Personal Finances: Quitting Time

Every day you hear about another major corporation’s retirement plan imploding. Or you read another dire prediction of Social Security insurance shortfalls. But you’re going to be OK. Right?

Sure, most physicians will earn enough over a career to finance secure, comfortable retirements. But how much security and comfort were you planning on?

Are you positive you are putting away enough money to meet every retirement goal you have? Maybe it’s time to give your retirement strategy a routine checkup.

Many physicians who are retiring now started out in the 1970s with promises of lucrative buyouts from younger partners when it came time to hang up the old stethoscope. For most docs, that strategy hasn’t worked.

“It’s a whole different environment now,” observes Neil Brooks, a family physician who retired three years ago from full-time practice in Rockville, Conn. “Young physicians must be more proactive than we were. We didn’t have to think very strongly about the details of saving because we knew we’d always make a little more every year. It’s not as easy anymore.”

Even if your retirement strategy is a little rusty or if you haven’t taken time to nail down the details of living off your savings, experts say you can still get back on track for a comfortable retirement - one that won’t have you wearing a paper apron and serving French fries.

Whether you are just starting out or are nearing retirement, it’s never too late to plan and save, experts say. But the longer you wait the more compromises you may have to make. Or as James P. Sacher, a CPA and partner with the Cleveland-based financial consultants Skoda, Minotti and Co., likes to tell his clients, “Failing to plan is planning to fail.”

“Every time I hear someone say, ‘I don’t have time to do all this planning,’ my reply is that you don’t have time not to do it because waiting just creates much bigger issues down the road,” he says.

Get started

Once upon a time, physicians could rely on hefty buyouts from partners to add to their retirement nest eggs. No more.

Bruce Johnson, an attorney with the Faegre and Benson law firm in Denver, says the buyout concept is no longer something to plan a retirement around. “It’s now fairly rare to see a huge buyout or some huge parachute for doctors when they leave practice; instead it’s usually some cash for their share of depreciated hard assets.”

So if there’s not much cash to gain from the partnership agreement, what should you do?

Or perhaps the better question is, where do you start? After all, as a young physician you are probably busy trying prioritize your flow of cash into paying off educational debts, buying a house, perhaps starting a family, and saving for the ever-increasing cost of college education.

Erik W. Thurnher, an emergency physician for Kaiser Permanente in Irvine, Calif., and a certified financial planner, suggests gathering up your banking, savings, and brokerage statements as well as insurance policies, retirement plan statements, and a list of current monthly expenses. Rank your goals - debt payoff, retirement savings, etc. - in priority order, and identify a cost for each. Determine if any of your lesser-ranked goals can be delayed or reduced temporarily without penalizing your ability to get to that goal. For example, you may want to pay off your mortgage in 20 years instead of an accelerated 15 years to allow you to continue making the maximum contribution to your retirement account.

“When you’re starting out is the time to establish good financial habits, not overspending but also getting good investment practices ingrained,” Thurnher says. “If you get started in the wrong direction, or just don’t get started, it can have a long-term impact on your financial well-being.”

As a physician, you are already late to the savings game with a career that probably didn’t start until you were in your late 20s or early 30s. In other words, that plan you had to retire by age 58 had better get in gear, and fast.

“The biggest mistake we see is the younger physician not taking advantage of their practice’s retirement plan by putting as much as they possibly can into it,” Sacher says.

He says to think of retirement savings as paying yourself first. He urges young physicians to manage their other financial obligations around retirement planning because you only have one chance to put money into a retirement plan at a young age. “Through the miracle of compounding, contributions made at a young age will really pay off in retirement,” he says.

Brooks says that making the maximum contributions early in his career meant less pressure to constantly plan and re-plan his general retirement savings strategy, which was to simply contribute the maximum allowable into a qualified plan.

“It’s amazing to see how much what may now seem like little amounts saved each month over the years has added up to,” he says.

