School on the Right Financial Foot is my coaching program for rising funded grad students (matriculating fall 2019).

Objective: To guide rising graduate students to start graduate school in a strong financial position and position themselves to be financially successful during their PhDs.

Topics: The core areas of focus of the program are drafting a budget, researching and committing to housing and transportation, estimating moving and other transition-related expenses, saving for your transition, and setting realistic financial goals. As needed and as time allows, we can also discuss increasing income, saving for retirement, debt payoff, tax on fellowship income, and building credit.

Mechanism: The coaching component consists of four sessions over approximately 2 months – one 55-minute session and three 25-minute sessions. You will additionally receive three template documents to assist you: a balance sheet, a budget, and a moving expense tracker.

Price: $174.99

Next step: Interested in learning more? Let’s have a quick 15-minute chat about the program. Sign up below.

Further reading: Rising Grad Student Resources

Fellowship Income Can Trigger the Kiddie Tax

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The Kiddie Tax is an alternate, higher rate of calculating tax due that applies to young people. While it was intended to ensure that wealthy parents paid their full share of tax on their investments, it also sometimes applies to graduate students whose income comes primarily from a fellowship or training grant.

Kiddie Tax fellowship graduate student

If you have found this article through search, it’s likely that your (software or human) tax preparer has determined that you owe the Kiddie Tax. This article will help you understand what the Kiddie Tax is, who it applies to, how it is calculated, and how to avoid it in the future.

What is the Kiddie Tax?

Back in the early 1980s, finding tax shelters (i.e., legal ways to avoid paying tax) was all the rage because tax rates were much higher than they are today. The top marginal tax rate was reduced to 50% in 1981 and finally to 28% in 1988 with the last major tax reform prior to the Tax Cuts and Jobs Act (source).

One of the tax shelters was for parents to put income-generating assets in their minor children’s names. The children were (presumably) in much lower tax brackets for investment income than their parents, so overall the family paid less in tax for those assets (source).

In 1986, the “Kiddie Tax” was enacted to close this loophole. Under the Kiddie Tax, a child or young adult’s unearned income is taxed at a higher rate than it would be if they were older (with all other factors being the same).

How Does the Kiddie Tax Affect PhD Students?

The way the Kiddie Tax is written and structured makes sense for the purpose of preventing wealthy parents from sheltering their income using their children. However, it has an off-label effect on PhD students.

The Kiddie Tax applies to all children through age 17, some children through age 18, and some students through age 23. It applies to “unearned income,” which includes not only investment income but also income from fellowships, scholarships, and training grants.

This means that a graduate student under the age of 23 whose income is from a fellowship may be taxed not at the ordinary income rates that they will be at age 24+ but rather at the rates designed to apply to estates and trusts.

(Applying the estate and trust tax rates to young adults subject to the Kiddie Tax is actually an improvement that the Tax Cuts and Jobs Act made over the previous system, which was to tax the child’s income at the investment income tax rates that applied to the parents. This system presumed that the parents were willing to tell the child their income so that the child could use the correct tax rates, which obviously was not always the case.)

The PhD students most in danger of the Kiddie Tax applying to them in a way that will massively increase their tax due are those who received fellowship (non-compensatory) income for an entire calendar year, e.g., January of the first year through December of the second year.

For example (approximate numbers), in 2018 a single PhD student age 24 with $30,000 of taxable fellowship/scholarship income and no other income, deductions, or credits would pay $1,970 in tax or an effective tax rate of 6.6%. A student with the same profile who is 23 would pay $5,050 in tax or an effective tax rate of 16.8%.

Who Has to Pay the Kiddie Tax?

The Kiddie Tax does not apply to every graduate student on fellowship, though it applies to many.

The instructions for Form 8615 lay out who has to file the form and (potentially) pay the Kiddie Tax. There are five qualifications for being subject to the Kiddie Tax, all of which must apply. If any one of the following is not true for you, you aren’t subject to the Kiddie tax.

1) You had more than $2,100 of unearned income.

Taxable fellowship and scholarship income counts as “unearned income.”

