Rolling net worth versus conventional retirement planning - a possible time bomb for the dental profession
Some years ago, I think around twenty, a financial adviser called Paul Etheridge devised a clever computer program that could plot the progress of various assets owned by clients throughout life and into retirement. It became known within the financial planning industry as a “rolling net worth” calculation.
If insufficient funds are available from other sources i.e. practice sale etc we now have to get used to entertaining our family and friends in a much smaller space
To give a very basic example if a client owns a large house and decides that on retirement he or she will place say 50% of the value into their retirement pot that amount of money is then recorded in the software and earmarked for retirement planning. The software will then pickup that figure and project it forward either as a capital amount or potential income into retirement. The visual graphic section of the report presented to the client will now show a green ascending graph reassuring them that they will not run out of cash into retirement.
I believe it is important to explore the above concept and consider that there may be a future problem here. Most of us through our working life, if things go well, acquire progressively larger properties as we go along or extend and improve the properties we live in or a combination of the two. In the run-up to retirement usually the family have flown the nest and we enjoy lots of space and entertaining our friends and family in our favourite place on earth. We become really comfortable in this environment and look forward to going home every evening to enjoy the fruits of our labour.
Then retirement comes along and potentially if the above situation applies everything has to change, 15 years ago we told our financial adviser that we were happy to build 50% of the value of our house into our retirement plan. As a consequence no backup plan was ever created. If insufficient funds are available from other sources i.e. practice sale etc we now have to get used to entertaining our family and friends in a much smaller space, in our view, a home should ideally be for life. Unfortunately there is no way to turn the clock back, retirement is here and there is no opportunity to change a decision that was made so long ago.
I can say that the above situation would be very unlikely with a client of DFA because we counsel clients very carefully indeed and warn them about the above scenario and we also show them how they can build in contingency plans without reducing their current standard of living. I'll come back to that later,
A job or a company equals a pension
If you work for the government or any large company it is almost certain that you will have an occupational pension scheme. It's a given that carrying out any form of paid work implies that some form of retirement benefit goes with it. In the case of dental surgeons, although their contractual arrangements differ from doctors, they still qualify for superannuation benefits if they perform NHS dentistry.
Without going into technicalities it's a very attractive scheme, but it has to be paid for and the downside is they deduct 6% of your income before you receive it. These contributions are tax-deductible as a business expense and represent excellent value for money, however many dentists of course now carry out much reduced levels of NHS work or even none at all meaning that their superannuation benefits are drastically reduced. I think something should be done about that but I'll return to that subject again a little later.
Conventional financial planning
The rolling net worth system as described above has in recent years gained an enormous amount of ground, in fact it would be fair to say that a significant number of financial planners use it. It definitely has its place and if used properly is an excellent financial planning tool. So why don't we use it at DFA? I went to some of the early presentations given by Paul Etheridge and decided not to use it. I have made an excellent living over many years demystifying insurance products and financial planning for clients and I honestly believe the graphs produced by the system are not nearly specific enough and are generally confusing to clients.
Rolling net worth is a very complicated calculation and it's difficult for a client to fully understand how the figures are produced. Over the subsequent years I have attended a number of presentations given by companies that have produced their own software versions based on the rolling net worth principle and in every case I have rejected it. I am also concerned that the figures produced can be very easily manipulated by the adviser in a way that is not obvious and very difficult for a client to monitor.
We use an alternative and very effective software program that our clients like a great deal, it deals with each and every aspect of a clients financial planning separately. This makes it very easy to demonstrate to a client where the shortfalls are and how easily they can be overcome, in my view far superior to a rolling net worth graph which provides lots of coloured graphs without providing very specific figures. Our review provides the same clear and understandable approach to life cover, critical illness cover, income protection, professional expenses cover, savings, inheritance tax planning and most importantly retirement planning. Because each subject is separated so distinctly it is much easier to be sure that every risk has been covered.
To return to the original subject which is retirement planning our software will include detailed figures and calculations from the superannuation scheme, all existing pension plans and if appropriate some allowance for state pension. We rarely, if ever, include practice values in this calculation, we actively dissuade clients from using capital assets for retirement planning. Why? Some of these assets will have been created out of net income; retirement planning in my view should where ever possible be funded exclusively from gross income that way the taxman pays a larger proportion of the cost, the other way you potentially pay it all. In most cases you have worked hard to create those assets and they should be used as a backup or the icing on the cake rather than be dissipated as retirement income, some clients enjoy passing on the value of assets to children or grandchildren.
