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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

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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

How to Financially Manage Your NSF Graduate Research Fellowship

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Congratulations on being awarded the National Science Foundation (NSF) Graduate Research Fellowship (GRF) (or a similar remunerative, competitive, national fellowship)! Whether you’re a prospective grad student or a current first- or second-year PhD student, this fellowship is a great boon to your research, your CV, and almost certainly your finances. However, you may not yet realize that your finances will become a bit tricky once you start receiving your fellowship. With the help of this article, you can avoid the pitfalls associated with fellowship income and fully capitalize on the benefits.

NSF GRFP stipend

The NSF GRFP’s Negotiation Power

I’m sure you didn’t miss this headline info about the NSF GRFP: The fellowship pays you a stipend of $34,000 plus $12,000 of educational expenses to your institution for three years. Awesome! At the majority of universities in the US, that stipend amount is well above what you would be paid if you didn’t receive the fellowship, so you’ve effectively achieved a raise for the next three years.

But the good news doesn’t stop there: Your university/department might confer even more benefits upon you for winning independent funding. If the administration isn’t forthcoming about these additional benefits, it is appropriate to inquire about them.

Independence

Your new outside funding may give you a degree of independence in your research that you wouldn’t otherwise enjoy. This is highly dependent on your field, department, and advisor, but the fellowship may enable you to take your doctoral research in a direction that you advisor couldn’t or wouldn’t have supported without it. Perhaps you could take a risk on a side project, establish a new collaboration, or take extra time to rotate through a lab to gain new skills.

Additional Funding

At many universities, there is a standard offer of additional funding for winning a multi-year, lucrative fellowship like the NSF. This offer could come in one or more forms, such as:

  • A guarantee of funding for additional years
  • A one-time bonus
  • A stipend supplement above $34,000 while you have the fellowship
  • A stipend supplement after the fellowship concludes (e.g., up to $34,000/year for your remaining time in graduate school)

Not all departments offer additional funding to NSF GRFP recipients, but it’s worth inquiring about with your advisor, the administration, and current NSF fellows at your university. Stipend supplements during the time that you receive the NSF GRF are more common in high cost-of-living cities where the departmental base stipend is near $34,000/year to begin with. For example, searching “NSF” in the PhD Stipends database reveals stipend supplements awarded during the NSF GRFP years to students at the University of California at Berkeley, Northwestern University, and Columbia University, while a student at the University of California at San Diego writes that he/she received no funding incentive for winning the NSF GRF.

For Prospective Graduate Students

You’ll never have more negotiation power than you do as a prospective graduate student with an outside fellowship in hand. Unfortunately, you don’t have a lot of time to negotiate as the NSF GRFP awards list comes out approximately two weeks before grad school decision day, April 15.

Further reading: Vote with Your Feet, Prospective Graduate Students

As quickly as possible, you need to clarify if the offers from the universities you are still considering are going to be sweetened at all now that you have your fellowship. If the financial package from your preferred university isn’t up to par with your other offers (after considering cost of living differences), you can tactfully ask if a bonus, stipend supplement, or guarantee of future funding is possible.

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Budgeting with Your Fellowship Income

There are two vital questions you need to ask of your department before you can begin creating a budget for your NSF GRF stipend.

  1. After the fellowship ends, what will my stipend be?
  2. How frequently is my fellowship disbursed?

Accelerate Progress on Financial Goals

In my ideal personal finance-oriented world, an NSF fellow would live on (less than) the base stipend from his department and put all the excess income received toward growing his wealth. There are a few advantages to that approach:

  • Your lifestyle roughly matches that of your peers in your department.
  • You can relatively quickly achieve financial goals such as saving or debt repayment.
  • If your income is set to drop once the fellowship ends, you avoid acclimation to the higher, temporary income and don’t have to make major lifestyle sacrifices once the three years are up.

Some financial goals you could work on during the time you receive the additional fellowship funds are:

  • Eliminating any troublesome debt (e.g., credit card balances, medical debt, car loan)
  • Saving up cash for short-term needs and expenses (e.g., emergency fund, targeted savings accounts)
  • Investing for long- and mid-term goals (e.g., retirement, house down payment)
  • Pay down student loans

Further reading:

This strategy is easiest to implement for graduate students who start the NSF GRF after one or more years in grad school. Just put all of your ‘raise’ toward financial goals and don’t change anything about your lifestyle! Prospective grad students will have to be more conscious about setting up their grad student lifestyle on a lower income than they will start out with.

Preparing for the Post-Fellowship Income Drop

If you choose to upgrade your lifestyle with your fellowship stipend, be careful to maintain any long-term financial contracts at a level that will be sustainable for you after your income drops (if it will). The two key areas to watch out for are housing and transportation expenses. While it is possible to reduce your spending in either of these areas during grad school, it is a painful process, so it is preferable to lock in your spending in those areas at a level that you can maintain long-term.

Budgeting with an Irregular Income

Sometimes, fellowships are disbursed to the recipient at a frequency other than monthly, e.g., once per term. This schedule can cause issues for budgeting, which is usually framed as turning over each month.

One of the advantages of an infrequent disbursement schedule is that you are paid at the beginning of the period rather than the end, so the money you need throughout the period is already available to you. However, you may not be able/inclined to use typical budgeting software functions and prefer to set up your own budgeting system.

One of the most useful budgeting concepts for people with irregular incomes is that of fixed vs. variable expenses. At the beginning of your budgeting period, project the fixed expenses that will be paid during the period, such as your rent/mortgage, debt payments, certain utilities, subscriptions, etc. Then allocate your remaining income to your variable expenses at a frequency that is convenient for you. For example, you can estimate the variable utility bills that you may pay monthly during the period, plan to spend no more than a certain amount of money each week on groceries, and give yourself a lump sum of money for entertainment for the entire period to be spent as opportunities arise. In this way, allocate your fellowship disbursement so that you are sure that your expenses won’t exceed your income (leaving some buffer for unexpected expenses).

Income Tax Implications of the NSF GRFP

Your NSF GRFP stipend is subject to federal income tax. (It is usually subject to state and local income tax as well, but there are some exceptions.)