The definition of “unearned income” from p. 1 of the instructions for Form 8615 is:

For Form 8615, “unearned income” includes all taxable income other than earned income. Unearned income includes taxable interest, ordinary dividends, capital gains (including capital gain distributions), rents, royalties, etc. It also includes taxable social security benefits, pension and annuity income, taxable scholarship and fellowship grants not reported on Form W-2, unemployment compensation, alimony, and income (other than earned income) received as the beneficiary of a trust.

2) You are required to file a tax return.

The Form 1040 instructions (p. 9-12) answer the question of who has to file a return.

Chart A (p. 10) is for most people under age 65. It states that you must file a return if you are single and your gross income is at least $12,000.

Chart B (p. 11) is for dependents. You are required to file a tax return if you are single and:

  • Your unearned income was over $1,050.

  • Your earned income was over $12,000.

  • Your gross income was more than the larger of

    • $1,050, or

    • Your earned income (up to $11,650) plus $350

For the purpose of Chart B only, taxable scholarships and fellowships are “earned income” while “unearned income” includes taxable interest, ordinary dividends, and capital gains distributions.

If your gross income was less than $11,650 and your unearned income (taxable interest, ordinary dividends, and capital gains distributions) was less than $350, you do not need to file a tax return and are not subject to the Kiddie Tax.

Alternatively, you can use the IRS’s Interactive Tax Assistant to determine whether you are required to file a return: Do I Need to File a Tax Return?

3) You are a student under age 24

To be subject to the Kiddie Tax, you must be (Form 8615 p. 1):

  1. Under age 18 at the end of 2018,

  2. Age 18 at the end of 2018 and didn’t have earned income that was more than half of your support, or

  3. A full-time student at least age 19 and under age 24 at the end of 2018 and didn’t have earned income that was more than half of your support.

Full-Time Student Status

Form 8615 refers to Publication 501 for the definition of ‘full-time student’ (p. 12):

To qualify as a student, your child must be, during some part of each of any 5 calendar months of the year:

  1. A full-time student at a school that has a regular teaching staff, course of study, and a regularly enrolled student body at the school, or
  2. A student taking a full-time, on-farm training course given by a school described in (1), or by a state, county, or local government agency.

The 5 calendar months don’t have to be consecutive.

Full-time student. A full-time student is a student who is enrolled for the number of hours or courses the school considers to be full-time attendance.

You do not have to be a student throughout the calendar year to be defined as a student and subject to the Kiddie Tax. You are considered a student if you are a full-time student in (part of) 5 calendar months, which do not have to be consecutive.

Support Test

Defining support and who/what provided it is the trickiest part of determining whether you are subject to the Kiddie Tax. First, you must determine your support, and then calculate whether your earned income amounted to more than half of your support.

The Form 8615 instructions defines support as (p. 1):

Support. Your support includes all amounts spent to provide you with food, lodging, clothing, education, medical and dental care, recreation, transportation, and similar necessities. To figure your support, count support provided by you, your parents, and others. However, a scholarship you received isn’t considered support if you’re a full-time student. For details, see Pub. 501, Dependents, Standard Deduction, and Filing Information.

Publication 501 includes the Worksheet for Determining Support (p. 15), which you must go through in detail. Your support is the amount of money that is used to pay all your living, education, medical, and travel expenses. The education expenses include the tuition, fees, etc. for your graduate degree.

If you do not have earned income totaling at least half of your own support, you may be subject to the Kiddie Tax. Scholarships and fellowships do not count as earned income for this purpose.

The support test being calculated this way creates a very high bar for funded graduate students as tuition can easily rival or exceed living expenses.

4) At least one of your parents was alive at the end of the year

If your parents (including adoptive and step-parents) are deceased, the Kiddie Tax does not apply to you.

5) You don’t file a joint return

If you are single, the Kiddie Tax may apply to you. If you are married filing jointly, the Kiddie Tax does not apply to you.

If you meet all five of these criteria, you need to fill out Form 8615, as the Kiddie Tax may apply to you.

How Is the Kiddie Tax Calculated?

Form 8615 calculates your Kiddie Tax. Part I calculates your net unearned income, and Part II calculates your tax.

You should carefully fill out each line and read the instructions to find the correct definitions. I have highlighted some points about each line specific to fellowship recipients, but you still need to read the full instructions.

