JADA Continuing Education
Understanding retirement finances
A challenge everyone faces
SANTO LOPORTO, B.S.
At about age 55 years, most people catch themselves daydreaming about places they want to visit and things they want to do in retirement.
Retirement is everyone’s favorite dream, including dentists. But daydreaming won’t make the dream come true. The only way to guarantee the comfortable and secure retirement that dentists deserve is to have a solid financial plan of action. Of course, one must follow the plan and make financially wise decisions along the way.
Participation in a tax-deferred retirement program is one of the smartest things anyone can do.
Since most dentists are sole practitioners or work in a small partnership, they do not have the traditional company pension and benefit package that many people in the corporate sector have available. As a result, they often are left to their own devices when coming face to face with the complexities of retirement planning. It is especially crucial for them to have a carefully thought-out retirement plan.
The fact is too many dentists drift toward retirement with no clear agenda and no action plan. Countless surveys report that retirement is the number one financial goal for Americans of all ages,1 but these same surveys show that most Americans do not save enough for their golden years and find retirement planning a huge challenge. There are many stories out there about retirees, including well-educated professionals, who did not adequately plan for retirement and found themselves with much too little, too late.
The goal of this article is to provide information that will assist dentists in taking the steps needed to achieve a financially secure retirement, while avoiding missteps. I hope the information provided below will help improve your chances of having a comfortable and financially secure retirement.
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IS IT POSSIBLE TO RETIRE AND MAINTAIN ONE’S LIFESTYLE?
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The answer is "yes." A growing number of people are enjoying their retirement years in financial comfort, and some are even able to retire before age 65 years. Many early retirees owe their good fortune to the long-running bull market and smart stock investments made in their tax-deferred retirement plan.
Participation in a tax-deferred retirement program is one of the smartest things anyone can do to improve his or her chances of achieving an early and comfortable retirement. It also can offer vital flexibility in the management of one’s retirement savings.
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HOW MUCH RETIREMENT INCOME DOES ONE NEED?
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Most experts say that retirees will need an income equal to about 70 percent of their preretirement income.2 Based on current life expectancy charts, sufficient total assets will be needed to support that income level (plus inflation) for 25 or more years of retirement.3
To estimate living expenses during retirement, dentists need to calculate all major expenses. Include housing and related costs such as property taxes and utility costs; food; clothing; car and transportation costs; income taxes; health care and insurance costs; entertainment and vacation expenses; charitable contributions; and any debt payments.
When estimating expenses, it is important not to be too conservative. Remember that entertainment expenses will go up, since most people would like to travel more during retirement. So will utility costs, because most people will be home more as well. Expect health care costs to rise as one grows older. In addition, inflation will ratchet up many costs by about 4 percent every year. The box
("Estimated Annual Retirement Expenses") provides a work sheet to aid in calculating these costs.
Sources of income.
Dentists should examine some basic sources of retirement income, starting with Social Security. The Social Security Administration will estimate anyone’s benefit. (The toll-free number to order a free Personal Earnings and Benefit Estimate Statement is 1-800-772-1213; online requests can be made at "www.ssa.gov".)
It is important to remember that Social Security retirement benefits cannot begin until age 62 years, and people who decide to collect at that age will receive benefits that are 20 percent lower than they would be at age 65 years. The benefit will be more than 13 percent lower if one begins drawing benefits at age 63 years and nearly 7 percent lower at age 64 years. Any plan that includes retirement before age 62 years must take into account the lack of Social Security benefits during these initial years.
Spousal income.
Another important component to include in planning is the income of one’s spouse. He or she may have a traditional company pension plan that many dentists do not have, plus other tax-deferred and taxable retirement savings accounts, as well as access to group health insurance coverage and other benefits.
Beginning at about age 45 years, one should estimate the current value of his or her retirement nest egg. Retirement income resources include all tax-deferred qualified accounts and any Simplified Employee Pension, or SEP, plan or individual retirement accounts, or IRAs. In addition, dentists should include any taxable assets set aside for retirement purposes, such as individual stock holdings, bonds and savings accounts. Regardless of one’s age at retirement, the biggest portion of retirement income will come from this collection of assets. Adding it all up will provide a good estimate of just how large the retirement nest egg is.
Estimating the size of one’s nest egg is easy compared with trying to determine how much it will grow by the time retirement arrives. For any retirement plan to work correctly, it is necessary to know how long one’s retirement assets will last once regular withdrawals begin to be made.
