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Retirement planning basics: How to plan ahead for down the road

Physicians don't have many years to save money, so they should start as soon as possible. Here are a few ways.

By Katherine Vogt, amednews staff. Nov. 17, 2003.

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When he was a younger man, Joseph Hans, MD, looked ahead to his golden years and realized that he would need some money to make them glitter.

"I had the foresight to know that I was not the best enlightened individual to manage investment money. So I elected very early, after accumulating a small amount of money for myself and my employees, that professional management was the best way to go," said Dr. Hans, who incorporated his ob-gyn practice in 1972 for the sole purpose of developing a pension plan.

Now retired from his practice, Dr. Hans, of Phoenix, is wondering if he has put away enough money to sustain himself through this stage of his life. "I think there's an anxiety about how long your retirement funds last," he said. "You suddenly don't have a paycheck coming in, and it gives you a little uneasiness. I have no idea if I have enough money."

But that doesn't mean Dr. Hans is worried. Like others who have looked ahead to retirement, he has his plan in place and has trusted financial professionals to help him make the most of it.

Financial experts say good retirement planning is crucial to good living later in life, especially for physicians. With typically shorter careers than other professionals, physicians have less time to save for retirement, so they need to maximize the efficiency of their savings and investments. And whether deciding on retirement plans such as a 401(k) or an IRA, forecasting a budget or considering insurance options, the choices can be crucial in facilitating a timely and comfortable retirement.

"For physicians especially, it's vital that they do the proper planning from the onset. They're open to a lot of liability, and they carry a lot of debt initially. The upside is that they generate a lot of income," said Bradley Bofford, a chartered financial consultant in Wayne, N.J.

Bofford said the sooner a person starts planning for retirement, the better. He usually recommends that physicians start with a pension plan right away, though some might have to wait until they are a few years into their professional lives and have managed to reduce their school debts.

For many people, their employers will decide what type of retirement plan they can use. But because many physicians are self-employed, they may have the flexibility to make that decision for themselves and their employees.

Kinds of plans

There are two main types of retirement plans offered through employers. One is a defined-benefit plan, which allows a retired employee to receive a specific amount based on salary history and years of service. Contributions to these plans can be made by the employee, the employer or both.

The other, a defined-contribution plan, allows the employee to defer some of his or her salary into the plan. With many of these plans, the employer can elect to match employee contributions. Bofford said defined-contribution plans are the most common and include several types of well-known plans such as the popular 401(k).

Named for its section in the Internal Revenue Service code, 401(k) plans allow employees to elect to defer some of their salary, before taxes, into a fund.

Employers often match all or part of the contribution and may offer a limited range of investments in which the funds can be placed. The fund grows tax-deferred, meaning taxes aren't paid on the money until it is withdrawn in retirement.

There are limits to the contributions. An employee can contribute up to $12,000 this year to a 401(k), though that figure will change in coming years, said Doug Charney, a retirement planner in Harrisburg, Pa. He said the fund also might be subject to a vesting schedule, which means the employee is fully entitled to the employer's matching contributions only after a certain period of time.

"Right now with the way the current law is set up for a doctor's practice, anything midsize or bigger, a 401(k) is the best way to go," Charney said. "It allows the doctors to shelter the most amount of money themselves and allows the employees to contribute, and they get a tax advantage for doing it."

But other types of plans may be better suited to specific needs. Keogh plans, for example, are tax-deferred plans that are designed for people who are self-employed. And 403(b) plans, which work like a 401(k), are tailored for nonprofit organizations such as schools and some hospitals.

Small businesses, such as a single-physician practice with a few employees, might benefit from using a simplified employee pension, known as a SEP. They allow for the employee to set up an individual retirement account, or IRA, so the employer can contribute money to it. The employee then manages the account by investing the money.

"The advantage to the SEP IRA is its low cost. You don't have to pay for an administrator, and it's very simple to run," Charney said. "The disadvantage is that you're limited on how much you can contribute." He said contributions may not exceed 25% of the employee's compensation, up to $40,000.

