As a private practice dentist, you have built a small business with a relatively reliable income stream, goodwill, and assets. Its value will provide you with a monetary gain in the year you decide to retire. Have you ever thought about how much your practice will be worth? Better yet, do you understand how it will impact your income in retirement?
Let’s take Dr. Smith for example. She has built a great practice, streamlined her operations, and has a great staff in place. It is a turnkey operation with a good location and solid patients. She has averaged $800,000 in revenue for the last 3 years and now plans to sell her practice to a new associate.
Dr. Smith is offered $600,000 for her practice; and, at 75% of her average revenues, this is a reasonable offer. This is not to say that practices are sold as a percent of their revenues – much more goes in to understanding it’s true value. However, without knowing the specifics and given recent trends in sales, 75% of revenues would seem to be a fair price.
Thus, Dr. Smith will receive a one-time payout of $600,000 for her practice. Of course, the IRS will take their share and, for simplicity sake, let’s assume that all of the proceeds are taxed at a long-term capital gains rate of 20%. Her net proceeds will be $480,000. What should she do with the money?
Reduce Debt or Invest Wisely?
Dr. Smith may still have debt either from her primary home or the proverbial cabin up North. If this is the case, the question always arises – should I pay off my mortgage or invest the proceeds? While there isn’t a harldine answer, there are general guidelines. Your personal situation will provide additional variables to take in to consdeartion, but two factors help dictate the decision: potential return and taxes.
On one hand, Dr. Smith could invest the proceeds in a diversified portfolio targeting a relatively conservative 4-6% annually. There is no sense in taking on high risk at this point in her career, and while any given year of returns may be higher or lower, the portfolio should remain steady. If we assume an average of5% returns, this is actually 3.9% after-tax, or $18,720 in annual income.
On the other hand, let’s assume Dr. Smith has a 30-year mortgage with an interest rate of 5%. She has 20 years left and the original cost of her home was $480,000 (same as the amount of her practice proceeds). There will be a tax benefit from the interest as a deduction; however, in the interest of keeping heavy calculations to a minimal, let’s assume it is immaterial. In order to service this debt, it would cost her $30,920 in mortgage payments annually.
As illustrated below, keeping the debt over the next 20 years will cost her significantly more ($269,040) than she would gain in a taxable investment account over the same time period[1]. Thus, it may be more prudent and financially efficient to pay off the debt rather than invest.
| Amount | Annual Payment/Return | 20 Year Result | |
|---|---|---|---|
| Debt (30 yr) | $480,000 | $30,924 | $618,480 |
| Invest (5% return) | $480,000 | $18,720 | $349,440 |
Of course, if her debt timeline is shorter, her tax bracket is lower, and/or her advisor can reduce the drag on returns through tax-efficient investments, then she may be better off investing. Every client’s situation is unique and deserves the individual attention of an advisor, but the general concepts will apply in most cases.
No Debt, Efficient Investing
In another scenario, let’s assume Dr. Smith was able to pay off all of her debt prior to selling her practice as well as save an additional $2m in retirement accounts. If she had no need for the proceeds from the practice sale, she would work with her advisor to build a tax-efficient portfolio with an appropriate risk profile. Since she will not be required to take distributions from her retirement accounts until the year in which she turned 70.5 years and because those investments grow tax-deferred until that point, part of the goal is to pull as little money as necessary from them as possible and insteand use the taxable returns for income.
If Dr. Smith keeps the proceeds of the sale in a taxable account, she would have $18,720 in annual income without drawing down on the $480,000 in the account. She’ll also be able to tap social security – adding an estimated $33,000[2]. Finally, if she withdraws 4% from her $2m IRA (which should allow her to protect the principal $2m), she will have an additional $80,000 for income. In all, her retirement income would be $130,920 annually while maintaining a liquid net worth of almost $2.5m.
| Account Balance | Income | |
|---|---|---|
| Taxable Account | $480,000 | $18,720 |
| Retirement Accounts | $2,000,000 | $80,000 |
| Social Security | $33,000 |
Annual Income = $131,720
Is that enough? Again, it depends. What are Dr. Smith’s lifestyle needs in retirement? Typically, a retiree will need 85% of their final year’s salary in retirement. Therefore, if Dr. Smith was pulling in $150,000 while working, she should be all set in retirement with the $130,000 from her taxable account, social security, and retirement funds. If there was a need for more money in retirement, we could provide a prudent schedule for drawing down on the $2.5m so as to ensure that her money outlives her.
Beyond simply providing investment solutions and execution, Edge’s wealth division aims to provide comprehensive wealth management. We engage our doctors to think about what they need and want out of retirement and to plan for the unexpected. If you are interested in discovering if you’re on the right path to the retirement you dreamed of, please contact Rob Joyce at Edge Wealth. We would be happy to review your investments and give an assessment of your progress as well as suggested changes, if any.
With conversation comes clarity; and, with clarity, we can put a plan in place to accomplish your financial and life goals. It is never to early or too late to get the answers, to invest with intention, and live confidentally with Edge Wealth.