Many experts say it is safe to assume an average annual inflation rate of about 4 percent and an average annual investment gain of about 8 to 10 percent on a typical retirement investment portfolio, consisting of the major asset classes of equity, debt, and long- and short-term fixed or guaranteed-return investments.4 The proportion of the portfolio in each class is based on one’s risk tolerance, time horizon and investment comfort level. People who retire in their late 50s, according to the life expectancy charts, can expect to enjoy 25 or more years of retirement.3
Figuring out how much one can safely withdraw from his or her retirement assets each year to pay for living expenses is the next step. Many experts say it is fairly safe to withdraw about 4 percent of the total value of one’s retirement assets each year, as long as an investment strategy is maintained that enables the funds to continue to be replenished. For example, one typically would be able to withdraw $40,000 a year from a retirement portfolio valued at $1 million. If stock investments perform well, more money can be saved or withdrawn, but if the underlying investments falter, withdrawals may have to be cut back.
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WHAT IS THE MOST EFFECTIVE WAY TO DRAW ON ONE’S NEST EGG?
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One of the first big decisions people face when they retire is what to do with the money in their tax-deferred retirement plan. Unless one expects a huge inheritance or other windfall, the tax-deferred retirement plan probably is a retiree’s single largest retirement asset. Handling it correctly is one of the most important financial decisions anyone will ever make.
Unless there is a pressing need for the money, leaving it where it is almost always is the right decision. Any money taken out of a qualified tax-deferred retirement plan will be taxed at the same rate as ordinary income. If the money is taken out before age 59
years, an early withdrawal penalty will be assessed and an additional tax penalty equal to 10 percent of the taxable amount may be due. Early withdrawals hurt in another way too, because the opportunity for further tax-deferred growth is lost.
Handling the tax-deferred retirement plan correctly is one of the most important financial decisions anyone will ever make.
Most financial advisers recommend that people use taxable assets before withdrawing assets from tax-deferred plans.5 The guiding rule is that one should refrain from making withdrawals from any tax-deferred retirement programs for as long as possible.
The first retirement dollars, therefore, should come from dividends, interest and mutual fund capital-gains distributions from one’s taxable portfolio. Since that money is taxed every year anyway, it makes sense to spend it first. The next thing to consider is selling off any taxable investments. Once again, the rationale for this is based on the fact that capital gains tax will have to be paid on any appreciation anyway. The tax bill still will be lower in most cases than the loss in tax-deferred growth resulting from withdrawal from a tax-deferred retirement account.
Once the majority of taxable investments are depleted, and age 59 years has been reached, it is safe to begin withdrawing money from tax-deferred retirement assets. Basically, there are two payout choices—the "term-certain" method and the "recalculation" method. In the term-certain method, the number of payouts is established up front and the payout never changes. The recalculation method requires recalculating withdrawals each year based on life expectancy.
Financial advisers recommend that most people choose term-certain payouts because they maximize the period of time during which the money will grow tax-deferred and leave more money for beneficiaries and heirs.6
Part-time work.
Working after retirement also can be a significant source of income. Some people might want to work part time, especially if they retired early and Social Security benefits are not yet available. One recent survey of retirees estimated that as many as 40 percent will do some kind of full-or part time work.7 Opportunities are out there to explore, and for many people they offer the chance to pursue a field of interest while supplementing their income.
Delaying retirement.
Another consideration is pushing back one’s retirement date a bit. While retiring as early as possible is almost everyone’s dream, we must also be realistic. If calculations reveal that a retirement portfolio isn’t yet ready to support the lifestyle planned, delaying the date by a year or two can be a solution. Delaying retirement can make an important difference in the amount of money needed to be saved. If a dentist decides to retire at age 62 years, for example, instead of age 60 years, he or she has two more years to build up savings and two fewer years needed to make withdrawals.
There are several ways to determine if one needs to delay retirement. One way is to put the planned amount of retirement income estimates to the test. Some retirement planners recommend that people nearing their estimated retirement date try to live on the expected retirement income for several months before actually retiring. When doing so, however, don’t include preretirement expenses such as business insurance, office or equipment lease payments, and commuting costs. Short of that, the work sheet (Box
) can be used to estimate annual expenses in retirement.
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WHAT SHOULD ONE’S INVESTMENT STRATEGY BE AFTER RETIREMENT?
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As retirement age approaches, it is important to begin a more conservative investment strategy. The reason for this is that more aggressive investment components may underperform at any time and a shrinking time horizon may not offer the opportunity to recoup the investment. Tone down the stock component as retirement nears and take conservative measures by adding bond funds, for example, and selling off aggressive stock funds. (A good rule of thumb is to have the conservative percentage of one’s portfolio equal to one’s age.) Maintaining a diversified portfolio also is important. By investing in several investment categories (that is, equity, long- and short-term debt, and guaranteed or fixed-return investments as well as different sectors of the equity and debt markets) and separate funds or instruments, one is more insulated from negative performance in any one investment category.
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WHAT ARE THE ISSUES TO BE AWARE OF BEFORE SELLING A PRACTICE OR HOME?