An alternative for small businesses could be what's known as a SIMPLE IRA, for savings incentive match plans for employees of small employers. Typically both the employer and employee contribute to these plans. Charney said the maximum amount that can be contributed by both in one year is $16,000 for most employees.

Sometimes it is possible to have more than one plan, allowing for greater overall contributions. Charney said a lot of people with profit-sharing plans, which use a formula to allocate contributions to employees, also have a 401(k) plan with it. The profit-sharing plan has limits on how much can be contributed to it, so adding another plan means "you can sock away more money," he said.

Choosing from all the different plans requires some research, Bofford said. "The most important thing is that [physicians] should do their due diligence and sit with an adviser who really knows what they're doing," he added.

Seeking advice

John D. MacDougall, MD, a retired general and thoracic surgeon from Indianapolis, said he learned a lot about retirement planning by reading various publications.

Still, he said, having professional advice to execute his plans was key. "That's essential if you have a corporation. You've got to stay legal. ... And there's no shortage of people who want to help you with your money. They've all got a stake in it, too, so you have to be wary," he said.

Dr. MacDougall was in practice for two years when he formed a partnership and established a pension savings plan in 1959. Originally he had a defined-contribution plan but he said it was problematic because it had contribution limits so he switched to a defined-benefit plan. "During my active years that was an advantage," he said.

Though officially retired, Dr. MacDougall, 78, still does some work as a consultant for a malpractice insurer, is a board member of a hospital and serves as an AMA delegate. And after decades of practicing medicine, he has some advice to physicians who are getting started.

"My advice would be No. 1, to the extent possible, stay out of debt. Don't spend money until you have it. And No. 2, only spend what you need and save the rest. That sounds like pretty simple advice but you'd be surprised how many young physicians don't know it," he said.

Thinking about debt and savings is one of the keys to retirement planning stressed by Errold F. Moody Jr., a San Francisco-area financial planner. And he said creating a budget can help clarify that picture both now and for the future. "It's necessary to start breaking things down into components so you start understanding what things have to be done now."

Moody said younger physicians should scrutinize both their professional and personal finances when figuring out a budget. They should consider how they are spending, what debts they owe and how their businesses are running. Budgeting might reveal discretionary money that could be used for retirement, he said. It also should help shed light on how much money might be needed in retirement.

Moody gave a basic example of extrapolating how much to save for retirement based on a budget for today. He said a 60-year-old physician who spends $150,000 per year would need to have saved about $2.5 million in today's money to live with that allowance until age 85. He calculated the figure considering inflation and projecting a probable average rate of return on investments. But he warned that this formula does not allow for all sorts of variables and does not take into account other income streams such as real estate.

Many experts say retirees should figure that during retirement they will spend about 70% to 80% of what they spent during their working years. That's because they often have fewer costs, with their children financially independent and their homes paid off.

But some new costs may develop in retirement, especially in terms of health care.

Marilee Driscoll, president of the Long Term Care Learning Institute in Plymouth, Mass., said retirees have to choose between relying on government programs to pay for long-term care or paying privately. "The big tradeoff is that in the vast majority of states, the most desirable type of long-term care is not going to be paid for by Medicaid."

If choosing to pay privately for a long-term-care plan, Driscoll said, a person first should look at what long-term care costs in the area. That will enable the person to determine whether it is better to go with an insurance plan or self-insure, she said.

Many financial experts say they tell their clients not to expect much income from Social Security in retirement. "We don't really bring that into play unless somebody is very close to retirement," Bofford said. "I very rarely factor that in as part of their retirement income because at this rate, unless things change drastically, it's going to run out."

But retirees may benefit from other income streams to supplement what is saved in their retirement plans. Home equity, profits from selling a business or business interest and life insurance policies can all provide income or be used as tools to borrow money during retirement.

And if those income streams don't produce enough money, there is always a fallback for survival: going back to work.

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