The secrets of financial flexibility

November 10, 2015

Doctors need a financial playbook that responds to their distinct careers. Keeping the cashflow to your practice flexible is important when starting out, but don't forget to plan for retirement.

Physicians frequently travel a different path than other professionals when it comes to finances. In general they start saving much later because of long training requirements, and many start their careers laden with debt.

As small business owners, they notoriously invest heavily in their practices, often foregoing traditional methods of savings. More recently they have faced dramatic changes in reimbursements and a trend toward hospital employment, which has meant greater difficulty for those trying to sell their practices at retirement.

In short, doctors need a new financial playbook that responds to changing conditions.

That was the case for Marc Williams, MD. After deciding early in his career not to complete his post-residency service requirement in rural pediatrics, Williams was faced with a substantial loan payback requirement that heaped debt on top of his home mortgage. Then he worked for five years in a large group practice that offered no retirement plan. “I certainly didn’t look at my financial life as grim,” he says, but he clearly realized that despite earning a competitive salary, he was in a hole and needed to quit digging.

So in 1991, when he learned his new employer not only had a retirement plan with employer matching funds but also paid for a year of individual financial planning services, Williams immediately signed up for both. Within about a year, he says, he had paid off his residency debt and was beginning to save for the future.

“It was a night and day difference all in a year,” says Williams, now 60. Along the way he steered his career into genetics and now is director of a genomic studies center for a large health system. He and his wife reared two children and donate about 13% of his salary each year to a variety of charities. He says he’ll have enough saved to retire within a couple of years, despite the late start on saving, but he plans to continue working because of his career interests and goals.

Next: How did he get there?

 

How did he get there?

“I say to young physicians frequently that we’re all really driven and control freaks and planners, but if you keep focused only on where you think you want to go, you’re going to miss a lot of opportunities,” he says. “I adopted the philosophy of the Japanese samurai-‘having no destination, I am never lost.’”

Career-wise, the philosophy led him to opportunities and additional fellowship training in genetics after an initial exclusive focus on primary care. And while deviating from a plan may seem counterintuitive when it comes to finances, flexibility can be important there as well, financial experts say.

“The reality is we don’t know how long we’re going to live, what income taxes are going to be in the future or what investment returns are going to be. We have to deal with a lot of unknowns,” says Jeffrey Lokken, CFP, an adviser with Financial & Investment Management Group who has advised Williams since that first employer-provided benefit decades ago.

As more of his clients get close to retirement, Lokken says, a big part of his job is getting them comfortable with change at a time when it feels natural to want to sit tight. They need to shift their focus from investment returns to cash flow, change their view of risk, respond to new tax challenges, and think globally about future portfolio returns.

Even clients with decades to go before retirement need to face some of those challenges, not to mention dealing with the possibility that future stock returns will be substantially lower in the coming decade, as many stock market observers are predicting.

“We’ve had a three-decade run with corporate profits rising faster than the economy,” says Chris Brightman, CFA, chief investment officer at Research Affiliates LLC. “It’s quite reasonable to expect muted growth in corporate profits going forward. When you start at a peak like this, our view is that lower-than-historical average returns are more likely than higher-than-normal.”

Next: The importance of portfolio diversification

 

Add in physicians’ industry-specific challenges with declining reimbursements and a wave of practice consolidations, and it’s pretty clear you’ll need a financial game plan moving forward.

What follows isn’t an all-encompassing financial planning textbook, but more of a playbook for handling some of the most pressing issues today’s physicians face.

The importance of portfolio diversification

Brightman notes that U.S. companies have fueled a big part of the most recent bull market in stocks, and hence account for a major share of the expectations for slower growth in the coming years.

With that in mind, he offers three ways to diversify investments: geographically, by asset class, and by individual company growth metrics.

“Virtually all non-U.S. equity markets, emerging and developed, have a much higher outlook for yields and expected returns,” Brightman says. While U.S. stocks recently had average share price/earnings multiples that were in the 20s-compared with the historical average of 16-stable developed markets like the United Kingdom were at about 12, while emerging markets stood at about 8.

Lokken has been recommending that clients devote up to 15% of their portfolios (with variations depending on individual circumstances) to international stocks. With so many U.S. companies operating around the world, the mix provides clients a total exposure to international markets of around 50%, he says.

Rebalancing a portfolio based on asset classes–or categories of investments such as stocks of large companies or small, growth oriented or value and the like–is another way to diversify out of high-multiple stocks, Brightman says. By the same token, rebalancing within an asset class by selling strong performers and buying undervalued stocks periodically can bring down your exposure to overvalued stocks, he says.

“This can be hard to do, particularly on the international side,” he says. “All this turmoil outside the United States is a wonderful buying opportunity and allows you to build wealth more quickly, but most people don’t feel that way intuitively. The bargain prices now are in non-U.S. stocks.”