Line 1

Line 1 asks for your “unearned income” as defined above. If you had no earned income (i.e., you were 100% on fellowship for the calendar year and had no other income sources), you can use the value from your Form 1040 Line 7. If you had both earned and unearned income, you need to fill out the Unearned Income Worksheet (p. 2 of the form instructions), which subtracts your earned income from your total income.

Line 2

If you took the standard deduction, enter $2,100. If you itemized your deductions on Schedule A, there is a different formula to use in the instructions.

Line 3

Line 3 = Line 1 – Line 2

If the value in Line 3 is 0 or negative, you do not have to pay the Kiddie Tax. (Translation: If you took the standard deduction and your unearned income is less than $2,100, you do not have to pay the Kiddie Tax.)

Line 4

Enter in Line 4 your taxable income from Form 1040 Line 10 (your gross income minus all relevant deductions).

Line 5

Enter in Line 5 the smaller of the values in Line 3 and Line 4.

Line 7

To calculate your tax, you have to use the Line 7 Tax Computation Worksheet on p. 4 of the instructions. This is very long and tedious form. It basically applies the estate and trust income tax rates to your taxable unearned income.

The estate and trust income tax rates escalate much, much more quickly than the ordinary income tax rates. You reach the top marginal tax rate of 37% with taxable unearned income over $12,500, whereas you need over $500,000 of ordinary to reach that top rate.

How to Avoid the Kiddie Tax

Once a tax year ends, you run out of opportunities to avoid the Kiddie Tax. To avoid the Kiddie Tax in the current or a future tax year, make sure that at least one of the five above points on who the Kiddie Tax doesn’t apply to is true for you. For example, you could:

  1. Delay your matriculation into grad school
  2. Configure your income and expenses such that you pass the support test, e.g.,
    • Request that you are paid by an assistantship instead of a fellowship for part or all of the calendar year
    • Earn a significant side income
  3. Get married and file a joint return.
  4. Find every applicable qualified education expense to make more of your fellowship income tax-free (e.g., your student health insurance premium if paid by scholarship)

The fact that fellowship income triggers the Kiddie Tax is unconscionable and highly financially damaging to an already vulnerable population (low-income students). This aspect of our tax code desperately needs reform.

Where to Report Your PhD Trainee Income on Your Tax Return (Tax Year 2018)

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There are two broad categories of PhD trainee income: compensatory and non-compensatory. Compensatory pay is W-2 pay, whereas non-compensatory is any other regular type of income for a graduate student or postdoc, e.g., Form 1098-T Box 5 or Form 1099-MISC Box 3. For US citizens and residents, both compensatory and non-compensatory pay are supposed to be reported in the ‘wages’ line on your tax return, i.e., Form 1040 Line 1. For non-residents (e.g., some international students and postdocs), other lines on Form 1040-NR and Form 1040-NREZ are used. Read on for the relevant tax code references.

PhD where tax return

Where to Report Compensatory (i.e., W-2) Income

Compensatory income comes from work as an employee and will be reported on a Form W-2. The terms used for employees at the postdoc level vary quite a lot, but at the graduate student level the positions are usually called assistantships (research, teaching, graduate, etc.).

Your gross yearly compensatory income will appear in Form W-2 Box 1, and the income tax that has been withheld from you pay will appear in Boxes 2 (federal), 17 (state), and 19 (local).

Form W-2 contains instructions for the employee (p. 7), which state: “Box 1. Enter this amount on the wages line of your tax return.”

On Form 1040 (for US Citizens and Residents)

The wages line of your tax return is Form 1040 Line 1, which is labeled: “Wages, salaries, tips, etc. Attach Form(s) W-2.”

The Form 1040 instructions for Line 1 (p. 26) state: “Enter the total of your wages, salaries, tips, etc. If a joint return, also include your spouse’s income. For most people, the amount to enter on this line should be shown in box 1 of their Form(s) W-2.”

On Form 1040NR (for Non-Residents)

The wages line of your tax return is Form 1040NR Line 8, which is labeled: “Wages, salaries, tips, etc. Attach Form(s) W-2.”

The Form 1040NR instructions for Line 8 (p. 16) state: “Enter the total of your effectively connected wages, salaries, tips, etc. Only U.S. source income is included on line 8 as effectively connected wages. For most people, the amount to enter on this line should be shown in box 1 of their Form(s) W-2. Do not include on line 8 amounts exempted under a tax treaty. Instead, include these amounts on line 22 and complete item L of Schedule OI on page 5 of Form 1040NR.”

