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Practice Management: The Dentist's Number Douglas Carlsen, DDS

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The Number is constantly referenced to identify the actual amount of money one needs to retire comfortably. Let’s take a closer look.
by Douglas Carlsen, DDS

Over the last three years I’ve conducted a survey of retired dentists to find consumption habits and income needs. Pre-retirement family incomes range from $120,000 to $800,000. Incredibly, I’ve found a clustering of retirement income at $140,000 per year. Of interest is the doctor who earned $800,000 in his practice and is now living on a retirement income of $155,000. The retirement incomes found are nowhere near the oft-touted 80 percent of pre-retirement income used by many financial planners. Is there a flaw in the planners’ reasoning?

According to Laurence Kotlikoff, professor of economics at Boston University, “The replacement rate method of retirement income calculation is a horrible offender... It generates over-targeting mistakes on the order of 50 percent.” ¹

In further research, I’ve found the 80 percent replacement retirement income rate most planners rely upon is based upon calculations done by the Center for Risk Management and Insurance Research at Georgia State University. The 80 percent figure does not include Social Security Benefits. Especially in this cloudy financial environment, economists are in agreement that the last pillar of any retiree’s financial fortress to fall will be Social Security. Using Social Security benefits, the final net replacement rate at the highest income studied, $90,000, ranged from 37 percent to 55 percent, depending on earning status of couples.² The range I have found for retired dentists is 15 percent to 70 percent with an average of 60 percent.

Using Bureau of Labor Statistics information for higher income retirees and interviews from dentist retirees, I have devised a retirement income projection form³ to estimate retirement income scenarios for dental couples. Please note that any income estimate needs to be checked closely by your financial planner or CPA.

Once we have a projected retirement income established for a dentist, we can easily determine the total amount of savings needed to retire – the number and how much per year he will need to save to reach that goal by a given date in the future. Let us evaluate four scenarios:

Dr. Average
Dr. Average is a 53-year-old boomer dentist who has savings of $225,0004, an income of $200,000 with a spouse earning $40,000, who wishes to retire at 66. All calculations in this article use 2009 dollars. The math is a little sticky in this section, but rest assured it eases up for the last three doctors.

First, we calculate Dr. Average’s retirement income need:
I assume that in retirement Dr. Average will have his home paid off, have all children out of the house, and will spend similar to that while practicing. According to the retirement income projection form, Dr. Average will need the average of $140,000 pre-tax income in retirement.

Now let’s find his “number” using standard retirement tables.5

Our average boomer Dr. Average will not work part-time in retirement, will have no inheritance and will have no rental income. He will generate $16,000 per year income from the sale of his average practice ($400,000 after fees at withdrawal of four percent per year). His family social security benefits will be $42,000. Almost all dentists will max out with $28,000 in social security benefits per year at age 66, with spouses receiving at least $14,000 due to the spousal benefit provision.

After subtracting the above $58,000 from the necessary $140,000, Dr. Average needs to generate $82,000 per year in retirement from savings. An annuity multiplier to age 95 shows $1,361,200 in total personal savings needed. This is his number!

Dr. Average currently has $225,000 saved, which will grow to $371,250 by retirement. Conservative estimates with a 50/50 equity/fixed income portfolio were used for our dentist’s pre- and post-retirement portfolio. Therefore, Dr. Average will need to save $989,950 in the next 13 years. Another calculation reveals that $59,000 annual savings will be needed until his retirement target age of 66. On a family income of $240,000 with a mortgage and high tax rate, $59,000 is nuts! Postponing retirement for two years lowers savings needs to $37,000 per year – much more manageable. Another option: our doctor could sell the practice at age 66 and work two days a week for four years. In this scenario, he needs only save $33,000/year until age 66.

Dr. Smart
Our next dentist had $1 million saved at age 58 and was on track to retire at age 62. He is able to save $50,000 per year. His practice value and all other variables are identical to Dr. Average. Due to the market crash of 2008, he now has only $700,000 and wonders how many more years he needs to work past his goal of age 62.

Using standard tables as before, we find that if Dr. Smart works for two-and-a-half more years, to age 64, he will likely have the proper savings to retire on an income of his projected need of $140,000 per year.

Dr. Downturn
Our next example is a dentist who, like Dr. Average, has minimal savings of $225,000 at age 53. He sustained a decline in business in 2008 and saved nothing. He also thinks he will not be able to save for the next two years, finally returning to savings ability in 2011. From age 56 on, he believes he will be able to save $30,000 per year. When will he be able to retire on an income of $140,000 per year?

Assuming that his portfolio of $225,000 grows little in the next two years and that it grows at a historical rate thereafter, Dr. Downturn will be able to retire at age 70.

Dr. Ritz
Let’s examine a scenario that happens more often than is published. Our 60-year-old dentist has nothing in savings, has an average boomer family income of $240,000, and will have a $3,500/month mortgage for the rest of his foreseeable life. Dr. Ritz hopes to have all debt except his mortgage paid off by age 65, yet cannot see savings as possible until age 65. At that time, he will be able to save $50,000 per year. The one bright spot is that his high-tech practice will net at least $600,000 in today’s dollars.

Under what circumstances may he retire, and when? If Dr. Ritz can save $50,000 per year starting at age 65, he will more than likely be able to retire on an income of $182,000 – remember he has a $42,000/year mortgage – at age 74.

Additional Years
One of the key points of any retirement scenario is that additional years in the work force make the largest difference in savings needed. As seen above, two additional years for Dr. Average decrease his yearly savings needed by more than $20,000. As Dr. Ritz illustrates, even one who has committed savings crimes year after year has a chance to catch up rather quickly after age 65.

There were numerous assumptions involved in the above dentist’s calculations involving portfolio returns, life expectancy and average consumption habits. All calculations were done using standard tables provided by the end noted organizations and cross referenced to a 90 percent success rate using Financial Engines (financialengines.com), a sophisticated Monte Carlo online program that utilizes thousands of market scenarios from the last 100 years. Please contact me for further details.

Note: couples need to generate a retirement income estimate before calculating retirement savings needs. The 80 percent rule may not be appropriate for many professionals, according to Dr. Kotlikoff and others.

The information provided in this article should not be construed as investment advice. Please meet with a qualified investment adviser to finalize the amount you need to save for retirement and to develop a proper plan to achieve your “number.” But please make sure he or she doesn’t just pull an income figure out of the air!

Bibliography
  1. Laurence Kotlikoff, “Why Target Practice Equals Financial Malpractice,” Investment News, June 11, 2007.
  2. Bruce A. Palmer, Ph.D, “2008 GSU/Aon Retire Project Report,” Tables A-1 to A-4, downloaded at http://rmictr.gsu.edu/Papers/RR08-1.pdf on January 3, 2009.
  3. Available by contacting me at drcarlsen@gmail.com.
  4. According to Michael Gerber, author of The E-Myth, and Amy Morgan, CEO of Pride Institute.
  5. Worksheets from Employee Benefit Research Institute America Savings Educational Council, and American Association of Individual Investors.
Author’s Bio
Douglas Carlsen, DDS, owner of Golich Carlsen, retired at age 53 from a 25-year private dental practice and clinical lecturing at the UCLA School of Dentistry. He writes and lectures nationally on retirement and financial topics from the point of view of one who was able to retire early on his own terms. Dr. Carlsen consults with dentists, CPAs, and planners on business systems, personal cash flow, and retirement scenarios. Visit his Web site: www.golichcarlsen.com; call 760-798-0886 or e-mail drcarlsen@gmail.com.
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