Further reading:

However, the taxation of fellowship stipends is handled completely differently by universities than assistantship pay.

Tax Reporting

While assistantship pay is reported on a W-2, fellowship stipends are not required to be reported in any particular way.

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A large fraction of universities, possibly the majority, do not report outside fellowship stipends on any official tax form. At most, the fellow might receive a courtesy letter, which is an informal letter stating the amount of the fellowship stipend received during the calendar year.

Some universities report fellowship stipends on Form 1098-T in Box 5 (along with other scholarship and grant income).

A small minority of universities report fellowship stipends on Form 1099-MISC in Box 3.

Whatever reporting mechanism used or not used, the important information to bring to your tax return preparation process is the amount of fellowship stipend paid to you during the calendar year. From that point, the fellowship stipend income is treated the same as any other fellowship/scholarship/grant income, and (possibly after some adjustments) it will ultimately be taxed as ordinary income.

Further reading:

Quarterly Estimated Tax

While you are required to pay federal and usually state income tax on your fellowship stipend, the vast majority of universities do not offer automatic income tax withholding on your fellowship stipend as they normally do for employee pay. (You should inquire whether automatic withholding is an option and use it if so, but the remainder of this section assumes it is not offered.)

This means that you will receive 100% of your gross fellowship stipend instead of your stipend net of income tax as you would assistantship pay. However, the IRS still expects to receive income tax payments throughout the year, so you will have to look into filing quarterly estimated tax.

Further reading: The Complete Guide to Quarterly Estimated Tax for Fellowship Recipients

As a default position, you should assume you are responsible for paying quarterly estimated tax. It’s possible that you won’t be required to in the year you switch on or off of the fellowship or if you’re married to someone with a high income and high withholding, but even in those cases it’s prudent to check.

The way you calculate your quarterly estimated tax due (and figure out if it’s required of you) is by filling out Form 1040-ES. That form will give you the amount of the payment you are supposed to make four times per year and an estimate of your total tax due for the year. You can make the payment online at IRS.gov/payments or through a host of other mechanisms.

Whether or not you are required to file quarterly estimated tax, it’s a great idea to set up a personal system that simulates automatic tax withholding. Open a separate savings account labeled “Income Tax” and transfer in the fraction of each paycheck you receive that you ultimately expect to pay in tax each time you are paid. Then, draw from that savings account when you make your quarterly or yearly tax payments.

This upcoming weekend I’m running an online workshop to help fellows file quarterly estimated tax. This is my first time giving the workshop, but if it goes well I plan to repeat it at least twice per year. If you would like to join my mailing list to be notified about future iterations of this workshop, please enter your information in the form immediately following this paragraph or at the end of the article.

Investing Implications of the NSF GRFP

The upside of receiving the NSF GRF is that your income is most likely higher than it would have been, which means you have an increased ability to achieve financial goals during graduate school such as debt repayment, saving, and/or investing.

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The downside of receiving the NSF GRF is that the stipend is not considered “taxable compensation” or “earned income.” It is taxable income, as discussed in the previous section, but it is not “compensation” or “earned.” If you receive only fellowship income in the course of a calendar year (and you’re not married to someone with taxable compensation/earned income), you become ineligible for certain tax benefits. The lost benefit that most commonly concerns graduate students is the ability to contribute to an Individual Retirement Arrangement (IRA).

Further reading:

An IRA is a tax-advantaged retirement savings vehicle. It’s a great idea to use an IRA (or other tax-advantaged retirement vehicle such as a 401(k) or 403(b)) for your retirement savings as it helps you maximize your long-term rate of return by protecting your investments from taxes. As a graduate student, you almost certainly don’t have access to the university 403(b), so the IRA is basically the only game in town for tax-advantaged retirement savings.

The catch is that you (or your spouse) must have taxable compensation during a calendar year for you to contribute to an IRA for the year. So if you go an entire calendar year with only fellowship income (you don’t have compensatory income from an assistantship or outside job and you’re not married to someone with taxable compensation), in that year you’re not eligible to make any IRA contributions.

It’s a catch-22: While you are likely more financially capable than ever of investing for the long term, you’re barred from doing so in a tax-advantaged retirement account.

I don’t think your inability to contribute to an IRA should stop you from working on your financial goals. It may be that you choose to prioritize another goal over retirement savings as a result of not being able to use an IRA, e.g., paying down student loans. But if saving for retirement is your top priority, you should pursue it; just use a taxable account instead of an IRA during any years of ineligibility.

Your tax burden can actually be quite low during grad school if you choose a long-term, low-turnover investing strategy. If you are single and your income in 2019 is below $39,375, your long-term capital gains and qualified dividends will be taxed at 0% at the federal level (you may still owe state and local tax). So it’s really not too bad to save in a taxable account as long as your income stays low. When you have access to an IRA or other tax-advantaged retirement account, you can probably shift your taxable assets into that account time to maximize the growth rate in the long term.

Further reading: Fellowship Recipients Can Save for Retirement Outside an IRA

What other questions do you have about financially managing your NSF GRF stipend?

Making Ends Meet on a Graduate Student Stipend in Los Angeles

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In this episode, Emily interviews Adriana Sperlea, a PhD student in computational biology at the University of California at Los Angeles (UCLA). Living in Los Angeles is financially challenging to say the least, and Adriana has found ways to improve her cash flow over time, such as by doing a summer internship, moving into subsidized graduate housing, living car-free, and budgeting intensively. She has even recently started contributing to a Roth IRA! Adriana and Emily additionally discuss how Adriana discovered that she owed a large tax bill on her fellowship income and how she paid those back taxes and started paying quarterly estimated tax.

Links mentioned in episode

grad student los angeles

0:00 Introduction

0:54 Please Introduce Yourself

Adriana Sperlea is a PhD student at the University of California, Los Angeles. She is studying Bioinformatics through an interdepartmental program. She is an international student from Romania. Her stipend is about $32,500 and she says it goes up a little bit every year. Each month, she receives $2,400. She is in her fifth year of her program.