On Form 1040NR-EZ (for Non-Residents)

The wages line of your tax return is Form 1040NR-EZ Line 3, which is labeled: “Wages, salaries, tips, etc. Attach Form(s) W-2.”

The Form 1040NR-EZ instructions for Line 3 (p. 6) state: “Enter the total of your effectively connected wages, salaries, tips, etc. Only U.S. source income is included on line 3 as effectively connected wages. For most people, the amount to enter on this line should be shown in box 1 of their Form(s) W-2. Do not include on line 3 amounts exempted under a tax treaty. Instead, include these amounts on line 6 and complete item J of Schedule OI on page 2 of Form 1040NR-EZ.”

Where to Report Non-Compensatory Income

Non-compensatory income is given as an award and is not in exchange for work as an employee, and therefore no W-2 is issued. At the graduate student level, non-compensatory pay is usually called scholarships, fellowships, and grants. The titles used for postdocs receiving non-compensatory pay vary, but they are not considered employees.

Non-compensatory pay will be officially reported to the student on a Form 1098-T in box 5, on a Form 1099-MISC in box 3 (rarely Box 7), or on a Form 1042-S in Box 2 (for non-residents). It also might be unofficially reported on a courtesy letter or not appear on any documentation at all.

Please note that when you calculate the taxable portion of your non-compensatory income for the year, you have two choices for what to do with your qualified education expenses: to take a deduction or a credit. See How to Prepare Your Grad Student Tax Return for more details.

Publication 970 Chapter 1 discusses where to report the taxable portion of scholarships, fellowships, and grants (p. 6):

How you report any taxable scholarship or fellowship grant income depends on which return you file.

Form 1040. If you file Form 1040, include the taxable amount in the total on line 1. If the taxable amount was not reported on Form W-2, also enter “SCH” and the taxable amount on the dotted line next to line 1.

Form 1040NR. If you file Form 1040NR, report the taxable amount on line 12. Generally, you must report the amount shown on Form(s) 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, box 2. See the Instructions for Form 1040NR for more information.

Form 1040NR-EZ. If you file Form 1040NR-EZ, report the taxable amount on line 5. Generally, you must report the amount shown on Form(s) 1042-S, box 2. See the Instructions for Form 1040NR-EZ for more information.

The Form 1040 instructions for Line 1 state: “The following types of income also must be included in the total on line 1… Scholarship and fellowship grants not reported on Form W-2. Also, enter “SCH” and the amount on the dotted line next to line 1.”

Form 1040NR Line 12 is labeled: “Scholarship and fellowship grants. Attach Form(s) 1042-S or required statement (see instructions).”

The Form 1040NR instructions for Line 12 state: “If the grant was reported on Form(s) 1042-S, you generally must include the amount shown in box 2 of Form(s) 1042-S on line 12. However, if any or all of that amount is exempt by treaty, do not include the treaty-exempt amount on line 12. Instead, include the treaty-exempt amount on line 22 and complete item L of Schedule OI on page 5 of Form 1040NR.”

Form 1040NR-EZ Line 5 is labeled: “Scholarship and fellowship grants. Attach Form(s) 1042-S or required statement.”

The Form 1040NR-EZ instructions for Line 5 state: “If the grant was reported on Form(s) 1042-S, you generally must include the amount shown in box 2 of Form(s) 1042-S on line 5. However, if any or all of that amount is exempt by treaty, do not include the treaty-exempt amount on line 5. Instead, include the treaty-exempt amount on line 6 and complete item J of Schedule OI on page 2 of Form 1040NR-EZ.”

Why You Should Contribute to Last Year’s Roth IRA

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Good news for you investors: The calendar may say 2019, but you can contribute to your 2018 Roth IRA up until tax day! Why is this good news? Because you can continue to contribute to your Roth IRA (if you have contribution room) without taking up contribution room in 2019. In this way, you can roll forward some of your contribution room, even over multiple years. This is particularly useful for those of you expecting income increases in 2019 or so.

