July 1, 2019
by Dr. Wilson Chen BSc., DDS, CFP, FMA
July is here, and Canadians everywhere are trying to squeeze the most out of our abbreviated summer. Hopefully, we’ve all set aside time to reconnect with family and friends and to recharge our internal batteries.
For many of us, the summer lull is also a time to step back and reflect on the big picture – how we want life to unfold in the months and years to come.
Financial planning is a big part of this examination. Like it or not, your dreams come with a price tag, and you need to ensure that your savings will support the lifestyle you choose.
Through healthier living and the miracles of modern medicine, we are now living longer than ever. According to data presented by Sun Life Insurance, for a healthy 65 year old couple, there is a 50% chance that one spouse will reach age 95. Furthermore, there is a 25% chance that one will celebrate a 98th birthday. Longevity is wonderful, and costly. When we speak with retirees, by far the biggest worry is outliving their money.
So how do you achieve a successful 30 plus year retirement? Here are three suggestions:
Set your financial GPS
Know how much you need to retire and make sure your savings and investments are on course to meet your goal. Set realistic lifestyle estimates and add in a margin of safety.
For many of us, retirement can be broken down to three segments. Income needs in the first stage may be higher, as we take advantage of good health and free time to travel more and interact socially. We tend to spend less in the middle segment as we stay closer to home and participate in less robust activities. The final stage is a wild card – health and long term care issues may put pressure on your savings and income. Planning must be in place to anticipate various scenarios.
Projections will never be exact, but having a definable target makes it much easier to reach your destination. (See inset article – How much do I need to retire?)
Define your risks
Take some time to address events that could derail your anticipated retirement. These include health issues, disability, death, job loss, marriage breakdown, and investment loss. Once identified, an action plan can be developed to negate or diminish these risks.
Risk plays a big part in investment mentality. Often investors concentrate on the returns of an investment without realizing the risks taken to achieve this. In the end, preventing major loss is crucial to long term gains. Quality investments should be our mantra since one or two absolute losses can negate years of disciplined investing.
Downplay the right side of the brain
Successful investing has more to do with emotional consistency than stock market insight. Our left brain, the analytical and logical twin, may appreciate the historical outperformance of the stock market and the short term peaks and valleys. However, it is often trumped by the anxiety and euphoria that reside in the right brain. Many retirement plans have been waylaid by knee jerk responses to short term market gyrations.
As investors, we often have to remind ourselves of Warren Buffett’s advice “be fearful when others are greedy and greedy when others are fearful”.
Of course, this is easier said than done. It means suppressing the very human responses of the right brain and trusting the fundamentals of investing. Focusing on the big picture will help temper some of the highs and lows in order to smooth out your journey.
How much do I need to retire?
Talking about savings and planning strategy is all well and good – but practically speaking, what is foremost on everyone’s mind is how much they need to retire in comfort.
We all have a different vision of retirement lifestyle and the numbers vary widely depending on your view. Spending time at home with family and friends will require a different income level than travelling around the globe. Defining your retirement personality is the first step in your calculations.
The second step is to identify your monthly lifestyle expenditures at the present time and break out which costs will continue into retirement. For example, costs to upkeep your house and/or cottage will likely continue while school expenses for your children (hopefully) will not.
Using the data above, play around with the numbers until you have a reasonable approximation of what you will spend in retirement. In many cases, dentists find that they need to set aside more for vacations/holidays and healthcare while eliminating or decreasing commuting, investment contribution, insurance and children expenses.
Historically, people used 70% of their present income as an approximation of their retirement income need. We have found that this is often a high estimate. Most retired dentists usually live on closer to 50%-60% of their pre-retirement income.
Rule of thumb
One quick and easy way of setting your savings compass is to use an established rule of thumb. This may not be entirely accurate, but it certainly can point you in the right direction.
Back in the 1980’s, William Bengen, a financial advisor in the U.S., devised a yardstick called the 4% rule. By looking back over decades of historical performance, his simple formula estimates the annual income you can safely withdraw from a diversified stock/fixed income portfolio over a 30+ year period with minimal risk of running out of money. The calculation goes something like this:
Assume you can save $2 million by the time you retire in your 60’s. Then for the first year of retirement you can safely withdraw $2,000,000 x 4% = $80,000. The following year, you can withdraw $80,000 plus an inflation index. If inflation was 2% for the year, then you can safely withdraw $80,000 x 1.02 = $81,600. Investment growth should sustain the annual withdrawals for the rest of retirement.
Working backwards, the formula becomes a rule of 25: Suppose you feel that you will require $120,000 for your first year of retirement, and this income will need to increase to compensate for inflation in later years. Using the inverse of the 4% rule, you will likely require a lump sum of $120,000 x 25 = $3.0 MM to fund you through retirement.
It is also important to remember that many dentists have other sources of cash flow which can affect the amount you need to save for retirement. Retirement cash flow can include: Canada Pension Plan (CPP) benefits, Old Age Security (OAS) benefits, rental income from properties, cash value from insurance policies, individual pension plan (IPP) benefits, pension from spouse, etc.
Full Retirement Projection
A rule of thumb is great for dentists who are looking for a general savings goal to shoot for. However, as you approach retirement, it is important to work with your financial planner or advisor to perform a full analysis.
A full retirement analysis can dive deeper into your present spending and, hopefully, make a more reliable estimate of future income need. It can also take into account different expenses at various stages of retirement as well as any one time expenses during retirement. Tax rates and inflation can be built in the projection.
More importantly, an analysis can compare different income scenarios so that you can make an informed decision on the amount of savings required. Since various asset classes are taxed at different rates, your advisor can also suggest a withdrawal sequence that will optimize your individual tax situation.
When should a full retirement plan be done? My recommendation is 10 years before your anticipated retirement. This gives you enough time to augment your retirement savings if necessary or to adjust your expense habits in order to fund retirement. Once a true target is established, regular reviews and adjustments can be made to the plan in order to achieve your goal.
For many dental practice owners, it is also important to look at a transition plan for your practice. Ten years will give you enough time to make changes to increase revenue and decrease expenses, review employment contracts and leases, revamp procedural processes, market your practice, reorganize your professional corporation, and possibly set up an individual pension plan. All of this will help to optimize the value of your practice(s) upon sale. A full valuation of your practice should be done five years before sale and updated as retirement approaches.
Quantifying your target retirement amount helps to motivate savings and gives you a concrete number to work with. Using a rule of thumb, especially early in your career, will provide an adequate guideline. Ten years before retirement, a comprehensive retirement plan will set you on course for a rich retirement, free of worry and surprise.
About the Author
Dr. Wilson Chen BSc., DDS, CFP, FMA received his DDS from Western University in 1992 and, for over 20 years, built a family dental practice in Hamilton. In 2014, he sold his practice to take a more active financial management and business advisory role for dentists and their families. Wilson is a partner at the Wyndham Group of Raymond James Ltd. He is the only practicing dentist in Canada to hold the Certified Financial Planner (CFP) and Financial Management Advisor (FMA) designations.