3:03 How do you live within your means in Los Angeles?

Adriana says that getting outside financial support wasn’t an option for her. Her family doesn’t have the means to provide her financial support. As an international student, she doesn’t qualify for subsidized loans. After her third year of graduate school, she had a summer internship that provided an income on top of her graduate stipend. This is the only extra income she has been able to receive outside of her stipend. Due to regulations on visas, international students cannot work side hustles. It is illegal for international students to be employed outside of the university. Emily says that international students are in a tough financial position because they don’t have access to options to loans or side income that U.S. citizen graduate students can access.

Adriana was on a training grant that required her to do an internship. It was the Biomedical Big Data training grant. She received pay for her internship and continued receiving her graduate student researcher funding. She lived in San Diego for her internship. San Diego is cheaper than Los Angeles, but she still had to pay her portion of rent for the apartment she shared with her partner in Los Angeles.

6:56 What is your approach to budgeting in Los Angeles?

Adriana says that before she created your budget, she had to figure out your housing costs. She lives in graduate student housing, which is subsidized and affordable, but there’s not enough available for all graduate students at UCLA. In Los Angeles, you have to shop around a lot and hustle to make housing costs work with your stipend income. Many people use Craig’s List. Finding housing that costs 30% of your income is not feasible in Los Angeles, but housing that costs 40% of your income could be feasible.

Adriana explains that the subsidized housing at UCLA is available through a lottery system. Those who get into the subsidized housing are allowed to stay for seven or eight years, basically as long as needed to complete the graduate program. The leases are month-to-month, so people move out at any time of the year. Adriana says there isn’t enough available, so she pushes for more student housing. She lives in a junior one bedroom, which costs $1,300 per month. She pays $650 for rent because she shares the one bedroom. It helps lower housing costs to share a one bedroom, but for many people this is not an ideal situation.

Adriana says that housing and transportation are the two big items for the budget. She doesn’t have a car, but she shares one with her fiancé. She says to find affordable housing, you need to spend time looking for uncommon offers, start early, and have patience. You may need to sacrifice certain amenities and quality, but look for places livable and clean. Ultimately, there is only so much you can do.

13:30 What is the system that you use for budgeting?

For her budgeting system, Adriana uses a manual spreadsheet. She inputs her income and monthly fixed payments first. Then she divides the remaining income by four, for four weeks of the month. This sets her variable spending income for each week. Whenever she buys something, she inputs it. She always has a sense of what she spends. She buys groceries on the weekends and cooks her meals, so she doesn’t go out to eat during the week. She doesn’t spend anything Monday through Friday. Often, she has about $100 leftover to use on the weekends for fun.

Emily recaps Adriana’s budgeting system. Adriana subtracts her monthly bills from her monthly income. With the remainder, she divides by four for each week. She uses it for groceries first, then doesn’t spend money during the week. She has wiggle room for miscellaneous and money leftover for the weekend. Adriana adds that if she sees something she wants to buy, she puts it on a list. At the end of the month, she looks at her list and ranks the things she wants. This reduces impulse purchases and formalizes the practice of delayed gratification.

17:30 What do you do about large expenses?

Adriana has a savings account with $2000 to $3000. She has this savings because her rent decreased since she moved into subsidized housing and she received extra income during her internship. She uses this savings account for big expenses that are necessary, and then she gradually fills it back up. She says that before her internship, it was really tough to make big purchases. For example, she didn’t go home to Romania often because she didn’t have enough for flights.

Emily recaps that Adriana got a boost from her summer internship. This helped her get ahead. She repays herself into savings instead of using a credit card. Adriana says she has credit cards for maximizing rewards but she does not spend unless she actually has that money. She has a healthy fear of credit cards.

20:16 Any other comments about your budget or how you make it work in Los Angeles?

Adriana has loosened the reigns on herself. She says she has gotten a sense of it after manually managing her budget for so long. Emily says Adriana has internalized her budget. Her budget is in her mind, so she is less dependent on the spreadsheets. Emily says that if you go to a new city, you get thrown. If there’s a big shift in your life that’s a good time to start carefully tracking again.

22:00 Can you talk about saving for retirement?

Adriana shares that about one year ago, she asked her fiancé’s dad about investing. Her fiancé’s dad talks a lot about investing, so she asked to learn more. He recommended the book A Random Walk Down Wall Street. Adriana realized that investing is not rocket science and super simple. She thinks there is a weird culture around investing to make it sound more complicated than it is. She says that it’s easy, there’s a low risk way to do it, and during graduate school is the best time to invest. She thought that you have to worry about the market, but she jokes that the best strategy is to forget your password.

Adriana uses a Roth IRA. This account pays taxes on her money now. She says this is better because during graduate school, this is the lowest tax bracket that she’ll ever be in. It’s the lowest tax bracket that exists, so this is a good time to invest. She puts $200 in every month. She can budget that now because her rent costs are low. Adriana likes to check in and see she’s accumulated money. Emily writes about investing on her blog and agrees investing is easy.

25:54 Can you tell us the story of your big financial mistake from your second year?

When Adriana started graduate school, she was taxed as an international student. As an undergraduate, she went to college in the U.S. She always had taxes withheld and she never had to worry about taxes. But after Adriana started graduate school, Adriana’s residency status changed from non-resident alien to “resident for tax purposes.” This means the U.S. can tax her like she’s a resident. This tax status changed in June of her first year of graduate school, but it was retroactive for the whole calendar year. She had never heard about this issue from anyone else. In June when her status changed, the IRS refunded her about $3,000 that was originally withheld from her. At the time she didn’t fully understand why she received this money, and she spent it. But when April came and she had to do her taxes, she learned that she owed about $3,000 in taxes. It was pretty scary for her.

Emily says this tax mistake is pretty common. For the first full calendar year that you’re in graduate school on a fellowship-style stipend, you’re supposed to pay quarterly estimated tax. Most people don’t know about this.

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30:28 How did you pay the tax balance?

