Simple retirement plan red flags: What you need to know about your saving rate

By Jake Jacklich, CFP

It’s October and that means that the 2011 deadline for new SIMPLE IRA pension plans has passed. But you might be happy that you missed it; a dentist with SIMPLE IRA can be a “retirement planning red flag”. Mathematically this retirement plan is a red flag because even if it is fully funded and invested wisely the account is not likely to accumulate to a value sufficient to sustain the doctor’s standard of living throughout a 30-year retirement.

You have two big things working against you; first you had to finish 8 years of school prior to earning your first real paycheck and the IRS limits the amount you can save annually in a SIMPLE IRA when compared to other retirement plans.

For example: assume that a 27-year-old associate dentist earns $120,000 per year with an expected increase of 4% per year. The doctor, who wants to retire at age 65 with investible assets sufficient to provide 80% of her pre-retirement income, believes she can get 8% return on her money. If she starts at zero, it can be shown that, she needs to invest more than 16% of her salary throughout her career. This works out to be more than $19,000 the first year. The problem is that the IRS limits her contribution to $11,500 for 2011. If she gets a 3% salary match of about $3,500 from her practice the best she can do is too invest $15,000. Therefore she is only saving about 79% of what she needs to; mathematically speaking she is behind before she even gets started.

Starting young and investing wisely is the best-case scenario. Most of us wish we were fortunate enough to have been in a position to invest $15,000 right out of school. Unfortunately it gets worse the older she gets.

Now assume that the 40-year-old doctor has an account balance of $350,000. She owns her practice and her husband works as her practice administrator. Their combined income has is $200,000 per year and is expected to increase at 4% per year. It can be shown that this doctor and her husband now need to save more than 22% of their annual family income to provide 80% of their current pre-retirement, assuming 8% return each year. Keep in mind that these figures are hypothetical and are meant for illustration purposes only. They do not representative actual results of any specific investment. Investment results will vary considerably depending on the type of securities involved, general market conditions and other factors.

Attractive SIMPLE IRA benefits for the self-employed dentist may include the flexibility in contributions, low administration costs and relatively low payroll-matching requirements. These arguments may make sense if you are starting a business early in life and you have a five-figure annual profit expectation — this is not the profile of the average dentist. Many business, tax and financial advisors recommend them to dentists as a starter retirement plan; the downside is that you might be lulled into a false sense of security. You might think that you must be “on track” because your investments are doing well and you are maxing out your plan each year. One of the biggest risks to the success of your retirement goal is that you fail to figure out and achieve your “required saving rate.”

What you should do: First figure out how much you need to invest annually. Then focus your energy on growing your practice’s profits to the point that allows you to save the amount of money you need to save each year. Finally put the right amount of money into the right plan. Keep in mind however that investing involves risk and the potential to lose money so review you plan and your financial goals annually to ensure you stay on track.

Bottom line: I believe the SIMPLE IRA plan is mathematically insufficient for most dentists — they just don’t know it yet.

Note: The opinions expressed are meant to be general in nature and should not be construed as investment or financial advice related to your personal situation. Please consult your financial advisor prior to making financial decisions.

Jake Jacklich is a CERTIFIED FINANCIAL PLANNER™ practitioner and Financial Advisor with Waddell & Reed in Virginia Beach VA. He works primarily with self-employed dentists to help them better understand their money. His core competencies include financial planning, analysis of the doctor’s current financial position, dental practice valuation, tax sensitive wealth accumulation and distribution strategy, risk management, investment strategies, practice transition and retirement planning.

Jake is securities licensed in AR, PA, VA, and WI and he can be reached at 757-374-6979, via email at [email protected] or at www.JakeJacklich.wrfa.com.

Waddell & Reed, Inc. Member FINRA and SIPC.