by Brian Hufford, CPA, CFP
What will keep you from saving 10 percent of gross production in 2007? “Forced” savings is one of the most powerful benefits of qualified retirement plans. Plans have to be funded by the tax return due date. With large increases in deductible 401(k) contributions and the ability to combine different types of retirement plans, most doctors are saving more than twice as much as they did five years ago. If forced savings is so important, just think what could be achieved by properly aligning your financial priorities.
Imagine a pyramid with five levels. We’ll call this pyramid the Priority Alignment Pyramid. Let’s create a 2007 financial plan for you with the Priority Alignment Pyramid.
Base Level - Lifestyle and Taxes
Among general dentists, lifestyle and taxes amount to approximately 27 percent of gross production. You should save at least 3 percent of gross production outside your retirement plan in personal investments. These two amounts combined represent the practice’s 30 percent average after-pension net income. Whether incorporated or not, why not pay yourself a salary or draw equal to 30 percent of gross production? Pay all personal bills from your home checking account. This will avoid the confusion of not knowing how much your family spends with some bills paid by the practice and others paid at home. The approximate breakdown of the 30 percent is: 18 percent in lifestyle, 9 percent in federal and state taxes, and 3 percent for savings. If you cannot pay a monthly salary of 30 percent of monthly production, one of the other priorities of your practice overhead is out of line.
Second Level - Debt
How do you properly manage debt? To achieve the most wealth and the proper alignment of financial priorities, you need to manage the repayment of debt. Many dentists have poor debt management practices. Make a simple list of all of your debt, both practice and personal. List how much you owe and the monthly payment of each debt. If you own an office building, don’t count debt payments on that. Office debt is part of your total practice overhead.
Divide total monthly payments by total debt. The monthly payments should be no more than 0.8 percent of total debt. If you owe $1 million including your home mortgage, equipment loans, auto loans, etc., your monthly payments should be approximately $8,000. If your monthly payments are more than 0.8 percent, you are probably repaying debt too rapidly, and in all likelihood, will be unable to save. Thus, you will lose years of compound growth of savings.
Third Level - Capital and Large Expenditures
Capital and large expenditures are large expenditures that occur in any given year. These include equipment, automobiles, office remodeling, home remodeling, college costs, etc. If your debt payments in the second level are 0.8 percent per month or approximately 10 percent annually, then you cannot afford much more than an additional 5 percent of production for large expenditures - both practice and personal. Many doctors in their mid-40s or older have retired much of their debt, and simply pay cash for cars or equipment. So, even though debt payments are no longer the issue, these doctors are still unable to save 10 percent of production because they are paying cash for large expenditures. Make saving your first priority. Use debt wisely.
Fourth Level - Income-for-Life Savings
We need to replace income by working with income from savings to retire. This goal can be achieved rapidly by saving 10 percent of production. Normally, this savings occurs in private practice dentistry with a tax deductible retirement plan. If your spouse is not contributing to a 401(k) plan in employment elsewhere, why not fully fund an additional amount for your spouse in your practice? Have a study performed on a combination 401(k) - a Cash Balance Plan. Many doctors save almost $100,000 or more using this combination with employed spouses. Your retirement savings in dentistry should be roughly 10 percent of gross production in qualified plans with properly designed plans.
Fifth Level - Legacy Goals
If you have the other four levels of the pyramid covered, you have reached the top! Now you can fund legacy goals. Legacy goals include children’s college, or charitable or investment goals. Legacy goal funding makes life worthwhile. These goals offer the greatest sense of accomplishment. They help you leave a legacy from your working years. Many parents sacrifice their retirement to fund their children through college. The pyramid is a level-at-a-time project. It happens easily if your priorities are aligned!
So, why not align your financial priorities in 2007?Brian Hufford, CPA, CFP®, is president of Hufford Financial Advisors, LLC, an independent, fee-only planning firm that helps dentists achieve financial peace of mind. The company is recognized as the only strategic alliance partner for financial planning services for the Academy of General Dentistry. Contact Hufford at (888) 470-3064, or at [email protected].