Thurnher uses the example of two young physicians who want to retire at age 58. Doctor A starts saving immediately after residency at age 28, and contributes $20,000 per year to her retirement plan. If she earns the historical stock market return of 11 percent, she’ll have about $3.9 million by age 58. Doctor B, who delays his savings plan until age 33, can make identical contributions and earn the same returns, but will end up with $2.3 million - 40 percent less.

Ronald Paprocki, a Chicago attorney and certified financial planner, cautions young physicians to avoid the temptation of shifting too many resources to a narrow set of financial goals, such as paying down educational or mortgage debts rapidly.

“Too often, when young professionals approach these decisions at all they fail to see the financial impact of how a strategy to pursue one goal might affect reaching the other goals,” says Paprocki, whose firm Mediqus Asset Adviser focuses on financial and investment advisory services to physicians.

Failing to look at the bigger financial picture can hold other hazards to your financial health, he says. For example, trying to accumulate money rapidly but failing to do adequate estate planning or protecting personal assets from creditors can leave you open to disaster should you lose a large court judgment or take a big business loss with personal wealth pledged as collateral.

And don’t ignore the biggest enemy of them all: procrastination.

“In spite of the great amount of data and information now, and how easy it is to get to it and use it, they (physicians) are still procrastinating, and procrastination is the number-one obstacle to successful retirement. It’s interesting how that has not changed in the 28 years I’ve been doing this,” says Paprocki, coauthor of the book, The Prescription for Financial Health: An Authoritative Guide for Physicians.

Midcareer crisis

A fever seems to take hold of physicians when they reach their mid- to late-40s: They have a burning need to see where they stand in their retirement savings planning, says Thurnher.

“As you start getting closer to retirement, you should do cash flow-based financial planning,” he says. “Look at all of the cash flows and try to more carefully estimate what you are going to need to live on in retirement.”

Thurnher and other financial planners use a variety of software tools to help clients analyze how living costs may change and the probability of reaching savings goals under scenarios of how various allocations of investments may perform.

A rule of thumb you may have heard is that spending in retirement will be 90 percent or even 80 percent of your current spending. Not so, says Sandi Weaver, a certified financial planner and CPA who runs Financial Security Advisers in Prairie Village, Kansas.

“Most folks have more time after they retire and want to be active, so the standard of living really doesn’t drop,” Weaver says. “If you are spending a third of a million a year now, having a $1 million or $2 million nest egg isn’t going to do it. That’s just three to six years banked.”

At midcareer, physicians should start putting hard figures on their post-retirement annual living budget. The detailed planning exercise should start at least 10 or, better still, 15 years before retirement.

Thurnher observes that annual spending declines as people get older. As mortgages are paid off, the costs of disability, life insurance, and certain other expenses drop away. In addition, your most active and expensive hobbies might also be retired as you get older. Many retirees move to smaller houses or even relocate to slower-paced and cheaper locales, he says.

One thing not to count on is dipping deep into the future equity of your home or other real estate. Thurnher recommends using “very conservative estimates” of real estate growth rates of 3 percent to 4 percent annually.

“Don’t overestimate how much real estate equity will be there for retirement spending,” he says. “There’s been so much above-trend real estate appreciation recently that it’s best to use over-conservative estimates.”

Is it too late?

It’s never too late to beef up your retirement account, but it can be almost too late.

Weaver often sees physicians who failed to nail down enough details of retirement and now face tough choices in their late 50s: work longer or trim retirement spending or both.

Thurnher says the first step is to crunch the numbers. “Doing this process will give you a much better sense of what you need to save between now and retirement. You might find your current plan is adequate after all,” he says.

Weaver observes that many of her savings-starved physician clients can save more money by maxing out retirement savings, putting cash into taxable accounts, and then taking budget-cutting steps like downsizing primary residences, revising post-retirement travel plans, and stop playing lender-of-first-resort for their grown children.