What actually happens when you use your own capital assets for retirement planning is that you let the taxman and your patient base off the hook when in my view the taxman should be paying between 40% and 50% of the cost with the patients paying the rest. When you buy a product from a large company that provides their staff and executives with a pension scheme its a given that the cost of that pension has been added to the cost of the product, so in effect you are paying for their company employee benefits and of course that is the way it should work.
Anyone who has visited our website will notice that we claim to be not just IFA's but also business planners to the dental profession.
In our view dentists should allow for a small proportion of their hourly rate to provide a retirement safety net under the practice. To do this effectively you have to have an adviser who understands how the turnover in your practice is produced. Anyone who has visited our website will notice that we claim to be not just IFA's but also business planners to the dental profession.
Before I set up DFA I took that responsibility very seriously and suspended my company for a period of five years. The first year of that sabbatical was spent with Denplan as Regional Manager Southwest region, this of course gave me a major insight into all the financial aspects of a dental practice and very usefully taught me why and how to construct a very effective patient payment plan. Year two and three of that period was spent in London attached to a dentist only quality IFA, here I learned all about the various dentist only contracts and products that are vital not only to minimise cost, but also to optimise efficiency in planning a dentists protection and retirement arrangements. Year three and four was with a dentist only accountant, whilst creating and running their financial services division I picked up a wealth of knowledge in relation to reading a set of accounts, benchmarking, practice valuations, hourly rate calculations and general management of a dental practice.
I hope you will forgive me for blowing my own trumpet, but hopefully I can demonstrate how we are able to apply that knowledge to ensure that our clients have absolute security in retirement with the practice picking up the bill.
How to avoid you or your family paying for your financial plans
Remember this is where a fee-based financial planner is so important; you need to pay an expert with a detailed knowledge of how a dental practice operates to review all your financial arrangements without the need for a financial product to be sold to generate a commission. Commission does not necessarily, but can distort the advice process by creating the need to focus on one area or product i.e.your adviser could be much more interested in selling you an insurance policy than advising you to start a pension. As described above you need to see all your financial plans and requirements in one easy to understand document, this is then reviewed in detail to ascertain your requirements, it's your financial plan so you need to make the decisions not the financial adviser, he or she is there to give guidance and information.
When the total cost has been established then, and only then we consider the issue of affordability. Obviously if the practice is doing very well this won't be a problem, but we find probably 9 out of 10 new clients will not be able to initially afford all of the recommendations we have made. It's extremely important to establish the total cost which will include all retirement planning, savings, school fee planning etc and as previously mentioned trying not to build in too many of your existing assets, that way there will be some pressure on the practice to provide the necessary funds. So now we know what we need or want and we know the total cost and for the purpose of this exercise we will assume there isn't enough cash available.
This is the point where many IFA's will cease working, for us this is where the most interesting part of our work begins. First of all we benchmark the accounts to make sure you're profitability levels are at or near the national averages, of course you don't have to be average and the majority of practices of course are not, but you need a starting point and benchmarking will tell us initially if your costs are too high or if your turnover is too low. The methods we use to improve the above are far too numerous to mention here, but when an adviser works only with dentists anomalies and inefficiencies are very easy to spot and of course on a day-to-day basis we pick up masses of good ideas on how to improve patient recruitment, handling and retention.
So how much of a difference do we have to make? Well that's the incredible thing in that for most of our clients depending on turnover of course we only need to increase profitability by just a few percentage points to free up the necessary cash to fund all their financial and retirement plans. Now let's be very very clear exactly what we have done here, we have improved the cash flow sufficiently to fund a comprehensive long-term financial plan without stripping out or earmarking any of the major assets such as home, practice bricks and mortar value or goodwill fixtures and fittings.
This means that when you come to retirement you can stay in your home, you can sell the practice and spend the cash or invest it or hold it in trust for the next generation, at the very least you will have a cash reserve that you can call on for those extra special expenses in retirement and to use for extra income if you need it. Practice values have fluctuated enormously over the last 15 years, no one can guarantee what those future values will be.
Don't have a ticking time bomb in your arrangements that is set to go off at retirement when you no longer have the ability to change things. Start now to guarantee the peace of mind you deserve. Even if you only have just a few years to retirement you can always make a difference. Last, but by no means least modern pensions are a low-cost tax efficient investment vehicle which no business owner should ignore, there are some subtle reasons why your financial advisor may not be recommending them.
If you would like to find out more please read our article “the debate – pensions - friend or foe”
Martin Haines is principal at Dental Financial Associates, he has been creating financial plans for nearly 30 years, the last 16 working exclusively with dental surgeons. DFA offer a free no obligation “get to know us” meeting at the practice for prospective clients which provides a relaxed discussion about potential financial planning needs.
