This article was originally published by Progressive Dentist.
Have You Ever Heard of Tax Freedom Day?
It’s the day each year when we Americans have earned as much as the annual income taxes we’ll pay. After that (at least in theory), the rest of the year’s income becomes your own.
This year, Tax Freedom Day arrived on April 24th, once we’d collectively paid nearly $5 trillion in federal, state and local taxes.
Alas, for most dentists, your personal taxation emancipation takes longer – somewhere around early May or even early June if you factor in all the extra obligations that can eat away at a dentist’s income: Social Security, Medicare, AMT, Additional Medicare Tax…
The moral of the story is that dentists must plan carefully to reach what I call their Financial Freedom Day.
That’s not necessarily the day you retire, mind you. It’s the day after which your personal preferences rather than your financial obligations determine whether you’ll continue to practice full-time, part-time, or not at all.
Sounds pretty good, doesn’t it?
But how do you get there, and how do you know when you’ve arrived? The answer is: planning.
By this, I mean more than wishful thinking and vague resolution. Planning for Financial Freedom Day unfolds in three steps involving quantitative and qualitative action:
- Measuring and Defining: Where do your personal and professional finances stand today? What gaps exist between your income and your aspirations?
- Assessing and Implementing: What changes are possible and advisable for bridging those gaps? How will you make those changes happen?
- Monitoring and Adjusting: How will you assess your progress and take corrective action as warranted over time?
Measuring and Defining: Knowing What You’re About
So how does an enterprising dentist quantify what it’s going to take to get from “someday” to Financial Freedom Day?
Unless you plan to study financial planning, investment management, risk management, estate planning, taxes and accounting, and a few other wealth specialties … you’ll be ill-equipped to calculate the numbers without some help.
Enter the dental CPA/wealth advisor and practice-integrated wealth management professional.
There are really good financial planners who can help determine your current financial position and suggest how much you should save if you want to retire by a certain age.
But if they’ve not also learned about and worked with dentists’ specialized interests, that’s where the conversation typically ends.
Your financial freedom friend should know his or her business of finance and understand your business of dentistry. Why does this matter? So you can optimize the power of your practice to create wealth rather than detract from it.
Besides plugging in traditional financial planning factors (expected income, personal and professional obligations, your investment profile, etc.), a dental practice’s specific challenges and opportunities also add up.
They can add up in your favor if managed appropriately, or as additional obstacles if overlooked.
To illustrate let’s take a look at a hypothetical Dr. Steve, who has the following circumstances:
- He and His Spouse are 62
- Earning = $360,000
- Spending = $330,000 Including Taxes
- Current Retirement Saving = $30,000
- Retirement Saving Needed = $80,000
- Saving Gap = $50,000 (after-tax)
- Saving Gap = $?? (before-tax)
Dr. Steve’s practice is large and his retirement plan has 12 participants in addition to him and Mrs. Steve.
Funding the saving gap of $50,000 in the retirement plan (pre-tax) carries too high a cost in staff contributions, even considering the tax deduction, so Dr. and Mrs. Steve must save after taxes.
To calculate the “before-tax” amount required to fill the after-tax gap, we added $50,000 of income to Dr. Steve’s tax projection for the year, and found that the additional taxes (federal and state) were $34,000.
Thus, Dr. Steve needs to generate additional net income of $84,000 from his practice.
So, if $84,000 is to hit the bottom line, what does Dr. Steve need to produce for that to happen?
Some reverse engineering of Dr. Steve’s Profit & Loss Statement can get us started.
First we work our way up through the current practice expenses to see what might change with a significant increase in production. Hint: Dental Supplies and Lab Fees vary with production.
Since Dr. Steve’s practice is well staffed, he will not have an increase in fixed overhead – at least for the time being.
After studying the Profit & Loss Statement, we look at patient refunds, Dr. Steve’s collection percentage, and fee adjustments. These help us determine the gross production necessary to add $84,000 to the bottom line.
Assuming variable expenses of 15% and another 10% for fee adjustments, patient refunds, etc., we calculate that Dr. Steve will need to produce an additional $112,000 ($84,000/75%) to reach his goal.
That is $700 per day assuming 160 business days in the year, or about $88 per hour assuming an eight-hour day. Dr. Steve and his team may be able to figure out how to hit that goal on their own.
Or a Dental CPA could suggest some basic ideas, like making sure all patients are captured in the re-care system and current on their exams and radiographs.
That may or may not be enough, but there is good news.
Assessing and Implementing: Create Your Future
Dentists are among a handful of professionals who have the envious ability to effectively determine their income. To name a few of the possibilities, you can:
- Add patient treatment hours
- Shave dollars from your overhead
- Create technological efficiencies
- Enhance your income-generating skills – such as case or treatment management
- Enhance your staff’s income generating skills through training and education
- Hire general or specialized consultants (in areas like hygiene, communications or marketing)
- Or, use a Wealth Management tool and “rediscover” (re-examine) your patients by scheduling some extra time with specific ones to discuss their oral health and ask how they feel about their smile.
In these ways and more, most dentists have extraordinary flexibility to implement the changes necessary to move from identifying income gaps to bridging them.
In my experience, it’s not the opportunities that are lacking, it’s the experience required to identify, seize and make best use of them.
Yet again, planning can save the day. Armed with accurate metrics and informed advice, the most successful dentists I’ve seen typically invest heavily in themselves, their staff, their facility and their practice.
In so doing, they stand the best chance for increasing their upfront profits as well as the future value of their practice, for when the time comes to sell, merge or bring in a partner.
Monitoring and Adjusting: Rinse and Repeat
Of course even the most perfect planning cannot prepare for everything the future has in store for us. Life is characterized by more curveballs than home runs.
Whether we’re talking about your dental practice, your investment portfolio or your life goals, we’re also talking about risk and uncertainty.
That means balancing the risks you must take in pursuit of the rewards you hope to receive.
For that, we professional financial types typically apply Monte Carlo planning to help you assess whether the risks your taking and the outcomes you’re hoping to achieve are on target over time.
Beyond keeping a close and periodically repeating tab on all of the action items above, your practice-integrated wealth advisor can help you prepare for your ideal Financial Freedom Day by guiding you and your family through a clear process for coordinating your personal wealth management with your professional interests.
As your personal wealth grows, so too does the scope of your advanced planning interests, including:
- Accumulating wealth (investing, tax management, etc.)
- Protecting wealth (higher-end insurance and other risk management strategies)
- Bequeathing wealth (estate planning)
- Donating wealth (charitable planning)
If these and other interests are to come together efficiently on your behalf, they call for integrated rather than isolated attention. They also require regular revisiting as your life’s circumstances evolve.
So, to circle back to the moral of our story, I want to leave you on a high note about the importance of financial planning for dentists.
There’s only so much you and I can do when it comes to shortening the day we reach Tax Freedom Day each year.
But when it comes to determining your personal Financial Freedom Day, the opportunities are abundant, and yours to seize (with the right support).
I know that, because I’ve seen it happen. I’m not saying it’s a cake-walk, but neither is running a dental practice, and you’ve already tackled that, right?
So go ahead, one step at a time, accompanied by a dental-specific advisor: Measure and define where you’re at, assess and implement where you want to go, and monitor and adjust your course along the way.
You’ll be there soon enough.