More common is the physician who wants to ramp up retirement savings beyond the limits allowed under the rules of the practice’s qualified plan. Those plans feature tax-free contributions, tax-deferred growth, and protection from creditors, but place ceilings on annual contributions.

For example, federal rules allow you to contribute a maximum of $15,000 annually to a profit-sharing 401(k) plan and an additional $5,000 if you are over age 50. Rules intended to prevent retirement discrimination also limit how much additional money the practice’s partners can contribute to their own retirements under profit-sharing plans. Sacher notes that federal rules would not allow you to contribute substantially more to profit-sharing than your other partners. And you should not count on younger partners to dramatically boost their profit-sharing contributions just to help you out.

A number of medical practices are setting up defined benefit plans. While these plans are losing favor elsewhere - they cover just 20 percent of private-sector American workers now - they seem to be making a comeback at physician practices.

“Several years ago, we never would have talked about defined benefit plans, but now we’re having that conversation regularly,” says Sacher. “That’s because the physician population is getting older and more are thinking about ways to put away money into a qualified plan.”

These more traditional retirement savings vehicles use formulas based on the average compensation a physician earned in his final five years of practice. Such plans can greatly benefit older physicians. Unfortunately, hiring the actuaries and legal advisers to set up a defined benefit plan isn’t cheap. Annual administration costs can easily top $5,000, making them much more expensive to operate than a profit-sharing plan with a 401(k) saving option.

Adds Sacher, if you have too many older workers or physicians in your practice, the required minimum contributions can be costly. Because these plans cannot be easily discontinued and must be adequately funded each year, younger physician partners may balk at taking on a commitment that will be around long after you’ve left.

Other ways to save

To continue saving for retirement once you max out federally qualified retirement savings plans, you may opt for either a nonqualified retirement plan or taxable savings, such as mutual funds, stocks, bonds, or other investments. Protecting these assets from creditors isn’t a given, and taxes are also a consideration.

Thurnher says taxable investment accounts are not as bad as they sound. Changes in federal tax law have reduced both long-term capital gains rates and qualified dividend tax rates to just 15 percent. Many financial planners expect that Congress will extend these tax breaks beyond their scheduled expiration in 2008.

“You just have to be careful to not let the tax tail wag the investment dog, so to speak,” he says. Even if today’s low tax rates on capital gains and dividends go away, there are other ways to minimize your tax burden, such as seeking growth-oriented investments or matching gains and losses.

It’s also possible to purchase life insurance or annuities that are protected from creditors and many types of judgments. Setting up trusts can provide some protection, too, says Paprocki. Your state may allow you additional options, such as transferring taxable assets into a domestic asset-protection trust.

But don’t get so focused on asset protection that you forget why you are putting that money away in the first place: to save for your retirement. “You want to make sure you are not choosing something for all of one type of benefit to the point you overlook some of the drawbacks that might be there,” Paprocki says.

Physicians and other high-earning professionals can choose an array of nonqualified plans that allow them to defer taxes. However, many experts suggest avoiding them. While nonqualified plans may offer much more generous contribution limits and no early withdrawal penalties, they are generally built on what Johnson calls “creative approaches,” such as using life insurance or annuities.

Johnson says he sees those plans infrequently and only then at smaller medical practices. “Two or three physicians may be able to talk themselves into one of these more creative plans,” he says. “But as a practice gets larger, more people are involved and there’s less chance they’ll all want to get into something that’s not completely qualified and pretty risk-free in terms of being suspect or disqualified.”

Another option to rapidly increase retirement savings with some level of protection is a 412(i) defined benefit plan. A 412(i) plan buys annuities or life insurance so your employer - your practice - can make significantly higher annual tax-deductible contributions for you. The plan may allow your practice to exceed the much-lower limits on profit-sharing contributions. While a 412(i) looks attractive if you are over age 50 and want to ramp up retirement savings, experts say to tread cautiously. The 412 plans widely touted by commissioned salespeople could be trouble, Paprocki says.

