Did you make forward financial progress in 2014? In other words, did you move closer to your financial goals? Very few dentists can answer that question. The reason for this is because they do not have measurable targets. In order to answer the question, you must first know what your target is. How much money do you need to retire? And what do you need to do this year to move further toward that target?
CASE STUDYLet’s look at a case study from our files that shows how a typical dentist and his wife—we’ll call them Dr. and Mrs. Wong—dealt with the question of how much money they needed for retirement.
Background information46-year-old couplegoal to retire at age 60assume full CPPsix per cent investment return/three per cent inflation
Current Financial Position$396,550 in RRSPs$22,610 in TFSAs$278,754 in non-registered savings$125,000 in annual spending (after-tax, indexed for inflation)
After assessing Dr. and Mrs. Wong’s current financial position, we determined they needed additional savings to reach their target goal.
Additional savings need$3,031,000 or $136,100 annually
Knowing this figure was a good starting point, but Dr. and Mrs. Wong also needed to make decisions about the following:
• what type of account(s) the money should be saved in that would be best for income-tax planning – for example, a Registered Retirement Savings Plan (RRSP) or Professional Corporation Investment Account (PC) • how they would monitor the program to track the actual progress of each account, versus the targets they set.
This form of financial management takes some legwork to set up. However, I have found that once a program is set up, it dramatically increases one’s chances of achieving financial independence.
Choosing the right account(s) to reach a savings goalThe type of account you use affects the amount of income tax you pay. Therefore, when deciding on an account you must also consider the impact on your retirement cash flow. For example, starting at age 71 the government mandates minimum withdrawals from your RRIF. If your RRIFs are too high, these minimums will incur a high tax rate and also trigger a “clawback” of your Old Age Security benefits, which means you will have to pay back more than $6,200 per year in government benefits.
Below are the pros and cons of using various types of accounts to make up for an additional savings need.
1. Professional Corporation Investment Account (PC)
Pros:• Money earned from practicing dentistry that you leave in your PC is taxed at a low rate, so you end up saving more
• When you take money out of your PC you will owe tax, but with proper planning you may be able to get themoney out at a favourable rate
Cons:• The money you earn on your investments within thePC is taxed at the top rate—if there is not proper planning• Having money in this account could affect your abilityto claim the capital gains exemption when you sellyour practice.
2. Registered Retirement Savings Plan (RRSP)
Pros:• You receive a deduction from current income forcontributions• Investments grow tax-deferred
Cons:• Withdrawals are fully taxable.
3. Tax-Free Savings Account (TFSA)
Pros:• Contributions are not deductible, but investmentincome grows tax-free• Withdrawals are also tax-free
Cons:• There is currently a maximum contribution of $5,500per year.
4. Open account (also called a non-registered account)
Pros:• Withdrawals are tax-free
Cons:• Contributions are not deductible• Investment income is taxable.How did Dr. and Mrs. Wong choose to meet their additional savings need?Dr. and Mrs. Wong need to save $136,100 per year or $34,075 quarterly. Working with them, we provided a successful three-step solution to their savings gap which is outlined below.Step 1. Save $34,000 annually in RRSPs. By doing so, the Wongs would save half the contribution amount in income tax.Step 2. Set up automatic savings of $92,100 per year in a PC. The money left in a PC is taxed at only 15 per cent.Step 3. Save $10,000 annually in TFSA accounts (each spouse has their own account).The net effect is that Dr. and Mrs. Wong are reducing their income taxes now, their savings occur monthly, and they receive a quarterly statement for each account which will help them stay on track with their savings target.
Using your numbers as a long-term guideKnowing the amount you need for retirement is not enough. Your savings target should be used to motivate you towards a successful retirement. Track this figure quarterly. The most powerful tool we use at McNulty Group is what we call “The Monitor”. It illustrates the financial progress you’ve made towards your retirement goal every quarter compared to your target.
In summaryTry to be conservative when it comes to the assumptions used in your retirement projections. Once you know how much you need to retire, use the target amount as a guide for all your practice and personal financial strategies. Monitor your progress towards that target quarterly and remember, what gets monitored gets improved.More information about the case study is included in our new book The $6 Million Dentist.