Adriana only had about $1,000 set aside. She feels a bit lucky that she was disputing with the IRS for money that she hadn’t gotten back due to a treaty between Romania and the U.S. that provides for international workers to get their taxes back from first five years from working with non-resident alien status. This dispute got resolved at the same time as her large tax bill. She also applied for a payment plan with the IRS. Anyone can do a payment plan with the IRS if you haven’t done one in past five years and your balance is less than $200,000.

Emily says that many people are intimidated by the IRS, but it sounds like Adriana had a good experience. Adriana says she spent a lot of time on hold. But if you’re a graduate student and you realize you can’t pay your tax bill, the IRS is a place to turn to and get a payment plan with no interest.

34:40 Final Comments

Adriana says budgeting can be tough and time consuming, and a little bit stressful. She says it’s worth it because it’s more stressful to not be able to pay rent. Emily says that it’s better to fess up, face up to reality of the situation, and engage with it. Don’t try to run and hide, because that compounds the problems.

35:18 Conclusion

Investing Strategies to Grow Your Wealth During Your PhD Training

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The most important investment you make during graduate school or your postdoc is in your career. But alongside that primary objective, many PhDs also invest money during their training. By far the top challenge or impediment to investing during graduate school or a postdoc is the low pay, and only a fraction of trainees are financially able and ready to invest. However, investing even a small amount of money on a regular basis throughout graduate school and a postdoc can have an enormous impact on lifetime wealth. The even better news is that the process of investing itself is simpler and easier than you probably think.

investing strategies phd training

 

Many investors, both novice and experienced, fall into the trap of thinking that to maximize their investment outcomes, they should focus on choosing the best investments. In fact, there is no reliable way to pick winning investments. There are only three aspects of your investments that affect your investment outcome that you can control: your savings rate, your investment asset allocation, and the cost of your investments.

This article outlines how to grow your wealth during graduate school by optimizing those three factors and implementing a few other key strategies.

A version of this post was originally published on GradHacker.

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Choose Passive Investments

Empirical studies have borne out time after time that passive investing is a more successful strategy than active investing after costs are factored in. Basically, what that means is that buying a set of investments that is representative of a market sector overall (e.g., the entire stock market) is more successful in the long term than trying to pick winners from that same sector. In trying to beat the market, both professional investors and individual investors consistently fail to even match it.

Passive investing is a far simpler strategy than active investing and much less time-consuming to initiate and maintain because there are plenty of high-quality passive investment products available. To enact a passive investing strategy, buy an index fund or an indexed exchange traded fund (ETF). For example, there are index funds and ETFs that reflect the entire stock market or the S&P 500, among numerous others.

The great bonus here is that passive investing is far more time-efficient than active investing. You don’t have to research individual investments to death; just buy them all!

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Maximize Your Savings Rate

Instead of putting your time and energy into agonizing over your investment choices and trying to optimize them, direct it toward increasing your savings rate into your investments. You can free up more cash flow for your investments by decreasing your expenses or increasing your income.

As simple as that sounds, every grad student knows that both time and money are very tight during this phase of life. If you pursue increasing your income or decreasing your expenses, you must be very selective about how you do so. The following posts discuss both of these strategies in much more detail.

Decreasing your expenses:

Increasing your income:

Increase Your Income

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Pick an Asset Allocation and Stick with It

Your asset allocation is the percentage of your investment that is in each asset class or sub-asset class. The three main asset classes are stocks, bonds, and cash. Your asset allocation should be chosen with respect to your investing goal. For a very long-term goal, such as retirement for someone in her 20s or 30s, a very aggressive asset allocation is appropriate, such as 80-100% stocks. If you are a DIY investor, your brokerage firm can help guide you to an appropriate asset allocation.

Your asset allocation should change as the timeline on your goal grows shorter, but not quickly or dramatically. A common pitfall that investors fall into is trying to time the market by changing their asset allocation, i.e., they pull money from stocks into bonds or cash when they anticipate a stock market drop and then try to find the right time to push it back in. While the theory of selling high and buying low is fine, it’s almost impossible to successfully time the market consistently, even for professionals. Instead, maintain your appropriate asset allocation and ride the market down and up.

Minimize Investing Costs

All investments have costs associated with owning and transacting them. You can think of those costs as directly coming out of your investment returns. Over the course of several decades of investing, these costs can reduce your balance in retirement by hundreds of thousands of dollars!

In fact, costs are one of the big reasons that active investment strategies fail to perform as well as passive investment strategies. While active strategies sometimes do generate higher top-line returns than passive strategies, their higher cost almost always knocks the real return experienced by the investor below than that of passive strategies.

With mutual funds, index funds, and ETFs, the cost of owning the investment is expressed very clearly in its expense ratio (a percentage). A low-cost ETF or index fund will have an expense ratio of a couple tenths of one percent or lower, while a high-cost, actively managed mutual fund will have an expense ratio of one percent or higher. For a passive strategy, look for funds with very low expense ratios.

Watch out as well for fees tacked on top of the expense ratio of the fund you purchased itself; these are often charged by the person or institution managing the account, such as a 401(k) administrator, a financial advisor, or a roboadvisor. Make sure that you have a compelling reason for paying such a fee before signing up for one, because it will come directly out of your returns.

Dollar Cost Average

The strategy of dollar cost averaging (as opposed to irregular lump sum investing) is to invest a set amount of money on a regular basis. If you receive a regular stipend/salary, this translates to investing the same amount of money every pay period, ideally through an automated transfer.

One of the big advantages of dollar cost averaging is that committing to the strategy prevents you from attempting to time the market. When you use your discretion over the timing of your investment schedule, many of us will try to guess whether the market is on an upswing or downswing and shift our buying behavior accordingly. This is rarely a successful strategy, whether it is done haphazardly or very deliberately.

In fact, dollar cost averaging actually guarantees that you “buy low and sell high” in a sense, although you are not selling. Because you invest the same dollar amount every period, when the market is low you buy more shares and when it is high you buy fewer shares.

Use a Roth IRA

If your investing goal is to save for retirement – likely the first investing goal you should set as it is the longest-term – it is a great idea to use a tax-advantaged retirement account. A tax-advantaged retirement account protects your investments from taxes over the decades between your contribution and withdrawal in retirement; paying tax year after year would otherwise eat away at your returns. Therefore, using a tax-advantaged retirement account maximizes your returns, as long as you abide by the restrictions on access that it imposes.

