8-step financial plan for dentists
Facts are facts. Dentists have a more condensed window for achieving financial independence when compared with other career paths. Before their first day as a practicing owner-doctor, the typical Dentist has racked up a few hundred thousand in student debt, been through dental school, residency program, and at lease 2 years of clinical work in someone else’s practice before being eligible to receive bank funding for their first practice… Late start… Piles of debt… It’s no wonder why the majority of dentists fail to accumulate a sufficient retirement fund by the age of 65! Dentists must be meticulous money managers to overcome these hurdles, but unfortunately, with countless financial obligations jockeying for the owner-doctor’s attention, things inevitably fall through the cracks and return on dollars are lost. To help you avoid this, and ensure the surplus cash flows from your practice are going to their most efficient use we’ve designed an 8-step financial plan for dentists to help practice owners organize their debt and retirement savings goals.
Pay off credit cards and other high-interest debt
Credit card interest payments can be upwards of 20% and are generally non-tax deductible, therefore they are the #1 priority to take care of. If you have any pay-day advance loans or other above market rate loans (upwards of 6-7% in after-tax interest) from the list of debts below, you can consider them in this category as well. Tackle the highest interest cars first while meeting your minimums on the others, even if they are close to their max. Aim to keep your credit card debt under 30% of your maximum available credit, but ideally pay them to zero every month.
Accumulate a rainy day fund of 3-6 months living expenses
A general rule of thumb is to establish a cash reserve large enough to support your normal living expenses for 3-6 months depending on your risk tolerance. Setting this aside will help you sleep easy knowing that if for whatever reason you [or your spouse] become unemployed, or you are hit with some unanticipated expenses, you’ll have enough to keep you afloat while figuring everything out. Priority #1 and #2 should generally be tackled in tandem, while airing on the side of aggressively paying down credit cards with the highest rates. Worst case, you hit a rough patch you can’t support with your rainy-day stash, you build back up a bit of the CC debt you aggressively paid down in step #1 to keep you afloat.
Max out IRA savings
If eligible, use a Roth IRA to squirrel away $5,500 per year ($6,500 for Individuals 50+) in after tax dollars and enjoy tax-free distributions at retirement. Roth IRAs also enjoy the benefit of not being subject to Required Minimum Distributions (“RMDs”) and provide some tax efficiency diversification from your tax deferred retirement accounts (e.g., traditional 401k accounts). Roth IRAs begin to phase out at higher income levels though. If you exceed the AGI limitation for Roth IRAs do a Roth conversion by putting the money in a non-deductible traditional IRA and converting it to a Roth in that same tax year.
Max out 401k savings
Providing a 401k in your practice is a great way to squirrel away up to $53k in pre-tax money with the caveat that you’ll have to allow staff to participate which will cost you. Generally speaking, if the practice can support the cash requirements of funding the 401k it makes sense to start one but be sure to speak with a dental-specific CPA/ Financial Planner before you do. We advise against the “Do it Yourself” or “DIY” 401k options out there as the non-discrimination and fiduciary responsibilities of the doctor are a lot to manage on your own. These plans can (and often do) cost more in remedial efforts vs paying a trusted adviser to administer the plan properly upfront.
Pay off student loans
Although never guaranteed, it’s reasonable to expect a long-term return of ~7% on a moderately aggressive diversified portfolio. That return plus the tax deduction you get on contributions, often make the 401k a higher priority than making extra payments on your student loans. If you have any loans with interest above 7% the case to tackle those first becomes a more compelling argument however. Added bonus: depending on your income level, up to $2,500 of student loan interest is tax deductible.
Pay off home mortgage
Assuming you have a home mortgage, paying it off early is a lesser priority than student debt as mortgage interest is tax deductible and not capped at $2,500. At lower income levels this is fully deductible. As your income rises, itemized deductions begin to be phased out and Alternative Minimum Taxes (“AMT”) kick in, diminishing the tax effectiveness of mortgage interest. Today’s rates on a 30-year fixed are below 4% and if you’re higher than that, it’s time to look into refinancing. While refinancing means extending out payments for another 30 years, a proposition no doctor loves to hear considering their tarnished relationship with debt, it generally makes sense to lock in lower rates for mortgages as well as practice debt.
Pay off practice debt
Different from mortgage interest, practice debt interest is never phased out from being tax deductible no matter how high your income is! With today’s rates on a 10-year fixed note hovering around 4% (fully tax deductible) it’s reasonable to assume that you can outperform the interest cost in the long-run with your investments in tax-advantaged investment accounts. For that reason, our opinion holds that it’s more profitable to put your money to work for you rather than handing it to a bank. However, we do acknowledge the psychological burden most dentists have with carrying debt, so if a client decides they want to pay down debt rather than increase savings, we will absolutely support that decision. There is no right or wrong answer here, just a good answer and a better one from a “dollars and cents” perspective.
Consider taxable investments, whole life insurance, or Defined Benefit plan
After you’ve tackled all your debt, maximized your savings in tax-advantaged accounts, and your only other investment options do not provide any tax benefits, you may want to consider starting a defined benefit plan for your practice or a whole life insurance policy. Which option to pursue will generally depend on how close to retirement you are when reaching this rung of the financial independence ladder (among many other factors far and away beyond the scope of this article). The closer you are to retirement the more you might lean towards a DB plan, the further away, the more a whole life policy might make sense. Many other factors will effect that decision though including, life expectancy, pre-existing health conditions, wages of staff, and their demographic information as well.
These are two of the more complicated options. With both you are locking yourself into an obligation to fund the vehicle (premiums for whole life, and contributions for the DB) through thick and thin and for better or for worse. Additionally, the whole life policies generally carry a hefty commission which causes a large incentive for brokers to place them. Before getting into either be sure to talk to an independent, fee-based investment adviser and be sure you’ve tackled all of your other priorities first.
Hope you enjoyed our article and if you have any questions, reach out to one of our CFO Advisors today! We’d be happy to assist.
Disclaimer: This order assumes prevailing market rates on debt and adequate insurance coverage. All doctors should be adequately covered by insurance and debt minimum payments should be made on-time and in full, regardless of where they fall in the priority ladder. This list excludes education savings and lifestyle savings priorities.
-Paul Lipcius, CPA, CFO Advisor at PracticeCFO