Retirement Financial Planning
It has been said that financial needs decrease in retirement, but that 70-80% of preretirement income is necessary to maintain one's lifestyle after retirement. While such a rule of thumb may not be a suitable guide for each individual orthodontist, it calls attention to a need of any orthodontist to set up a game plan. The farther one is away from possible retirement, the less clear many of the factors may be, but that ought not preclude planning, which must be an ongoing exercise in light of changing economic conditions, tax laws, and personal decisions.
The report of the results of the JCO survey of orthodontist retirees (published in this issue) is illuminating, if not a guide for future retirees. The average orthodontist in the study reported an annual income equal to his or her income during the last year in practice. Moreover, the retirement fund and annual retirement income are described as adequate or more than adequate by 97-99% of the respondents. Money may not buy happiness, but freedom from financial concerns in retirement certainly appears to contribute to happiness in retirement.
How big a retirement fund should one have? It should be big enough to produce an annual desired income for the actuarially estimated life expectancy of the retiree and spouse without placing those funds at great risk. This is an individual matter, but the average orthodontist retiree reported that a retirement income of $50-100,000 and a retirement fund of $500,000-1,000,000 were adequate. It is well to keep in mind that, at any rate of inflation, more will be needed in the future to maintain one's standard of living.
In estimating the future size of the fund, its return should not be predicated on an optimistically high yield. At the present time, it is possible to achieve a 10-11% annual return with limited risk. It is not predictable whether this will always be so. It might be prudent to plan the total retirement fund size based on an 8% annual yield or less. That creates a margin for error and a pleasant surprise if the yield turns out to be better than planned. It also encourages very safe investments.
What are prudent investment vehicles for retirement plan funds? Self-employed orthodontists who are not incorporated can establish a Keogh retirement plan. The present maximum annual contribution to a Keogh plan is $30,000. Even with the recent reduction in the maximum allowable annual contribution to corporate retirement plans, the law permits up to $90,000 to be contributed to them annually. These plans may not always have the same advantages as they have today, but for the present they appear to represent the best investment vehicles for the average orthodontist. The opportunity to invest substantial amounts tax-free until the money is withdrawn creates a situation in which a 10% yield on these before-tax dollars is the equivalent of an investment at 30% or more in after-tax dollars, and there are not many investments that have that high a yield and none such could be called safe.
What are prudent kinds of investment? A retiree's chief concern after building an adequate retirement fund is not to lose it. Safety is the number one priority in the investment of retirement funds. Unfortunately, there are not many highly safe investments. Some investments with a smaller safety factor and a higher return might work out well, but it is not prudent to take very much downside risk with retirement funds, nor does it appear to be necessary. The responses to the JCO retirement study indicate that the respondents were heavily committed to prudent investment of retirement funds, and that they have done a superb job of achieving financial security in retirement.
The safest investments are U.S. government instruments--T-bonds or T-bills, bank certificates of deposit, and some annuities. Bank CDs are insured up to $100,000 by the Federal Deposit Insurance Corporation, so one would need a separate bank for each $100,000 so invested. Treasury bonds can decline in value, but they retain their face value if held to maturity. Retirees need not be limited to these three investments, but it is important to realize that all investments other than these three have a certain amount of risk, chiefly because the principal can decline in value.
Retirement funds should not be invested in tax-free municipal bonds, because all funds are taxed when they are withdrawn from the retirement plan--including tax-free bonds--and the tax-free advantage would be lost. Properly selected tax-frees are suitable for investment outside the retirement plan. Likewise, retirement plans are not generally proper vehicles for investment in anything that does not have a yield, because it is the pyramiding of the yield that provides the great leverage of these plans. Therefore, real estate, gold, gemstones, etc., are suitable for investment outside of retirement plans.
Everyone should keep an up-to-date record of net worth, listing all assets and liabilities. Not many can project very far ahead what their assets and liabilities will be in the future, but an accurate, updated version is useful. Attention should be given to the liquidity of the various assets. By definition, retirement income is the yield on investments, and it must be received on a monthly or quarterly basis to pay for current living expenses. This will best be achieved with assets that have a steady, reasonably predictable yield. It would be wise to consider only such assets as retirement assets and the rest as part of one's estate.
When should one start accumulating retirement funds? It is unreasonable to start too early. In the early practice years, other priorities take precedence. Still, it is important to start in time to produce the desired amount, and the amount one is permitted to or is able to put into a retirement fund also influences over how many years such contributions should be made.
The average orthodontic practice levels off or declines after 14 years and after the orthodontist is 45 years old. One may become less inclined to even consider retirement under those circumstances, until it is too late. So it seems prudent to begin to think about retirement around age 45, and to make plans at that time for the accumulation of a retirement fund. That does not necessarily mean starting the fund at that time. However--assuming one were to plan retirement at age 65, which is average--if one were to reach age 50 and have an annual income that was at or below average, that would be a prudent time to start putting aside as much annually as possible into a retirement plan. It will probably take that amount of time for those with an average income or less to build a suitable retirement fund, especially if one is unincorporated and limited to the $30,000 annual contribution to a Keogh plan. Because there are other considerations than retirement involved in the decision to incorporate and to establish a corporate retirement plan, each orthodontist will have to make that decision independently. For some more affluent practices, it is possible to accumulate the necessary funds over a 10-year period in a corporate plan. For most, five years would be too short a time to accomplish the goal.
Reference to the compound interest chart shows that annual investment of $10,000 at 8% interest compounded quarterly would take 20 years to build a $500,000 retirement fund and 27 years to build a million-dollar fund. Investing $30,000 a year at 8% interest compounded quarterly could achieve the $500,000 fund in about 11 years, and the million-dollar fund in about 16 years. Some investments compound more or less than quarterly--and some not at all--but this should be a rough guide to when it would be prudent to start investing in a retirement plan.
What about the orthodontist who says, "Retirement funds are no concern of mine--I don't plan ever to retire"? Two-thirds of the respondents to the retirement study reported that they retired according to plan. That leaves one-third who retired not according to plan for reasons sometimes beyond their control such as ill health. It seems prudent to accumulate a retirement fund against the possibility that one's practice may decline, or that one may be forced to retire, or that one may change one's mind. Far better to be glad you did than to wish you had.