John K. McGill, CPA, MBA, JD, and Brad Kucharo, CPA, CFP®
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Doctors face more financial decisions in the five years preceding retirement than at any other time in their lives. Getting these decisions right can add hundreds of thousands of dollars to the doctor’s nest egg in retirement. Conversely, making mistakes can cost hundreds of thousands of dollars — possibly forcing the doctor to postpone retirement or, worse yet, die at the drill! Since there are no financial “do-overs,” it’s important to plan for retirement correctly the first time. Below are the first four of the top 10 planning strategies to help doctors achieve financial security in retirement:
1) Maximize practice value. Increased competition and higher barriers to starting a new practice (higher equipment and technology costs, greater difficulty in arranging financing) has led to increased practice values recently, says Roger K. Hill, a practice transitions specialist with The McGill & Hill Group. Unfortunately, many doctors diminish their practice’s value by starting to “coast” as they near retirement, says Hill.
It’s important that doctors sell their practice near its peak value. Accordingly, Hill recommends that doctors use their best efforts to maximize profitability in the years before they sell, since this is the key driver of practice values. Doctors should set their fees on a scientific basis, and be sure to raise them annually. They should further explore ways to improve productivity through expanding their procedure mix, increasing efficiency, and boosting case acceptance rates through offering more flexible payment arrangements. Finally, they should place greater emphasis on controlling overhead costs, which is more critical in this era of slower growth.
2) Minimize taxes on the sale of the practice. Doctors can use several strategies to minimize income taxes on their practice sale, says Blake W. Hassan, a tax attorney and CPA specializing in the practice transition area, (704) 424-5450. Doctors should minimize the amount of practice sale proceeds taxed at ordinary rates (up to 35% currently) through allocating virtually all of the intangible practice value to themselves personally, in exchange for their Assignment of Personal Goodwill and Covenant Not to Compete Agreement. Amounts so received qualify for long-term capital gain treatment, taxed at a maximum rate of 15% for federal income tax purposes. In the typical practice sale, allocating the proceeds this way often saves $80,000 or more in federal and state income taxes, says Hassan.
Hassan has two strategies to reduce taxes on the remaining portion of practice sale proceeds, typically taxed at ordinary rates (up to 35% currently).
First, he recommends closing the practice sale as close to the beginning of the new tax year (January 1) as possible, so that the sale income will not be added on top of the practice profits generated in the year of sale. Further, Hassan recommends that incorporated sellers have their corporation pay the brokerage commission and other transaction costs from the amounts otherwise paid to it. This will offset amounts that would otherwise be taxed to the doctor at ordinary rates, rather than capital gain rates.
3) Delay retirement plan distributions for as long as possible and then withdraw only the minimum required amount. Doctors should plan to tap sources of funds to generate the cash necessary to live on in retirement in the following order — to reduce taxes and maximize net worth. Doctors should utilize practice sale proceeds first, since these will be subject to tax whether the proceeds are saved or lived on. Use Social Security benefits next, consume personal investments thereafter, and dip into retirement plan and IRA proceeds last, to maximize the tax-deferred buildup within these accounts.
4) Minimize or eliminate taxes on Roth IRA conversion. When a doctor sells his/her practice, the practice retirement plan is typically terminated, and the proceeds rolled directly into an IRA. Since most practice sellers typically receive all of the proceeds in cash at closing, all related federal and state income taxes are due in the year of the sale. Thereafter, when the doctor is using the proceeds to live on, there are little, if any, federal or state income taxes. This creates the perfect opportunity for doctors to convert a portion of their fully taxable IRA into tax-free Roth IRAs each year, with little, if any, federal or state income taxes. While all amounts converted are considered as taxable income, they are typically offset by the doctor’s itemized deductions, exemptions, etc. Thereafter, the doctor’s Roth IRA balances will grow with each conversion, and all income and gains will be completely tax-free!
Next month we will discuss the remaining six strategies.
John McGill and Brad Kucharo provide tax and business planning exclusively for the dental profession and also publish the popular newsletter “The McGill Advisory” through John K. McGill & Company, Inc., member of The McGill & Hill Group, LLC. The Group’s members and affiliates serve as a one-stop resource for tax and business planning, practice transition, legal, retirement plan administration, CPA, and investment advisory services. For more information, visit www.mcgillhillgroup.com or call (704) 424-9780.