The IRS’s Retirement Account Contribution Window Extends until Tax Day

Every calendar year from January 1 to December 31, you can contribute to your retirement account for the current year. (This applies to IRAs (Roth and traditional), 401(k)s, 403(b)s, etc.) You can also contribute to last year’s retirement account in the subsequent calendar year up through tax day. You can even open and fund an IRA for the previous year!

Right now, between January, 1, 2019 and April 15, 2019 (tax day), you have the choice of contributing to your 2018 IRA or your 2019 IRA (assuming you are eligible and have contribution room in both years). In fact, you should contribute as much as you can to your prior year IRA before switching over to the current year IRA.

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Eligibility and Contribution Limits

I’m going to clear up the caveats I’ve been making right here.

Eligibility: You need taxable compensation in a calendar year to contribute to that year’s IRA. Employee (W-2) and self-employment income are both taxable compensation. Fellowship income, if not reported on a W-2, is not taxable compensation. If you are a graduate student or postdoc with a fellowship through an entire calendar year and no other source of income, you won’t be eligible to contribute to an IRA in that year. However, if you are married and your spouse has taxable compensation, you can contribute to a spousal IRA.

Further reading: Grad Student Tax Lie #9: If You Have an Income, You Can Contribute to an IRA

Contribution limit: The contribution limits on IRAs are pretty low, at least in comparison with workplace-based retirement accounts like 403(b)s and 401(k)s. For 2018, you can only contribute a maximum of $5,500 ($6,500 for those over age 50) or the amount of taxable compensation you had in the calendar year, whichever is lower. You do not have to contribute the entire $5,500 in a year; it’s fine to contribute $1,000 or $3,000 or whatever you can. When I say contribution room throughout this post, I mean the difference between your contribution limit, e.g., $5,500, and the amount you’ve already contributed. (In 2019, the limit has increased to $6,000 per year!)

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Why Is Contributing to an IRA So Important?

You may be asking yourself why I’m writing about Roth IRA contributions in particular. After all, once you’re out of graduate school and actually able to save more money, don’t you have a reasonable expectation of receiving a 401(k) or similar employee benefit?

1) Yes, you probably will work somewhere that provides you with a 403(b) or 401(k) or other type of workplace-based retirement account (or you’ll be self-employed and have self-employment retirement accounts available to you). Exception: Some postdoc positions (and adjunct!) might not offer a 403(b). But you don’t know the future, so I think it’s better to be cautious and roll forward as much contribution room as you can.

2) Even if you have a workplace-based retirement account available to you, the rule of thumb for retirement contribution priority is: workplace up to the match, IRA, then workplace again. This is because you can buy just about any fund you want through any brokerage firm in your IRA, whereas your options in your workplace based account will be severely limited. It is assumed that you can find better quality (read: cheaper) investment options through your IRA, so that should be prioritized. (However, you should definitely check out your options through your workplace account before assuming this is true for you; some universities offer good, low-cost institutional investment options that might be even better than what you can buy as an individual.)

3) Your workplace might only offer a traditional retirement account, so an IRA will give you the option of using a Roth, which you could take if you think it’s the better choice for you in a given year.

Why Am I Specifying a Roth IRA?

As far as your taxes go, if you’re contributing to a Roth IRA in both calendar years, it doesn’t matter which one you choose during the overlapping period. If you were contributing to a traditional IRA instead, it would matter: Your contributions to last year’s IRA would count for a tax deduction on last year’s tax return (hence being able to contribute up until tax day). But with a Roth IRA, you aren’t taking a tax deduction, so you’ll pay your full tax on the contribution no matter in which year you make it.

Always Contribute to Last Year’s IRA First

Now we come to my suggestion to contribute as much as you can to last year’s IRA before switching to this year’s (roll forward contribution room), either because you have reached your contribution limit or because tax day has passed.

The advantage is most clearly seen in the year that you experience an increased ability to contribute to your IRA (as long as you haven’t been maxing out your contribution room). This could happen because:

  • You decrease your expenses so that you can save more
  • You start earning a side income
  • You finish your PhD and take a higher-paying position (postdoc or Real Job)
  • You finish your postdoc and get a Real Job

In these cases, you may be able and want to contribute more than $6,000 to your IRA in one calendar year, and you are only able to do that if you split the contribution between your prior year IRA and your current year IRA.

