by Brian Hufford, CPA. CFP
What will the 65-year-old today say to you down the road about your financial management? Perhaps this person will ask if you really had a clear vision of what financial issues were really important in 2007. This column aims to check your financial vision so that you will have no regrets at age 65.
Every financial vision check that I perform starts with the ultimate number that a dentist needs to be financially able to exit dentistry. So many dentists tell me, “I don’t want to retire.”
To me this is a healthy attitude, especially if one shares the belief that “retirement” as defined by the dictionary is “being put out of use.” No one wants to be put out of use. Sometimes though, I think that a doctor who doesn’t want to talk about retirement is really saying that he or she does not want to think about financial issues at 65. These people may think that other financial issues are more important than saving for the future.
You have probably noticed that many financial planning articles talk about “how to” use the right calculations and strategies. I could lead you through one more iteration of the “right way” to do inflation-adjusted calculations. I could discuss how to choose the right investment return assumption for you or even direct you to a Web site where you could perform Monte Carlo mathematical simulations.
Everyone needs to believe in the numbers behind the personal savings amounts. Frankly, I don’t believe I can improve someone’s results by writing about “how to.” Former UCLA men’s basketball coach John Wooden (a fellow Hoosier) says that the most important key to achieving great success is “to decide upon your goal and launch, take action, move.” Wooden is telling us that a goal is important for success but implementation is the key.
Confusion about retirement calculations is one of the biggest inhibitors in creating an action plan to address adequate savings. Let’s see where you stand.
Your 20/20 financial vision can be created with The 20/20 Retirement Savings Rule™. This is a rule of thumb that greatly simplifies retirement savings calculations in general dentistry.
The first 20 relates to your retirement income need. Instead of determining a retirement budget, factoring in social security and inflation - or guessing what percentage of current gross income you will require - a good estimate of your retirement income need before tax is simply 20 percent of your 2006 gross production.
So if your gross production is $800,000, then your current retirement income need is 20 percent of production, or $160,000 in today’s dollars. This number equates to approximately 70 percent of your current income from this practice after your current owner’s benefits.
The second 20 relates to the rule of thumb that it is not safe to withdraw more than 5 percent of your retirement capital annually during retirement. A 5 percent withdrawal rate is 1/20th of the retirement capital. Therefore, by multiplying your retirement income need by 20, you can easily estimate the savings you need at retirement in today’s dollars.
In our example, simply multiply $160,000 by 20 to get the retirement capital need of $3.2 million. Now you have a Coach Wooden goal.
What about inflation? If you are retiring more than three years from now, inflation is a major issue. We can easily take care of this by using a simplified inflation-adjusted investment return.
Suppose you think a realistic investment return assumption is 8 percent and that inflation will be 3 percent. Simply use the net inflation-adjusted return of 8 percent and subtract 3 percent to give you 5 percent in your savings calculation.
The last step is to input assumptions into a financial calculator. You can find a financial calculator easily on the Internet. Input PV (the present retirement savings you have), I (the inflation adjusted return), FV (the retirement capital you need at future retirement), and N (the number of years to retirement). Calculate PMT (the annual savings you need to reach your goal). To fine tune the annual savings amount, simply increase the savings by actual inflation each year.
So are you saving the goal amount? Don’t forget Coach Wooden’s formula - first the goal, then “launch, take action, move.” If you have a deficit, the key to success is to create a savings plan to eliminate it. Remember that unless you take action, the percentage of your deficit savings in 2007 is likely to be the deficit you will ultimately have at retirement. Do it in 2007!
