John K. McGill, JD, MBA, CPAand Jeffrey A. Harrell, CFA
According to Pfau, the required annual savings rate is between 16.6% and 35.9%
Is it possible for doctors to truly feel secure when it comes to saving for retirement? Fears of coming up short and having to ask their kids for a bailout can haunt many doctors as retirement nears. While we would like to tell you this fear is unwarranted and doctors are typically well prepared, our 30 years of assisting doctors to successfully reach financial independence suggests otherwise.
Although the question, "Am I saving enough?" seems simple, answering it with confidence is problematic due to the number of variables that change over a doctor's lifetime. Major factors that affect a doctor's recommended savings rate include long-term practice profitability, an acceptable standard of living (pre- and post-retirement), paying for children's college education, potential health problems, a desired retirement age, inflation, investment returns, and more. As doctors near retirement, some of these factors become easier to predict, but the further away a doctor is from retiring, the more difficult answering these questions can be.
If a doctor is more than 10 years away from retirement, it can be a struggle to feel confident the person is saving an adequate amount of money for retirement. Even doctors who created a long-term financial plan must realize that it needs to be constantly reviewed and updated through the years.
Fortunately, doctors can now feel more comfortable they're saving enough if they follow the guidelines outlined by Wade Pfau in his research paper, "Safe Savings Rates: A New Approach to Retirement Planning over the Life Cycle." It won the inaugural Journal of Financial Planning Montgomery-Warschauer Editor's Award in 2011. The report outlines safe minimum savings rates based on the amount of time you have between now and your desired retirement age.
Although the details of the analysis are relatively complicated, Pfau's research identified the minimum necessary savings rate that will allow an individual to withdraw 50% to 70% of their final salary during retirement based on different asset allocations (stocks versus bonds). While a replacement rate of 50% may seem inadequate for many doctors, keep in mind that Social Security benefits and the lack of a mortgage in retirement will typically account for replacing or reducing an additional 20% to 40% of your current income or expenditures.
Within the report, Pfau created a table that indicates the various required levels of saving based on the remaining number of years in the accumulation phase, versus a projected amount of time in the retirement phase. What stood out was the savings rate a doctor needs with a 20- to 30-year accumulation phase ahead, and a 30-year retirement phase projection using the 60/40 fixed asset allocation scenario. According to Pfau, the required annual savings rate is between 16.6% and 35.9%. Put another way, a doctor with an accumulation range between 20 and 30 years looking to replace 50% of his or her income for 30 years needs to save between 16.6% and 35.9% of his or her annual gross income.
Unfortunately, most doctors are not saving anywhere near that amount and need to be prepared to either work well into their 60s or increase their savings rate dramatically. Now, before you throw in the towel and stop reading, keep in mind these numbers assume a doctor is starting with savings of $0. As a result, most doctors will need to make an adjustment based on their historical savings rate. Using the 16.6% to 35.9% range as an example, a doctor who has been saving 16.6% of his or her gross income over the past 10 years and is now 45 with 20 years to retirement needs to keep saving at a rate of 16.6%, not 35.9%. The lower your historical savings rate, the closer you will be to the higher end of this range.
Finally, doctors need to be acutely aware that many unknown variables (investment returns, health care costs, inflation, Social Security benefits, etc.) will ultimately affect their ability to retire on their own terms. However, the one aspect of retirement planning they can control is how much they save. Using the guidelines discussed here, doctors should review their current level of savings and look for ways to increase it to the level identified to ensure they are on a path to a safe and secure retirement.
John K. McGill, CPA, MBA, JD, provides tax and business planning through John K. McGill & Co., and Jeffrey A. Harrell, CFA, provides investment advice through McGill Advisors, Inc. (RIA). Both are members of the McGill & Hill Group, LLC, your one-stop resource for tax/business planning, practice transition, legal, retirement plan administration, CPA, and investment advisory services. Visit www.mcgillhillgroup.com.