But you should practice this every year, not just in a year when you expect an increased ability to contribute because:

  • You don’t know what will happen throughout the whole next calendar year, and your ability to contribute to an IRA could increase unexpectedly (e.g., you receive a windfall, a side income presents itself, you decide to leave grad school/your postdoc early for a better-paying job, you get married to a higher-earning person/spouse receives a raise).
  • You can roll forward your contribution room into future years. For instance, if you can contribute $5,000 each calendar year to an IRA, you can carry forward some or all of your $500 excess contribution room, so that in the year that you are able to contribute more, for example, you can contribute $5,500 to your current year IRA and perhaps $1,000 to your prior year IRA.

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An Illustration (with Numbers!)

The advantage of this strategy is more easily understood with an example.

Let’s say you’re a graduate student in 2018 and 2019, earning $27,000 per year, which is a gross monthly income of $2,250. You are a superstar saver, so you contribute 12% of your gross income to your Roth IRA every month. In 2018, your total contribution to your 2018 Roth IRA was $3,240.

In the first four months of 2019, you continue to contribute to your 2018 Roth IRA, which brings your 2018 Roth IRA contributions up to $4,320. In the eight remaining calendar months of 2019, you contribute $2,160 to your 2019 Roth IRA. Your remaining contribution room for 2019 is $3,340.

January 2020 hits and you start a Real Job! Your new yearly salary is $72,000, and you increase your savings rate to 15%. This means that you can put $900 each month into your retirement account(s).

In the first four months of 2020, you max out your 2019 Roth IRA with $3,340 and also put $260 into your 2020 Roth IRA or other retirement account options. You can use the rest of 2020 to max out your 2020 Roth IRA and contribute to your other retirement account options.

In this example, you ended up contributing $14,240 to your Roth IRA over three years ($3,240 in 2018, $6,000 in 2019, and $6,000 in 2020). Had you not rolled forward your contribution room, you would have contributed only $12,480 to your Roth IRA ($3,240 in each of 2018 and 2019 and $6,000 in 2020). (The rest of the money would go into your other retirement account options, presumably.)

The Psychology of a Ceiling

The previous illustration assumed that you would save at the same rate no matter what contribution room you had available or what account you used. However, if you are a competitive person, you might benefit even more from rolling forward your contribution room by contributing to your prior year Roth IRA first.

I’ve noticed that many people strive to max our their Roth IRAs each year, irrespective of the actual amount or percentage they might otherwise want to save. They use the contribution limit as their goal. This is not a good thing if you would otherwise contribute more than the limit, but I think many grad students and postdocs might have the opposite issue: without the limit serving as an implicit goal, they might contribute less than the limit.

By rolling forward your contribution room, you can create ever-higher savings rate goals for your Roth IRA, which might modify your behavior and help you save even more overall.

I fell victim (in a good way!) to this psychology in a similar scenario. When I started contributing to my Roth IRA, my goal was 10% ($2,400) per year. But once I found out that my now-husband maxed his Roth IRA out every year, I made keeping up with him and maxing out my goal, too. I found creative ways to gradually increase my savings rate. I didn’t quite make it to $5,500/year by the end of graduate school, but I sure got a lot closer than $2,400/year.

I think the contribution limit can create the same kind of competitiveness, and rolling forward your contribution room makes the challenge even greater.

My Personal Experience with Contributing to Prior Year Roth IRAs

A couple years before we finished our PhDs, my husband and I started following this suggestion of contributing to our prior year Roth IRAs as much as possible before switching to our current year Roth IRAs. It seemed not to matter much for a couple years until we experienced an income increase, and then having the extra contribution room was really helpful.

My husband’s Real Job offered a 401(k), but it was through a notoriously expensive full-service brokerage firm. Instead, we contributed our target amount of savings to our Roth IRAs (still maxing out the prior year first) and a self-employment retirement account (available through my business). The extra Roth IRA contribution room we created through rolling forward was particularly helpful in the transition year because 1) it took some time to figure out our 401(k) and self-employment retirement account options and 2) my contribution room in my self-employment retirement account wasn’t very high after working on the business for only a few months.

