Finances

Plan Your Retirement Finances Early On

By Adam Cmejla, CFP, CMFC

May 4, 2016

SYNOPSIS

All ODs exit their practice at some point—and meet the new economic realities of retirement. Here are tips to save and invest early so you can live well after the paychecks stop coming.

ACTION POINTS

UNDERSTAND NET PROFIT. Compute the tax implications of the sale, including what you’ll walk away with in after-tax proceeds.

BUDGET YOUR POST-RETIREMENT. Budget and track your spending to avoid over-spending in the first part of your retirement, to, in turn, avoid requiring a higher withdrawal rate on your assets.

CALCULATE RETIREMENT ASSET DRAW-DOWN. Determine your advisable withdrawal amount (calculated as a percentage of assets).

MANAGE RISK CAPACITY. Diversify to minimize market downturns. Measure the probability that your portfolio could recover from a market correction and still allow you to remain financially independent, given your existing withdrawal rate.

Everyone exits their practice. It’s common to focus on sale price. Just as important is planning for post-sale financial management. That process begins early on.

The process of selling and stepping away from a business that you’ve spent years building can be mentally and emotionally draining, but also liberating and exciting because it often leads into the next chapter of life: retirement.

There are many post-sale financial implications to understand, and how they impact you and your family immediately after retirement. The decisions around those implications will have lasting impacts on your financial success and independence as you transition into retirement. Here are four steps to help you manage your finances following retirement.

Practice Exit Strategy: Three Key First Steps

“WHAT’S YOUR NET? Understand different taxation rules of your practice sale.
DIVERSIFY. Minimize the potential for losses that are tough to recover from. As retirement looms, lowering portfolio risk becomes more important.
PLAN FOR CHANGE. Understand and project both your cash inflows and outflows in retirement.

Understand the “Net” of Your Practice Sale

Many clients that we talk to pre-sale have already gone through a moment of truth and clarity when they realize that the actual valuation of their practice is less than what they thought it was worth. However, once you have the valuation and an agreed-upon price from a buyer, it’s important to understand the tax implications of that transaction and what you’ll walk away with in after-tax proceeds.

There are two main components to the selling price of a practice: goodwill and “everything else,” such as equipment, etc. The goodwill of a practice is taxed at the long-term capital gains rate, which (unless you are in the 35 or 39.6 percent tax bracket) is 15 percent. The “everything else” portion represents depreciation recapture, supplies, equipment, etc., and that is taxed at either ordinary income rates, or 25 percent, depending on the asset and situation. This is why a savvy seller will strive to ensure that as much as possible of the sale is due to goodwill rather than tangible assets.

An important possible negotiation tool that can be used when the seller and buyer disagree on the price may be the amount of the sale that is attributed to goodwill. A seller who wants to sell may be better served coming down on price, but ensuring that a higher percentage of the sale is valued as goodwill. Doing this can help make the net (after tax) result come out relatively close to the higher original price.

Make sure you know what the sale will do to your overall tax planning for that year, as well as understand how the net amount after the sale will impact your ability to be financially independent in retirement.

How Has (Or Will) Your Personal Budget Changed Post-Career?

This may seem like an obvious one now that I’ve said it, but we’ve talked with many newly minted retirees who, prior to working with us, hadn’t considered the impact of no longer working and what that would mean to their budget. To be clear, I’m not talking about the cash inflows. I’m talking about the cash outflows. I typically phrase it this way: while you were working, which day did you typically spend more money…Tuesday or Saturday? In retirement, welcome to 365 days of Saturday. What this means is that most of the days that were otherwise spent making money are now spent spending money. Without proper budgeting and tracking of your spending, it’s very easy to over-spend in the first part of retirement, thus requiring a higher withdrawal rate on your assets.

Have You Calculated a Retirement Asset Draw-Down Strategy

A retirement “draw down” is the systematic and sustained withdrawal strategy from one’s investment accounts to subsidize their lifestyle in retirement while meeting their other financial and personal goals, such as leaving assets to the next generation, charitable inclinations, or other intentions.

A high withdrawal rate early in retirement can have a negative effect and cause a premature depletion of retirement assets later in life.You’ll need to understand, based on your portfolio of retirement assets, how you’ll be generating income for your family and how that income will be coming into your household. For most retirees, this may be a combination of withdrawals of retirement assets, owning certain income-producing assets (such as rental real estate), or other passive investment income. If you do need to set up a withdrawal strategy on your investment portfolio, understanding your safe withdrawal amount (as a percentage of assets) is imperative to your portfolio’s success.

Manage Your Retirement Plan’s Risk Capacity

Notice I did not say risk “tolerance.” As an investor, you may have a high risk tolerance and are comfortable taking higher degrees of risk with your investments. But your retirement plan has a different measure of risk, and that’s your risk capacity. We measure risk capacity in downside risk exposure to a portfolio and, given a certain level of assumptions, the probability that the portfolio in question could recover from a market correction and still allow the investor to remain financially independent, given an existing withdrawal rate.

Managing Investment Volatility

This chart shows the real cost of volatility. It show just how much a portfolio would need to recover based on a decline just to get back to even.

For example, the chart to the left shows the real cost of volatility. We illustrate how much a portfolio would need to recover based on a decline just to get back to even.

As you can see, managing downside risk is equally, if not more, important, than capturing upside gains. When you incorporate systematic withdrawals on a portfolio in retirement on a portfolio that sustains significant losses, the road to recovery can be very long, and sometimes can have a permanent negative effect on one’s long-term retirement plan.

There are many factors that play into your transition from practicing optometry into the joys of retirement. Proper planning and managing expectations before and during the process can help ensure success during retirement and allow you to enjoy the life you’ve worked so hard to achieve.

Adam Cmejla, CFP®, CMFC®, is a Certified Financial Plannertm and president of Integrated Planning & Wealth Management, LLC, a financial services firm that works with optometrists.For more information: Contact Adam at 317-853-6777 or adam@integratedpwm.com.

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