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Your Number Solved by Douglas Carlsen, DDS

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After you read this article I understand you might have questions and comments for me. I’m ready. Call me anytime at 760-535-1621.

The two queries I hear most often from dentists and see constantly addressed in video, audio, virtual and print media are, “How much money will I need to retire?” and “How much must I save per year?”

Software programs abound that attempt to answer these questions, yet retirement budget is rarely included and is the most important component. This article provides a simple arithmetical way to answer the above questions.

Note: All numbers in this article will be expressed in real, or 2012 dollars. It becomes too complicated to project in inflated dollars as different rates distort the figures dramatically. For instance, most dentists need a bit less than $2 million saved for retirement in 2012 dollars after the practice sale. For a dentist who wishes to retire in 20 years with two percent inflation figured in, $2 million becomes $2.9 million. For four percent, the number is $4.4 million. For five percent, $5.4 million. Many advisors like $5.4 million best, as they can possibly keep you as a client longer.

Always have your advisor use real dollars whenever possible. For our example dentist, we will use a 51-year-old doctor, born in 1959, who wishes to retire at age 66. His current family income is $250,000.1

Retirement Income Approximation
The first number a dentist needs to know is what his actual budget might be in retirement.

B = [N X (1-T)]-M-S-C+R
  • B is retirement budget not including taxes.
  • N is this year’s net income before taxes (net income for sole proprietors; salary plus net practice profit for incorporated doctors).
  • T is the percentage, expressed as a decimal, of income you pay now for personal federal, state and self-employment taxes. That total for a doctor with a $250K income is normally about 35 percent or 0.35.
  • M is your annual mortgage total. Include this number if you will have your mortgage paid off in retirement or will be paid off within five years of retirement. If you will have a mortgage for five years or more in retirement, do not include in above calculation.
  • S is your current annual retirement savings. This includes both taxed-deferred and non-deferred savings. Use zero if you aren’t saving now.
  • C is anything you consistently pay for now each year and won’t in retirement. College and grad school are examples.
  • R is anything else you will pay for consistently in retirement that you don’t pay now. Saving for grandchildren’s college is an example.
[Note: C and R are not included in the example.]

Let’s look at our example doctor. His taxes are 35 percent. His mortgage will be paid off in retirement and it is now $2,000 per month, or $24,000 per year. He is currently saving $3,000 per month or $36,000 annually for retirement.

The retirement budget is $250,000 (his family income) times 0.65 (1-0.35) or $162,500, minus $24,000, minus $36,000. This totals $102,500 and is after taxes are paid. Yes, you will be taxed in retirement, yet at a lower rate, averaging about 25 percent according to multiple dentists’ calculations from ESPlanner.2 Now, let’s find retirement income.

I = B/0.75
I is retirement income.

B is retirement budget not including taxes.

For our example doctor, we use our retirement budget of $102,500 and divide by 1-0.25 or 0.75. Note that 0.25 is the average tax rate paid in retirement mentioned earlier. This provides our doctor a retirement income need of $136,667 in 2012 dollars. This is 55 percent of his pre-retirement income. The 70-80 percent of pre-retirement income commonly used by advisors for retirement analysis was discussed in my March 2009 Dentaltown Magazine article3 and might not be appropriate for most dentists. A retirement budget of 100 percent of the pre-retirement amount is assumed here and is normally very appropriate.

In interviewing many retired dentists, retirement incomes often fall between $110,000 and $180,000, even with pre-retirement incomes more than $500,000.

Retirement Savings
Now, it is time to calculate the amount of savings that our doc will need for retirement (see worksheet below).




 


Assumptions: Retirement is age 66. All amounts are figured in today’s dollars. We account for four percent yearly inflation and it is assumed that investments will average four percent above inflation (the historical long-term average for a 50 percent stocks/50 percent bonds portfolio) before retirement and three percent after retirement. Life expectancy for both spouses is set at 95, and it is assumed all assets will be used during his lifetime. Social security income is an approximation and depends on a history of payments.

The key numbers in the article are B, the doctor’s budget ($102,500); I, total retirement income ($136,667); Line C3, your total retirement savings necessary when you retire ($1,617,240); Line D4, how much additional savings you will need from now until you retire ($789,240); and Line E1, your yearly savings necessary to reach your retirement savings goal ($38,673). The amounts in parenthesis are taken from the example doctor.

How’s our doctor doing? OK. He’s currently saving $36,000 per year and, according to the calculations, he needs to save at a rate of $38,673 per year. The above calculations provide a 50 percent chance that the doctor will not run out of assets before both he and his spouse die. Planners like to see at least a 90 percent chance one won’t run out of money. Using Financial Engines software, our doc would need to save $42,000 per year for a 90 percent chance of not running out of money and $50,000 per year for 95 percent chance. Realistically, he needs to save an additional $500 per month for assured retirement success.

To increase your chance of not running out of money to 90 percent, it might be prudent to increase Line E1, your yearly savings, by 10 percent.

Please note that the exercise on page 66 provides only approximate numbers for educational purposes only. Have a qualified financial planner find your actual projected retirement budget and use a Monte Carlo simulation software program to analyze how much you need to save for retirement. Do not rely entirely on the above calculations as all dentists have different portfolios and different retirement parameters than those listed in the assumptions paragraph.

References
  1. Note that those born in 1960 or later receive full SS benefits at age 67.
  2. ESPlanner can be found at www.esplanner.com. A group of ten dentists I evaluated with current incomes of $200K to $500K had an average projected total taxation of 25 percent in retirement, according to ESPlanner.
  3. Douglas Carlsen, DDS, The Dentist’s Number, Dentaltown July 2009, 48-50.
  4. Calculations taken for SS Quick Calculator at http://www.ssa.gov/oact/quickcalc.
  5. The multiplier of 20.3 is taken for 3percent annual growth from AAII tables for the scenario listed. Planners use various numbers. Many now like to use a very conservative 25 multiplier.
  6. Sections C, D, and E were modified from worksheets from the Employee Benefit Research Institute, the American Savings Educational Council, and the American Association of Individual Investors.


Author's Bio
Douglas Carlsen, DDS, owner of Golich Carlsen, retired at age 53 from private practice and clinical lecturing at UCLA School of Dentistry. He writes and lectures nationally on financial topics from the point of view of one that was able to retire early on his own terms. Carlsen consults with dentists, CPAs, and planners on business systems, personal finance and retirement scenarios. Visit his Web site: www.golichcarlsen.com; call 760-535-1621 or e-mail drcarlsen@gmail.com.
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