Further reading: Avoiding an Expensive 401(k) Plan through Self-Employment

How to Successfully Plan for Retirement Before and After Obtaining Your PhD

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In this episode, Emily interviews Dr. Brandon Renfro, a finance professor and financial advisor. Brandon shares the tortuous path that led him to his current faculty position at East Texas Baptist University and side business in retirement advising. They discuss the long-term financial effects of doing a PhD – both positive and negative – and how to have a successful retirement even if you can’t save (much) during your PhD training.

Links mentioned in episode

PhD plan for retirement

0:00 Introduction

1:05 Please Introduce Yourself

Dr. Brandon Renfro has a PhD in Finance. He is both an academic and a practitioner. He advises retirement advising for individuals. He does financial planning while being a tenure track professor.

2:02 What was your career trajectory?

Brandon says that he “walked backwards” or stumbled into his PhD. As an undergraduate, he planned to go to law school. He was advised to major in business in preparation for law school. He took an American enterprise course and saw a presentation about the time value of money in the retirement planning context. This presentation inspired him, so he majored in finance and loved it. He went to law school but says he crashed and burned. He was in the military and had GI bill benefits. He decided to use his GI bill benefits for an Master of Business Administration (MBA). He asked his MBA advisor about adjunct teaching. He had to have 18 graduate hours in the discipline to teach a course. He discovered he loved teaching. He decided he wanted to teach full time. He feels fortunate that he got a tenure track position at a liberal arts college in Louisiana, where he worked for three semesters. Now he is in his third semester at East Texas Baptist.

Emily points out that Brandon tried stuff and saw what stuck. Brandon agrees that this is important to explain to students today. He says many students set a goal and stick to it no matter what, even if the path isn’t right for them. He says there is a time when you should recognize if you don’t love what you’re doing and you should try something different. Brandon says he would tell his 18 year old self to major in finance, but at the time it didn’t occur to him.

Emily asks how Brandon handled the sunk costs of going to law school. Brandon clarifies that he didn’t meet the GPA requirements to continue law school but he wasn’t sad about it. He says he was miserable in law school. He had taken out loans to pay for the year in law school. He says it was $20,000 that he spent to learn that he didn’t want to be an attorney. He says if he looks at it like it’s money he spent to learn that he loves being a finance professor, it was worth it.

7:47 Given that a person has decided to do a PhD and maybe a postdoc, what are the effects of their financial outlook?

Emily starts by explaining that graduate students, postdocs, and early career PhDs have a lot of anxiety around saving for retirement. Most of these people are in their 20s or 30s and they know they are supposed to be investing for retirement. But planning for retirement feels overwhelming in the context of their competing financial demands, like student loan payments or saving for a house down payment, coupled with their suppressed income for an extended period of time.

Brandon says that if you put off starting a career to do a PhD, this will make saving and preparing for retirement a little more challenging. These are foregone years of savings. However, academics have the ability to work past typical retirement age. As a professor, you can work longer and save money for retirement for more years, even if you start work and start saving a little later in life. Emily clarifies that PhDs can add years on the back end, instead of on the front end, to the total years that they can work to save for retirement. PhDs can do this because their work is fairly intellectual, and hopefully they get better with time. It’s less daunting to add years at the end in these career paths than others. Brandon says it’s (physically) easier to talk about what you know than it is to work on a factory floor, and you can prolong the years you do this kind of work. Even as PhDs reach retirement age, they have options to be an instructor, lecturer, adjunct, or consultant. You can work less than a full time load, and still capitalize on your years of experience.

Brandon says even while you’re working in your 30s or 40s, you have the ability to leverage expertise outside the classroom. Even if you are working a full time tenure track position, you have a lot of knowledge that you can leverage in industry, even while you’re teaching. Emily shares that when she was an engineering PhD student at Duke University, she saw plenty of professors had consulting businesses or wrote books. In academia, there are many ways to step outside your primary role and leverage your expertise. Emily says that there are plenty of opportunities to have side hustles all through your career. She is part of a community of self employed PhDs, and many people’s self employed job is on the side of their full time job. Brandon believes there is a lot of potential for academics to be self employed. He says even if you were the lowest ranked student in the lowest ranked PhD program, you still have knowledge and you are already part of a select group. Emily says any PhD can find a market where their skills are valuable. They give examples of formatting and copy-editing and tutoring.

