Most dentists still follow a well established path to a successful career: Start a practice after dental school graduation; build a business over time while raising a family; provide impeccable service to a base of loyal clients; then, sell the practice and use the proceeds to retire to a tropical locale or mountain retreat.
But these days, the path is more difficult to follow. This isn't just the case for newly minted dentists who are launching their careers with heavy loads of education debt. It's also difficult for established dentists who face financial uncertainty and insecurity when looking to sell their practices in today's market.
However, there is a win-win alternative that allows a retiring dentist to realize a better financial outcome from the sale of a successful practice and allows a young dentist to realize the lucrative dream of owning his or her own practice. I call it the retirement income method.
Before I explain how it works, let's do some math to illustrate the problem facing both retiring and newly graduated dentists.
On average, a one-doctor general dentistry practice brings in $1.2 million in revenue each year, according to a 2013 report by CPA firm Cain Watters and Associates.1 After direct and fixed expenses, average net income for the same practice is $491,000 per year. (These numbers are slightly higher for specialty dentists and multidoctor offices.)
Let's assume after taxes and professional expenses, the average dentist's take-home pay is $250,000 per year—a salary that allows the dentist to service education debt and enjoy a comfortable family lifestyle.
When it's time to retire, many dentists look to sell their successful practices to the next generation of practitioners. Valuation of dental practices can vary by region and location. But let's use the national average of 65% of revenue, as cited in Dental Economics by Timothy Giroux, DDS, of Western Practice Sales, a dental practice brokerage firm.2 That would make an average lump-sum sale of $780,000 for a typical one-doctor general dentistry practice.
Don't get too excited about this figure because the IRS is first in line to collect its share. As a lump-sum sale, the proceeds will count as income on your tax return for the year of the sale. The sale may qualify for capital gains treatment, depending on how the transaction is structured, but is likely to trigger the Alternative Minimum Tax (AMT). Estimating an effective tax rate of 30%, the net proceeds from this lump-sum sale drop to $546,000.
Can you live on a $546,000 nest egg in retirement? Hardly. Using a standard annual withdrawal rate of 4% for retirement assets, the retiring dentist's annual draw would be $21,840. Trading a $250,000 annual paycheck for $21,840 per year isn't anywhere close to being a good deal. The retiring dentist would need a substantial amount saved back in other retirement assets to maintain his or her standard of living.
On the other side of the lump-sum sale, the newly graduated dentist comes into the market with an overbearing load of school debt-$241,000 on average in 2013, according to the American Dental Education Association.3 Between paying off this loan amount and trying to start and raise a family, most young dentists have little or no money to open and sustain a practice or to buy one from a retiring dentist.
This is why corporate-owned dental practices are proliferating these days. Retiring dentists often have no viable options other than selling their established practices to corporate behemoths. That means trading 30 years of sweat equity for pennies on the dollar. And new dentists have scant resources to purchase existing practices, trading the dream of business ownership and independence for indentured servitude under a corporate fiefdom.
Both new and retiring dentists can do better than a lump-sum sale to stay true to the path toward career success. An agreement structured around the retirement income method can be a win-win arrangement for both parties.
The agreement can be customized between both dentists, but the basic shape is the same: The established dentist exchanges ownership in his or her practice for an annual retirement income. The ownership shares are held in escrow until the new dentist has fulfilled the obligations of the contract.
Under this setup, the established dentist can retire or continue to see a smaller set of patients to supplement the retirement payment. As long as the retirement income payment from the practice exceeds the annual withdrawal amount received from the lump-sum sale proceeds, it's a better deal for the established dentist.
Here's an example of how the retirement income method can work between an established dentist and one fresh out of dental school.
Dr. Michael Jones has practiced for more than 20 years and wants to transition his client base to another capable dentist, someone he can trust to carry on the business he built and provide high-quality service to his patients. Dr. Jane Smith just graduated from dental school and is carrying a significant debt burden from student loans. But she brings the right mix of energy and determination needed to keep a practice going.
The two dentists forge an agreement using the retirement income method, in which Dr. Jones hands over to the younger Dr. Smith full ownership of his established practice—building, equipment, client list, everything. No money is exchanged up front. All of the fixed overhead costs of running practice—office space, utilities, accounting fees, insurance premiums, and more—are covered by Dr. Smith as the new owner.
As a young practitioner, she can look to Dr. Jones as a mentor for guidance on running the practice. And Dr. Jones can pass along what he's learned about building and managing a dental practice while stepping out of the day-to-day operations of the business. By mentoring his young apprentice, he can ensure the practice he built is passed to the next generation in capable hands.
The agreement could be structured so that his ownership stake is paid using the installment sales method. Using the $21,480 annual income calculation from the lump-sum payout from above as our hurdle rate, any payment above $1,790 per month would be a better deal for Dr. Jones.
The average dental salary on Glassdoor at one of the corporate dental practices is $144,711 per year.4 In all likelihood, Dr. Smith could afford to pay as much as $4,000-$5,000 per month to Dr. Jones for the opportunity to own her own practice when you compare what she would make in corporate dentistry (not to mention the quality-of-life issues for her, as well). It could be a win-win for both parties.
The biggest benefit of using a retirement income method is the freedom it offers to both new and established dentists. The financial worries about the payment, ownership, and practice development are eased by mentorship, trust, and mutual incentives. Both practitioners can focus on doing the work they love and following a career path that leads to long-term success and financial rewards for both parties involved.
1. How does your dental practice compare? Cain Watters and Associates website. http://www.cainwatters.com/PDF/HowDoesYourDentalPracticeCompare.pdf. Published 2013. Accessed January 4, 2016.
2. Giroux T. Purchasing a practice. Dental Economics website. http://www.dentaleconomics.com/articles/print/volume-101/issue-2/features/purchasing-a-practice.html. Published February 2001. Accessed January 4, 2016.
3. ADEA survey of dental school seniors, 2013 graduating class: Tables report. American Dental Education Association website. http://www.adea.org/surveys-and-reports/dental-school-seniors-2013-tables.aspx. Accessed January 4, 2016.
4. Salary: Dentists. Glassdoor website. https://www.glassdoor.com/Salaries/dentists-salary-SRCH_KO0,8.htm. Updated November 25, 2015. Accessed January 4, 2016.
Rusty Holcombe, CFP, is president of the Atlanta-based investment firm Holcombe Financial. He is the author of the book You Should Only Have to Get Rich Once. Holcombe Financial delivers a creative financial-planning process to clients ready to think differently about their wealth and develops tailor-made solutions to help maintain clients' independence forever. For more information, visit holcombefinancial.com.