Only very rarely do graduate students have access to a tax-advantaged retirement account through their universities; therefore, an individual retirement arrangement (IRA) is their only option if they are eligible. Some postdocs receive retirement account benefits through their universities and some do not. IRAs are set up independently and managed entirely by the investor. This may sound like a big responsibility, but this freedom of choice means you can pick the optimal investments for you.

IRAs come in two varieties: traditional and Roth. Roth IRAs are generally recommended for current lower-earners with great income growth potential, so they are an excellent fit for graduate students and some postdocs!

Details on Emily's Roth IRA

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Get Started ASAP

Probably the biggest investing mistake you can make is to procrastinate getting started. On average, the stock market ends two out of every three years higher than it started; if you’re ready to start investing but put it off, more times than not you miss out on earnings that could have gone into your coffer. I frequently speak with PhDs-in-training who stay stuck in investing analysis paralysis for years on end. You can always course correct if you realize you made a poor choice with your investments initially, but you can never recover lost time. So even if you aren’t confident you’re making the perfect investment, just get started!

My Experience with Investing During Graduate School

Investing is one of my favorite subjects on which to teach, write, and coach, and my enthusiasm for the subject is due to the thrilling experience I had with investing during my seven years of PhD training. Starting at $0 in 2007, my husband (also a grad student over the same period) and I together grew our retirement investment portfolio to approximately $75,000 by the time we defended in 2014. The success we experienced is largely attributable to our aggressive and increasing savings rate and the long bull market that started in 2009.

I had an inauspicious start with investing when I first opened and funded my Roth IRA. I didn’t actually purchase the investment I intended to when I opened my account, so my money was going into cash! The really embarrassing part of the story is that I didn’t catch my mistake for over a year. When I finally did, I moved my IRA from that first brokerage firm to one I preferred and made sure that all my money went into my investment of choice, a target date retirement fund.

Deciding that a target date retirement fund was right for me only took a couple hours of research, and as it’s a set-it-and-forget-it strategy I have spent zero time over the last decade-ish maintaining it (though I do regularly check the balance). Instead of spending my time and energy monkeying with my choice of investments, I used them to find ways to add more money to my investments.

When I first started contributing to my Roth IRA in 2007, I saved 10% of my gross income, which was $200/month. After we married and combined finances, my husband and I set a lofty goal to max out two Roth IRAs each year. We used frugal strategies to incrementally reduce our spending to free up more money for investing. (Our top five frugal strategies alone helped us reduce our yearly spending by approximately $6,000.) While we didn’t quite achieve our goal during grad school, we did end with a 17.5% retirement savings rate.

Investing is about far more than just numbers to me. Investing throughout graduate school has not only given my family financial security, but it enabled both my husband and I to pursue our post-PhD dream jobs, even though they are risky and less remunerative in the short term.

I want other early-career PhDs to experience a similar degree of financial freedom as soon as possible in their lives, which is why I am such a proponent of investing even during the incredibly financially challenging graduate and postdoc training periods. If you’d like to go even deeper into this subject matter, sign up for my free 7-day email course on investing for early-career PhDs.

Should a Graduate Student Save for Retirement in a Roth IRA?

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For graduate students with sufficient stipends, investing during graduate school is a fantastic financial goal. Counterintuitively, the long-term goal of funding retirement should be the first or one of the first investing goals any individual has. An Individual Retirement Arrangement (IRA) may be an appropriate vehicle in which to invest during graduate school, when the vast majority of graduate students do not have access to a retirement account at their universities such as a 403(b) or 457. But not all graduate students are eligible to contribute to an IRA, and an IRA is only the best choice for certain investing goals. If a graduate student opens an IRA, she must choose either a Roth or a traditional version.

grad student Roth IRA

A version of this article originally appeared on GradHacker.

What is an IRA?

An IRA protects your investments from being taxed while they are growing. An IRA is not synonymous with certain investments, but rather is an envelope around whatever investments you have chosen. As the name implies, the IRA is intended to be used for retirement savings, and by protecting your investments from taxes over the decades, your investments will grow at their fastest possible rate. Due to the power of compound interest, not having to pay tax on the growth of your investments can make a significant positive impact on their value. Therefore, it is a very good idea to use tax-advantaged retirement accounts to the greatest extent of your ability.

In 2018, the contribution limit for people under the age of 50 is $5,500 per year or your amount of taxable compensation, whichever is lower. You can make contributions to your 2018 IRA until April 15, 2019.

Many brokerage firms require a certain minimum account size that may be too high for a grad student just starting out with saving. If that is the case for your preferred brokerage firm, you can save into a savings account or IRA at another brokerage firm (some waive account size minimums if you set up a monthly auto-transfer) and transfer the money when you reach the minimum.

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Who can contribute to an IRA?

Only taxable compensation (previously known as earned income) can be contributed to an IRA. A graduate student’s stipend is taxable compensation if it is reported on a W-2 at tax time. If a grad student has only fellowship or training grant income during a calendar year (not reported on a W-2) and no outside income, he will not be able to contribute to an IRA for that year. Senators Elizabeth Warren and Mike Lee proposed the Graduate Student Saving Act of 2016, which would include fellowship stipends as taxable compensation for the purposes of IRA contributions, but it was not enacted.

If you are married to a person with taxable compensation, you can contribute to a spousal IRA, again subject to the limit of $5,500 or the amount of taxable compensation. There are income limits as well for IRAs, but they are much higher than grad student stipend levels.

If your stipend is not taxable compensation, you can still save for retirement, though it may not be inside an IRA.

Is a Roth or a traditional IRA better for a graduate student?

There are two versions of IRAs available: Roth and traditional. The first-pass difference between the two types of accounts is when you will pay income tax on the money inside it. While the money in your IRA grows tax-free, you do have to pay income tax either upon the contribution (Roth IRA) or withdrawal (traditional IRA).