Next: Long-term care

 

Long-term care

Most physicians know that they need disability and life insurance. Long-term care insurance, on the other hand, has been a murkier proposition. Substantial recent rate hikes and concerns about the long-term viability of carriers are enough to give any consumer pause.

“It’s increasingly on my radar,” says Richard Sperry, MD, PhD, an anesthesiologist who suffered a setback to his retirement savings in the 2008 financial market meltdown. It was an experience that heightens his concern about large post-retirement expenses. “Like everybody else I had an eight-year period where things should have doubled and they didn’t,” says Sperry, 60, who also has a background in economics that he credits for minimizing the damage to his portfolio.

With a lighter nest egg and retirement within about seven years, Sperry has other worries. “I spend a fair amount of time trying to balance the assets in my portfolio. Without question I’ve become more conservative, but I’m left now wondering how much risk is appropriate” to make his savings last through retirement, he says. “I’m deliberating that right now.”

Adding to the conundrum for physicians is the fact that, like many mid- to late-career professionals, they could afford to pay out-of-pocket for a few years of nursing home care, but would be wiped out financially by a very long stay. A product catering to that type of unusually long need, with an elimination period of a few years before benefits kick in so as to reduce premium costs, doesn’t exist in the marketplace.

Most new policies cap coverage at five years, for a total initial value of about $300,000 before factoring in inflation hikes.

As you think about your strategy, be aware of these limits. You may want to get partial coverage at the lowest possible cost, then self-insure for the remainder.

You might also consider a deferred fixed annuity that starts at age 80 or 85, paying income whether you’re in a long-term care situation or not. If you buy that policy in your 50s or 60s, you get the benefit of mortality credits as other policyholders die off.

As with all types of annuities purchases, be sure to take your time, comparison shop and read the fine print of the contract. Annuity quotes are easy to find online or through some of the largest mutual fund providers’ websites.

Next: Moving old retirement plans

 

For a long-term care policy, you can hold down premiums by taking the longest elimination period available (usually 90 or 100 days), combining a long-term care policy with a life insurance policy, purchasing a group policy for your practice or combining coverage with a spouse. The latter can provide up to a 10-year benefit, notes financial planner Bill Driscoll, CFP, principal of Driscoll Financial in Plymouth, Massachusetts.

Another possibility is switching from a 5% inflation protection rider to 3%. If you’re older it might make more sense to take a larger benefit up front and skip the inflation protection, Driscoll says.

Moving old retirement plans

Offsetting higher-risk investments with the appropriate balance of more conservative ones is certainly a good defensive strategy, but sometimes the best defense is a good offense. In other words, focus on some of the levers you can control, instead of simply trying to mitigate the risks you can’t.

As providers move through their careers –and many are switching employers and practice models more frequently–the conventional wisdom has been to roll that last employer’s 401(k) (or in the case of many physicians, a 403(b)) into an individual retirement account (IRA), which allows more investment options and potentially has lower annual costs.

With recent changes to 403(b) regulations cutting management fees in many plans (on the heels of new fee disclosures in 401(k) plans), however, and considering a potentially lucrative tax move with Roth accounts, that might not be a good strategy anymore, experts say.

“I rarely have physicians roll over their 403(b)s because we want them to preserve their ability to do back-door Roths,” says Lokken. By that he means having clients make non-deductible contributions to a traditional IRA, then converting those accounts to Roth IRAs, in which after-tax contributions grow tax-free and are withdrawn tax-free in retirement.

Conversions are subject to a pro-rata rule that basically requires owners to pay tax on the amounts withdrawn for the conversion as though the money were coming equally from all of their traditional IRAs. If you have a large, traditional IRA full of pre-tax contributions, that could mean a hefty tax bill.

This is a key point to remember if you are working with a financial adviser. Depending on the adviser’s compensation model, there could be an incentive for the adviser to recommend a rollover into an IRA that he or she manages. That’s not supposed to happen if your adviser truly is acting in your best interest, but be aware that it does.

Next: Relocating for better compensation

 

Relocating for better compensation

You can also change practice models–or even move to another state–to try to stay ahead of the changes in healthcare or find a better tax climate. But be aware of the tradeoffs. Cardiologist Audrey Sernyak, MD, was part of a group practice that sold itself to a hospital system about five years ago. She says she enjoyed the security of employment, but her ability to save pre-tax dollars diminished. After she negotiated with the rest of her partners for her first hospital job, she moved as an individual to another employed physician model.

Once there, she found that she had less negotiating power. She no longer has access to a tax-deferred 457 savings plan or a profit-sharing plan as she once did. “I now put away about two-thirds of what I put away in private practice,” says Sernyak, 45.