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Since most dentists are sole practitioners or work in a partnership, selling the practice or disengaging from a partnership is another financially important step to take as retirement nears. A good business succession plan might include bringing in a partner who is willing to buy the practice from the dentist contemplating retirement. If ownership of the practice is shared with a colleague, a buy-sell or shareholder agreement should be in place to help smooth the transition.
In addition to consulting with an attorney and accountant before selling the practice or partnership interest, dentists should consider seeking the help of trained real estate professionals who can appraise the value of the dental practice and help find a suitable buyer. Of course, the proceeds from the sale of the practice should be added to one’s retirement portfolio.
Move or stay.
Deciding where to live is one of the biggest issues retirees face, and it can have a significant financial impact. Conduct all of the research before retiring and visit any locations that seem appealing. Housing and housing costs will be lead items on the expense work sheet. Some things to consider are the variety and supply of housing and the affordability of homes or apartment rents.
In addition, prospective retirees should investigate the climate, cost of living, cost of moving, taxes, crime, health care facilities, shopping facilities, social activities, recreational and cultural facilities, and any other important considerations. One caveat: go slowly. It usually is better to rent or lease one’s present home and then rent or lease a home in the retirement community. After six months or so, a decision can be made about whether to move there permanently.
Selling a home.
Because of changes in the tax law, selling a house has become a tantalizing option for many potential retirees. Tax laws now allow a $250,000 per-person exclusion from the capital gains tax on home sales and a $500,000 exclusion per couple. This is particularly good news for retiring couples who have owned their home for a long time and can expect to reap a large profit if they sell. They can relocate, trade down to a smaller house and add a nice sum of money to their retirement resources.
Dentists should consider seeking the help of trained real estate professionals who can appraise the value of the dental practice and help find a suitable buyer.
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WHAT ARE THE ISSUES TO BE AWARE OF IN HEALTH CARE COVERAGE?
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This is an area where a misstep can take a big bite out of a dentist’s retirement savings. Look for a plan that offers the best possible coverage with premiums and an out-of-pocket deductible that are affordable. Usually, the best deals are available through groups, such as the ADA or other professional organizations. Make sure that existing health insurance will be valid at least until one qualifies for Medicare at age 65 years.
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SHOULD ONE SEEK PROFESSIONAL ADVICE BEFORE RETIRING?
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Because retirement planning is so complex, it is wise to enlist the help of a good financial planner. Many prospective retirees say they feel enormous pressure when finally coming face to face with all of the decisions they must make regarding their retirement finances. An increasing number tell me they need the regular counsel of a professional financial adviser. A skilled adviser can help minimize taxes and help people make successful investment decisions.
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CONCLUSION
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I recommend that dental professionals listen to the high percentage of retirees who say they wished they had spent more time analyzing their retirement needs before they retired.1 Remember to design a plan and review it often. It is never too early to begin planning, but one should have an action plan mapped out by age 40 years. Set goals and checkpoints along the way to be sure you are on track. Use accounts and plans designed for retirement income, such as IRAs, SEPs, 401(k)s and other types of qualified plans. Monitor investment performance and rebalance the portfolio when necessary to maintain the investment strategy. Finally, seek out trusted professionals to help maximize returns and avoid missteps.
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FOOTNOTES
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Mr. LoPorto is an assistant vice president, The Equitable Life Assurance Society, 200 Plaza Drive, Secaucus, N.J. 07094, e-mail "santo.loporto{at}axacs.com". Address reprint requests to Mr. LoPorto.
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REFERENCES
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- Newman BW. Having a dream vs. paying for it: something’s lost in the translation. Available at: "www.401kafe.com/library/articles_retire.html". Accessed Dec. 27, 2000.
- Sullivan J. Post retirement planning: a key issue for the next century. Benefits and Compensation Solutions Magazine May 1997. Available at: "www.bcsolutionsmag.com/Archives/May1997/pstret.htm". Accessed Dec. 27, 2000.
- Reference for life chart. Available at: "www.retirelink.com/education/LifeExpectancy.html". Accessed Dec. 27, 2000.
- Perkins Coie Employee Benefits Group. Understanding your retirement plan options: retirement plans for growing businesses. October 1999. Available at: "www.perkinscoie.com/resource/eb/retplan.htm". Accessed Dec. 27, 2000.
- Welch JS. Optimal distributions from a tax-deferred retirement account. 1996. Available at: "www.i-orp.com/model.html". Accessed Dec. 27, 2000.
- Linton C. How to turn your retirement money into an income stream. Available at: "www.401kafe.com/library/articles_retire.html". Accessed Dec. 27, 2000.
- Aging information’s fact of the month. Available at: "www.benrose.org/aging/facts.asp". Accessed Jan. 9, 2001.
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