Initially, when people decide between the Roth and traditional IRA, they compare the marginal tax rates the taxpayer will be in upon contribution vs. withdrawal. The idea is to opt to pay the tax when they are in the lower marginal tax bracket. You know your marginal tax bracket currently; for graduate students without outside income, it is usually the 15% tax bracket or lower. You do not know what your marginal tax bracket will be during your retirement, as both your income and the tax brackets themselves will change in the intervening decades. However, this educated guess applies to the majority of graduate students: You are currently in a relatively low tax bracket because you are in training and building your career. Later in your life, you expect to have a much higher income and be in a much higher tax bracket. If that assumption holds, the Roth IRA is the more appropriate choice. Virtually every graduate student I’ve spoken with about this has chosen to contribute to a Roth IRA during graduate school.

The Roth IRA has some additional flexibility that the traditional IRA does not that may be attractive for graduate students.

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What are the pros and cons of using a Roth IRA?

As graduate students usually lack access to other tax-advantaged retirement account options, the best practice is to only contribute money to a Roth IRA that you intend to invest for retirement. This is in line with the government’s purpose in creating IRAs. The main con of using any tax-advantaged retirement account is that accessing the funds earlier may trigger an income tax payment and a 10% penalty. However, the Roth IRA is unusually flexible.

As you have already paid income tax on the contributions to your Roth IRA, you can remove them at any time without additional tax or penalty. Five years after opening a Roth IRA, a first-time home buyer can remove up to $10,000 without incurring a penalty.

Because of the Roth IRA’s flexibility, some people use it “off-label” as a general savings vehicle. Others may make contributions even if they are not 100% sure they will preserve the money for retirement. Just be sure to match your investment strategy with your intended use for the money; the type of investments you choose for long-term money should be different than those for mid- or short-term money.

Of course, saving for retirement is not an appropriate goal for every graduate student. If you are currently taking on debt (student loans, personal loans, credit cards), your first priority should be to minimize that debt acquisition or even start to repay it. If you can keep your head above water with your stipend but don’t have any kind of cash savings for emergencies or short-term expenses, saving those funds should be your goal, not investing (yet). Even graduate students whose stipends allow for saving may not want to start investing for the long term if they have other financial priorities and their values don’t align with early wealth-building.

If you are a graduate student with a livable stipend who values financial security or independence, using a Roth IRA for your retirement savings is a wonderful choice. If you don’t have taxable compensation, you can still save for retirement in another vehicle. If you aren’t sure what financial goal you are saving for, using a Roth IRA is an option but saving in a taxable account is almost as beneficial and prevents the different purposes from becoming confused.

Did you save for retirement during graduate school? If so, did you use a Roth IRA?

Everything You Need to Know about Roth IRAs in Graduate School

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As you are no doubt aware, graduate students are clamoring for information on investing for retirement. I’ve observed this during my seminars and it’s been documented by the Council of Graduate Schools’ Financial Education. Graduate students are wondering how to get started saving for retirement during graduate school or want to be prepared to start immediately following graduate school. Roth IRAs are an integral component of preparing for retirement for graduate students. This article covers everything you need to know about Roth IRAs in graduate school: what an IRA is, why you should use one, the differences between traditional and Roth IRAs, the type of income you need to contribute to an IRA (not all graduate student stipends are eligible), how much to contribute to an IRA, and how to open an IRA.

Roth IRA graduate school

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The information in this article is current as of 2017.

What Is an IRA?

IRA stands for Individual Retirement Arrangement. It is a tax benefit offered by the US federal government to incentivize saving for retirement. Anyone with taxable compensation (or a spouse with taxable compensation) can contribute to an IRA; it is not a benefit offered by your workplace like a 401(k) or 403(b). The contribution limit to an IRA in 2017 is $5,500 ($6,500 for people aged 50 and older) or your amount of taxable compensation, whichever is lower.

An IRA is not synonymous with particular investments; you buy investments inside (or outside) of your IRA. An IRA (and other tax-advantaged retirement accounts like a 401(k) or 403(b)) is like a shield that protects your investments from taxes.

If you invest in a regular taxable investment account, every year that you realize a gain you will pay some tax on the gain. This tax effectively suppresses the growth rate you see on your investments, which saps the power of compound interest. An IRA or other tax-advantaged account maximizes that growth rate by eliminating the tax, which ultimately maximizes the amount of money you have in your investments.

However, this tax-advantaged status comes with a trade-off. The purpose of an IRA is to help Americans save for retirement, so there are restrictions on when and for what purpose you can remove money from your IRA. In limited cases, you can remove money from your IRA without incurring any penalty, but in general you have to wait until you are 59.5 years old.

Why Use an IRA Instead of a Taxable Investment Account?

If you were to save for the long-term into a normal investment account, every year you would pay some tax on the gains you realized in the account. If your account had a great deal of turnover in the course of a year, you would pay your marginal tax rate on the gains (10%, 15%, 25%, etc.) plus whatever state tax would be due. If your account had very little turnover, your tax rate(s) would be lower. If instead your money was in an IRA (or a similar tax-advantaged retirement account like a 401(k) or 403(b)), all the gains would be tax-free.

Taxes on a regular investment account amount to death by a thousand cuts. Every year, a fraction of the growth (if there was growth) is removed through taxes and no longer serves as part of the principal for the growth in a subsequent year. Using a tax-advantaged account like an IRA allows the growth to continue unfettered. Over many decades, the balance in an IRA can be hundreds of thousands of dollars larger than the balance in a taxable account to which the same contributions were made.

Further reading: Taxable vs. Tax-Advantaged Savings

For short- or medium-term investing goals, taxable accounts are appropriate because of the complete accessibility of the money contributed. But for long-term investing goals such as retirement, it is very advantageous to use an IRA or other tax-advantaged retirement account.

Why to Contribute to an IRA during Graduate School

Graduate students have a limited income and plenty of claims on that income. They must first and foremost pay for their basic living expenses, which not all stipends can even cover. If there is any money remaining, the student must choose among upgrading his lifestyle, saving up cash, paying down debt, investing, giving, supporting family members, etc. He may very well have higher priorities than saving for retirement. However, there is a very compelling reason for starting to invest for the long term if possible: the power of compound interest aka the time value of money.