“These plans, because they have been oversold, may come under attack from the IRS at some point and you should be careful,” he says.

Sacher says many nonqualified plans seem to work out better for the person selling the plans than for the physicians who purchase them. “Besides, if it’s a nonqualified plan and the physician corporation doesn’t get a deduction for it, why would the practice want to use it as opposed to a qualified plan?”

Bye-bye buyout

If you were thinking that maybe, just maybe, there would be a little retirement cash from that buyout agreement you signed years ago, think again.

Johnson says that today’s buyouts are linked to “real money,” often a proportional share of the depreciated value of the practice’s hard assets (furniture, fixtures, etc.). For example, a physician leaving a six-physician practice with $1 million of equipment might expect to receive one-sixth of the depreciated value of that equipment. That is, not $166,666, but a lesser amount, depending on the age and current depreciated value of the equipment. Many buyout agreements place a higher value on such equipment than the lower value that has been declared for tax purposes under an accelerated depreciation calculation.

The buyout for your portion of your practice’s real estate corporation could be substantial depending on the equity. But never mind about getting paid much for all of those patient charts you brought into the practice, says Sacher. He points to an unpublished IRS opinion and his company’s evaluations that both place the value of patient charts
at $12 to $22 dollars each, and sometimes less.

“Payment of charts and goodwill are really more of a professional courtesy gesture,” says Marshall Maglothin, MBA, president of Blue Oak Hill Consulting of Holden, Maine. “If anyone’s going to pay you anything for your charts, they are really just saying thank you for helping to build the practice.”

While the delicious buyouts have gone away, soon-to-retire physicians should still pay attention to how they can ease out of full-time practice. You may want to transition to a pace in which you can explore new avenues of your profession instead of just perfecting your golf swing full-time. A carefully designed buyout arrangement that allows a period of time to ease out of full-time practice is becoming a common preretirement perk. But Johnson says the tricky part is setting the price and terms of the preretirement slowdown. Namely, what’s the ultimate cost to the practice for you to ease out, and how many other physicians want to do the same thing at the same time?

“If you’re not careful, you’ll get a practice that’s a lot of part-time workers,” Johnson says. “The partners have to think of what’s good of the practice, not just you.”

Getting advice

So how do you get started with all of this planning? Paprocki and others suggest using retirement planning software tools offered on many major mutual fund and investment planning Web sites. These tools may not be sophisticated enough to plan a multimillion-dollar retirement in detail, but they will get your mental wheels turning.

Weaver suggests finding a financial planner who can work well with the other experts you will likely need, such as your accountant, a life and disability insurance agent, and your attorney to evaluate buy-sell agreements and estate-planning options.

She also recommends asking if your adviser is on a fee-only basis or paid by commissions on what she or he sells you.

A typical fee-only arrangement may charge:

• One percent of the assets managed. Try to negotiate fees downward when your portfolio tops $1 million, Weaver says.

• An annual retainer based on the number of hours the adviser will spend on your account. Although retainers could run from $10,000 to $50,000, it may still be less than paying 1 percent of your assets for the advice, she says.

• An annual fee based on a combination of your portfolio’s assets and annual income.

Weaver says she meets new clients at least four times during the first year, and makes several telephone calls to help get their portfolios in shape. After that, she meets with them twice a year - one meeting to focus on investments and the other to focus on financial planning.

Ask your adviser to also send you quarterly statements with executive summaries showing your rate of return, how much you have invested, and where it is invested. Retirement projections should be revisited at least every two or three years to make sure you are making progress, she says.

How do you know you’ve found the right adviser? After all of the credentials have been checked and the fees compared and rates of return judged, “The most important determinant has to be the comfort level you have with your adviser,” Paprocki says.

Bob Redling is a freelance writer and a former editor of Physicians Practice. He can be reached via editor@physicianspractice.com.

This article originally appeared in the May 2006 issue of Physicians Practice.