She urges physicians in private practice to consider whether organizing as an S corporation is right for their practice. “Our practice didn’t foresee that one day we would no longer be a private practice, and we paid a huge price for that in the amount of taxes [owed on the sale],” she says.

Estate planning

Despite a late start on savings and considerable financial challenges, some physicians actually oversave for retirement, says Lokken, denying themselves unnecessarily as they reach the second half of their careers or working longer out of unfounded fear of running out of money. That creates an estate-planning issue.

“There are some physicians who are astonishingly good savers, and then they might inherit some assets and all of a sudden they have a lot more than they expected they would,” Lokken says. “So in those cases we’re having a lot of conversations about trusts.”

Even though the estate tax exemption limit is nearly $5.5 million, many clients want trusts that will give them more control over how their heirs spend their inheritance, he says. Standard restrictions include having children receive inheritances over time, such as a portion immediately if they lose their parents at a young age and then another chunk at, say, age 35.

Next: 'I was pretty surprised by the number of people asking about this'

 

“I was pretty surprised by the number of people asking about this. They’re saying they want to make sure the money sticks around” beyond the next generation, Lokken says.

That message apparently isn’t getting through to all physicians, however. A recent survey by AMA Insurance found only about half of physicians reported having certain estate-planning documents in place. “That blew my mind,” says Robin Robertson, CLU, principal of Pacific Peak Advisors. Even without estate tax obligations, those directives are very important, as physicians know intimately, she says.

Estate planning also can be an important tool for managing finances if you run into the above-mentioned need for long-term care, so taking care of this is extremely important, she says.

The small stuff

Finally, don’t forget the small stuff that can become big stuff over time, Driscoll says. Buying a large home as an asset-protection vehicle used to be standard advice for physicians but retirement accounts now accomplish that more effectively and they don’t come with maintenance costs, experts say.

And being smart about car purchases can make a big difference, particularly for younger physicians trying to get started on saving. Because of low interest rates, lease deals are very attractive compared with loans or even purchasing, Driscoll says. “If you don’t put a lot of miles on a car, it’s ridiculously cheap to lease cars right now. You don’t even typically pay maintenance costs,” he says.

Add up these timely moves and you’ll be ahead of the game in 2016.

Next: Yes, you can over-save for retirement

 

Yes, you can over-save for retirement

By Janet Kidd Stewart

Most physicians have heard a steady drumbeat about how they are saving too little for retirement.

Financial firm Fidelity last year studied its records on 5,100 physicians and found they were on track to replace just 56% of their income in retirement, well short of the recommended 71% for those earning more than $120,000 annually.

They saved about 15% of salary, including their own and their employers’ contributions. But that’s not enough, Fidelity concluded, because Social Security will replace a much lower percentage of income for physicians due to their higher-than-average salaries.

On the other hand, a subset of physicians actually is oversaving for retirement, some financial planners say. “I do see that, and it’s based on fear,” says Evan Welch, CFP, chief investment officer for Antaeus Wealth Advisors, whose father was a physician. “For a lot of doctors it was a fear of getting sued” as malpractice insurance rates soared that kept them very conservative about spending, he says.

Today, he adds, the motivating fear seems to be more about the future of medicine and reimbursement rates. “The mindset today is a fear about whether their income is going to continue to fall and expenses continue to rise,” he says. “This is particularly true for younger physicians coming out of medical school with loans. They’re really worried.”

And rightly so, Welch acknowledges, but sometimes the fear is overdone. “One of the biggest values we bring is helping clients run actual numbers so they can balance out those fears. Sure, you can save a lot but there’s also a point where you have to live a little. You could have a heart attack tomorrow, just like your patients, “We get to a number where I can say that as long as they are saving X, we don’t micromanage the rest of their spending,” he says.

Next: What is price-earnings ratio?

 

If you’ve been denying yourself vacations because you feel you have to reach a certain savings target by a certain age and you got started late, many financial planners now suggest indulging before retirement rather than after. The rationale: if it means retiring later, that’s typically a better tradeoff because you’ll still be earning income and reducing the total number of years you have to finance in retirement.

If you’ve always lived frugally, just make sure you’re spending on things that matter, advisers say. That way you won’t get to the finish line with regrets.

What is price/earnings ratio?

Price/earnings ratio is a company’s market capitalization (its number of common shares multiplied by the stock price) divided by its after-tax earnings over a one-year period. P/E is a common measure of how expensive a stock is relative to its current or future earnings. It is expressed either on a per-share basis or as a whole. A higher ratio means growth-oriented investors are paying a premium for profits, so as those valuations get richer, they become harder to sustain. Conversely, so-called value investors look for solid companies with lower P/E ratios, betting that those companies will deliver more earnings for each dollar of market capitalization.