As graduate students are most often in their 20s or 30s, time is currently on their side with respect to investing. Many Americans put off saving for retirement until their peak earning years in their 40s and 50s, but the advantage of starting earlier is that you need to save less money overall to reach the same endpoint. This is the time value of money: the money that you invest today is worth more than the money you invest years from now because the intervening time adds value. Investing even small amounts of money during graduate school can massively add to your wealth in retirement, much more so than large amounts of money saved later on.

The mechanism of the time value of money is the power of compound interest.

In qualitative terms, this is how compound interest works: In year 1, you invest some money and it earns a return (we’ll say a positive return, to keep things simple). In year 2, you invest more money which earns a return, plus your contribution and the return from the previous year also earn a return. In year 3, you invest more money and it earns a return, plus your contributions and earnings from previous years earn a return. Before you know it the increases to your account balance each year are coming more so from the growth your previous contributions than on your current contributions; after decades, most of your account balance will be due to growth rather than your direct contributions.

The power of compound interest is modeled by this equation, which represents exponential growth:

compound interest equation

Using the equation for compound growth, you can get an idea of how much money can grow with a given rate of return and time period. In real investing in the stock market, you will not receive the exact same rate of return each year like clockwork; in some years you will lose money, in others you will see a very high return, and everything in between. But on balance, over long periods of time, the math of compound interest reveals the scale of growth possible with even an irregular return like you would see from the stock market. (Investments that give a regular and guaranteed rate of return, such as bonds and certificates of deposit, are comparatively low-returning and not usually considered appropriate long-term investments for a young person.)

For example, if you invested $250 per month at an 8% average annual rate of return for five years during graduate school, in that time you would contribute $15,000 and your ending balance would be $18,369.21. The growth over that time period is nice but not staggering.

But if you then leave that money alone to continue compounding at 8% per year for 50 years – make no additional contributions – your money grows to a mind-boggling $989,688.35!

That’s an extra one million dollars in retirement that you would not have had if you had not started investing during graduate school!

The numbers above are for illustrative purposes only. It’s still incredibly worthwhile to begin investing during graduate school even at a rate of less than $250/month. Compound interest works the same on any sum of money, whether $5 or $5,000. The point is that investing with time on your side turns small amounts of money into large amounts.

Further reading:

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The Difference between Traditional and Roth IRAs

When you open an IRA, you have the choice between opening a traditional IRA and a Roth IRA. (You can contribute to either/both in the course of a year, but the maximum contribution limit applies to them both together, not each separately.) There are a number of differences between the two types of IRAs, especially when it comes to eligibility and withdrawing money in retirement, but there are two key differences that are most salient for young people who are eligible for both types: when you pay income tax and how to withdraw money without penalty prior to age 59.5.

Further reading:

When You Pay Income Tax

With both types of IRAs, you won’t pay any tax while the money is growing inside the IRA.

With a traditional IRA – unsurprisingly, the first type introduced into the tax code – there is an additional tax incentive upon contribution to the IRA, which is that you exclude the amount you contribute from your taxable income for the year (take a tax deduction). You take a tax deduction on the money you contribute, then your money grows tax-free, and then you pay ordinary income tax on the amounts you withdraw each year in retirement. The traditional IRA is a mechanism of tax deferral.

The Roth IRA is the newer type of IRA (named after the senator who introduced it). The tax break on the Roth IRA is the flip of the one for the traditional IRA. You pay the full income tax due on the contribution you make to the Roth IRA, then your money grows tax-free, and you withdraw it tax-free in retirement.

The key to choosing between a traditional and Roth IRA is to guess when you will pay a lower tax rate: upon contribution or withdrawal.

One way to approach this question is by considering when you will be in a lower marginal tax bracket: now or in retirement? The rationale behind this is that you are going to get the tax break on the last dollars of your income, which are likely to fall in your marginal tax bracket. You know your marginal tax bracket today; most graduate students without outside sources of income fall in the 15% marginal tax bracket or even lower (plus your marginal state tax rate). But you have to guess whether the marginal tax bracket you will fall into in retirement will be higher or lower. In the intervening decades, you will experience personal changes in your income and tax bracket, and there are likely to be legislative changes to the tax code and rates.

This guess is probably easier for graduate students than for the average American. Graduate students can make the reasonable assumption that their current income is much lower than their income will be throughout their careers and likely also in retirement. (Ask yourself: Do you want to be living the same lifestyle in retirement that you are in graduate school or would you like it to be more lavish?) Whatever might happen to the tax code more broadly, confidence that you are in a personal low-income and low-tax bracket period is a strong argument for the Roth IRA over the traditional IRA. I and virtually every graduate student I’ve spoken with about this issue chose the Roth IRA over the traditional IRA during grad school.

However, there are more nuanced arguments that you might consider that are more in favor of the traditional IRA, even for someone in a low tax bracket currently. Such arguments are beyond the scope of this article, but there is plenty of reading material available on the decision between the traditional and Roth IRA for you to dive into if you are interested.

Further reading: Traditional vs. Roth IRA: The Unconventional Wisdom

Penalty-Free Early Withdrawal

One of the big planning/psychological barriers to beginning to save for retirement is the nagging question “What if I turn out to need the money in the near future?” After all, life is unpredictable; sustained loss of income or a very expensive emergency might be just around the corner. Some people find it difficult to put barriers between themselves and their money no matter what degree of cash they may have accessible in an emergency fund or other savings. The prospect of sequestering money that can only be used many decades from now in retirement can be daunting.

The Roth IRA (as opposed to the traditional IRA) helps to alleviate this anxiety. While it is rarely a good idea to take already-contributed money out of an IRA (after all, you are unplugging that money from the power of compound interest), you do have that option with the Roth IRA. Because you have already paid your income tax on your Roth IRA contributions, you can withdraw those contributions at any time without penalty (or additional tax). Certain conditions must be met to withdraw earnings early without penalty or tax. For one example of a qualified distribution, the IRA must be at least five years old and the withdrawal is used to buy a first home (up to $10,000); there are other conditions that create qualified distributions as well.