17:13 How can someone handle the income jump after the suppressed income period of being a trainee in a PhD or postdoc?

Brandon says in one phrase, avoid “lifestyle creep.” When you suddenly go from an undergraduate or PhD student lifestyle based on lower income to receiving a full time income, you need to be mindful to not immediately start living at the new income. He says you don’t need to be extremely frugal, but use a moderate amount of your new income to build your emergency savings, pay down consumer debt, and pay down student loans in order to be much better off in the long run.

Emily shares the standard personal finance advice to commit a large percentage of your raise to your financial goals. Either all of the raise or as much of the raise as you can, put it towards goals instead of your consumption spending. She says it applies even more when you have a large income jump. Most of it should be used to accelerate financial goals. When Emily and her husband finished their PhD programs, they applied this concept to their new “real jobs” income. They had several financial goals that they focused on and avoided lifestyle creep.

Brandon shares his story about buying a house. He was unsure where he would get his tenure track position, but he wanted to build equity without committing his family to a large mortgage payment. He bought a small rent house before they bought a house to live in. Emily brings up that some people rent their properties as they move, in contrast to how Brandon purchased the property purely as a rental property.

23:40 Grad students and some postdocs don’t pay into the social security system. What are the long term effects of missing out on these years of contributions?

Brandon explains that social security benefits are based on 35 years of covered earnings. Essentially, it’s an average of your highest 35 years of earnings. If you’re starting to contribute later, do the math. If you’re in your early 30s, you may be in your late 60s before you have 35 years of covered earnings. The issue is that your benefit will be calculated with some zeros in the 35 year average, which skews down your average. When you’re on the back end of your career, this may influence your decision to work for a few more years to replace some of the years where you contributed zero dollars to social security.

26:59 What steps can someone who’s in or recently been in PhD training do to mitigate negative effects of lower income and not contributing to retirement?

Brandon brings up the psychological benefit of being used to living on a small income. He says to continue to live like that for a couple of years so that you can build yourself a financial cushion and start saving for retirement. He says eventually the feeling goes away and you get used to the new level of income. Psychologically, it’s harder to start saving for financial goals later.

Emily says that this is classic personal finance advice. Sometimes the lifestyles of PhD students are lower than those of college students. She says it’s difficult to deflate lifestyle. You might see the higher paycheck from your first real job, then you lock yourself into higher housing costs or buy a new car. It’s difficult to take a step back, but it’s much easier to keep a similar lifestyle and put the new income to your financial goals and slowly work up your lifestyle.

30:16 If a person starts saving during graduate school, what kind of effect can that have on retirement?

Brandon explains the first presentation that he saw on the effect of compound interest. If you started when you were 18 years old and you saved just $2,000 per year in a retirement account, you would have a million dollars for retirement if you simply earned the average market return. He says the same is still true if you start at 30 or 32, but there are a few less years for compounding to take effect.

Emily says that even during graduate school, saving a couple hundred dollars a month is accessible. It’s not a thousand dollars every month that you need to save. The earlier you take these steps, the more and more impact it can make. It really does make a difference to take these steps earlier.

Brandon adds that at least, don’t make negative steps. Buying a cheaper car or cheaper clothes can go a long way. Emily says that the professional students, like law students, were living a higher lifestyle even though they were living on loans. She says the smallest amount of debt that you have to take on during training will make it easier for you in a few years.

35:50 What do you do for clients?

Brandon can help with anything within realm of retirement planning. He can help someone starting out. He can help graduate students and postdocs sort through their different options for retirement plans. He can help with decisions about how to invest within retirement plans. Brandon encourages you to take retirement very seriously and to think very hard about putting off retirement. He says it’s really hard to make a strong case against contributing to a plan with an employer match. He says employer match is essentially free money. Emily says an employer match is a 50% or 100% return on investment.

Emily clarifies that someone looking at different options can ask Brandon for help considering which option to prioritize. Brandon can help overcome “analysis paralysis.” Brandon says something is almost always better than nothing, and you need to just do something. He encourages you to envision your retirement and what your financial goal looks like.

40:03 Final Comments

Brandon’s contact information is at brandonrenfro.com. If anyone has a question about something that he hasn’t published an article about on his website, send him an email and he will write about it!

41:15 Conclusion