With a traditional IRA, on the other hand, early withdrawals always result in tax due, and penalties are also assessed if the withdrawal is not qualified.

The Type of Income You Need to Contribute to an IRA

Only “taxable compensation” (formerly “earned income”) can be contributed to an IRA; while IRAs are independent of your workplace, they are not independent of work. For most Americans, this is a non-issue, because they work for their income. For example, they might be employees receiving W-2 income or self-employed; both of these types of income are taxable compensation. You can also contribute to an IRA if your spouse has taxable compensation. However, graduate students receiving stipends do not always have taxable compensation; many graduate students who have sufficient income to save for retirement are not eligible to contribute to IRAs.

There are two broad ways that stipends (the money that goes into your pocket for your living expenses) are paid. Teaching and research assistants are employees of their universities as well as students and receive W-2s at tax time. W-2 pay indicates taxable compensation. Graduate students whose stipends are paid by fellowships or training grants – really, any graduate student who does not receive a W-2 at tax time – are not employees and do not receive taxable compensation. (Their income is still taxable, it’s just not compensation.)

If in the course of a calendar year you do not receive any taxable compensation, you are not eligible to contribute to an IRA in that year. If you receive taxable compensation in a calendar year, you can contribute up to $5,500 or the amount of your taxable compensation, whichever is lower. If your stipend income comes from a fellowship, do not overlook other possible sources of taxable compensation when it comes to IRA eligibility, such as your spouse’s income, your side income, or summer income in between fellowship awards. For example, if you earn $2,000 in side income from tutoring in a calendar year, you can contribute 100% of it (after your business deductions) to your IRA.

If you don’t have any taxable compensation (or a spouse with taxable compensation) during a calendar year, you can still save for retirement. You can’t use an IRA, but you can use a regular taxable investment account. While an IRA would be ideal, over the short term using a taxable account won’t be very detrimental. It’s better to invest outside of an IRA than to not invest at all.

Further reading:

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How Much to Contribute to an IRA during Graduate School

The right amount of money to contribute to an IRA in a given year of graduate school might be $5,500, $0, or somewhere in between.

As a general rule, I think that every non-retired person with an income should be investing for retirement, ideally inside a tax-advantaged retirement account. Saving so that you can provide for yourself in the future is part of my definition of living within one’s means.

But graduate school is an extraordinary time of investment in one’s career, possibly to the exclusion of investing for retirement. While many graduate students are paid stipends that more than cover their living expenses, some graduate students are either not being paid a living wage or have unusually high expenses (e.g., have dependents).

To determine the right amount for you to contribute to an IRA, you must explore your means and your goals.

Means: How does your stipend compare to the local living wage? While the local living wage will not exactly match your expenses in every category, it should give you a sense of the baseline cost of living in your county. If your stipend is at or above the living wage and you aren’t making any progress with your finances, try to reduce your expenses so you can start to invest or accomplish other financial goals. If your stipend is below the living wage, you may not have the means to start investing right now; getting through graduate school without accumulating debt may be an appropriate financial goal.

Goals: Not all graduate students with discretionary income should jump right into investing. There may be higher-priority financial goals such as paying off high-interest debt or saving cash for emergencies or short-term expenses. But if investing for retirement becomes your top financial goal or a goal you work on concurrently with other goals, it is appropriate to contribute to an IRA.

If a graduate student does have the means to invest and investing is her top financial goal, rules of thumb come back into play. The most common (mainstream) retirement savings rates bandied about in the personal finance community are between 10 and 20% of income (gross or net). I think investing 10% of gross income into a Roth IRA is a great initial goal for a graduate student; it was my retirement savings rate when I started graduate school. It may be one easily reached (especially if you build it into your budget from the beginning) or quite challenging. If it takes you years of budget optimization to reach 10% (or you never do), that’s fine. If you want to go higher than 10%, that’s great too, and you’ll have a wonderful nest egg when you transition out of graduate school. (My husband and I reached a 17.5% savings rate from our gross income by the time we defended, but it took years to raise our savings rate to that point.)

A higher retirement savings rate will help you reach financial independence faster, but you always have to balance that against your quality of life in the present. But if you have the means and aren’t working on a more pressing goal, I do recommend regularly contributing to a Roth IRA during graduate school, even if it’s a small percentage. Getting into the habit of saving for retirement is as valuable as the savings itself; if you save during graduate school, once you have a Real Job you’ll never be able to tell yourself that you “can’t afford to save right now.”

Further reading:

How to Open an IRA

The actual process of opening an IRA is straightforward, but choosing where to open it and what to invest in inside the IRA will take some research and decisions on your part.

Briefly, using index funds (a passive investing strategy) is the most effective, least expensive, and most time-efficient manner of investing. You can buy index funds (e.g., the S&P 500 index fund) or a fund of index funds such as a target date or lifecycle fund at any number of brokerage firms. (Brokerage firms that specialize in trading single stocks, i.e., the ones you probably see the most advertisements for, may not offer index funds.)

When you select a brokerage firm, you need to ensure that: 1) it offers the investments you are looking for, 2) it is not too expensive to own the funds, and 3) you can meet the account minimums. Index funds are inherently inexpensive, but there will still be some price differences among brokerage firms. Different firms also set different account size minimums, such as between $1,000 and $3,000, but some waive these minimums if you set up an automatic savings rate into the account.

Further reading: Brokerage and IRA Account Minimums

Once you have selected your brokerage firm and investment, you are ready to open your IRA. You should be able to complete the process online in just a few minutes, and the brokerage firm’s website will guide you through the process. You will be asked for your personal information such as your name, SSN, and address. Once you have the IRA open, transfer in the amount of money you need to open the account and/or set up an automatic savings rate, and choose the investment(s) you want to buy with your money.

Leave any remaining questions you have about IRAs in graduate school in the comments and I’ll do my best to answer them! If you want to talk your specific situation over a bit, you can sign up for a free initial coaching call with me.