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Financial planning for the successful veterinarian (Proceedings)

Article

In establishing your cash flow plan, it will assist you in setting financial goals.

Financial planning for your early years in practice

As you complete your education and enter the workforce you are faced with many challenges. As you begin a working career many issues including those related to financial matters come to light. Once you have gotten through employment negotiations, you will have a good idea as to what your salary and benefits will be. The first important financial considerations that come to a new graduate include debt repayment of student loans, housing costs and transportation. It is important to consider that in establishing one's independence that an orderly plan be established with goals to achieve a desired result. The preparation of a personal cash flow plan can be a big help.

Cash flow plan

In establishing your cash flow plan, it will assist you in setting financial goals. Your financial goals should be established by determining their cost, ranking them in order of importance and in a time frame to accomplish. Sample financial goals might be:

Rank Goal Amount Time Frame

Pay off student loans

Purchase a home

Pay off credit card debt

Purchase a car

Make a large purchase (furniture, jewelry)

Plan a vacation

Save for retirement

Save for children's college education

Purchase disability insurance

Purchase life insurance

The success of a financial plan depends on the clear identification of all goals and objectives. The amount should be represented in today's dollars, or at their present value. An assumed inflation rate will determine the future value assigned to those goals. Short- term goals may be personal or practice related. The most common long-term goal in a financial plan is to retire comfortably. Once financial independence has been achieved, the next most common goal is estate and gift planning. Often, a financial planner can provide great value by identifying, quantifying, and agreeing upon goals that previously were unconfirmed.

Once goals have been established, prepare a net worth statement and cash flow statement. Since almost all areas of financial planning are controlled by cash flow, it is important to construct a cash flow statement, which is accurate and believable. The success of your plan rides on your implementation of financial strategies that arise from the foundation of your cash flow statement. If you don't believe the numbers, you will not implement the strategies, thereby allowing your plan to fail. Your standard of living is a function of your cash flow statement. A cash flow plan covers a specific period of time, and is the most difficult financial statement to construct because many perceive it to be a tool for setting up a budget. Most do not live a disciplined spending lifestyle. It is not designed to be a budgeting tool, although it certainly can be. A cash flow plan is designed to provide comfort when there is surplus income, which can be diverted for other planning needs. If there is no surplus income, perhaps a budget is in order to generate the funds needed. For example, if retirement savings are treated as just another periodic bill, you are more likely to succeed.

A comprehensive cash flow statement, or lifestyle budget outline, begins with an analysis of your operating checkbook and a review of various source documents, such as your tax return, credit card statements, pay stubs, and insurance policies.

A typical statement will show all cash transactions that occur within one year. It is helpful to establish a monthly equivalent to all items of income and expense, but for the purposes of getting started, items of income and expense may be noted by the frequency you are accustomed to receiving or spending them.

Home ownership

When planning a home purchase make sure you have checked your credit report and have cleared up any issues. Free credit reports are available during 2009 at www.annualcreditreport.com. Work with a mortgage broker and pre-qualify yourself before you begin looking for your first home. When looking at affordability, you don't want your mortgage payment or even rent for that matter to be more than 30% of your take home pay. Go on www.burzenski.com resource center for home financial calculators.

Retirement programs

If your employer offers a 401k or SIMPLE program take advantage and participate at least to the extent there is an employer match. If your employer does not maintain a plan, contribute to an IRA.

Some thoughts on early retirement savings are:

1. Do not live beyond your means. The real cost of an expensive lifestyle is the lost opportunity for your money to compound. For example, having a car payment of $250 per month instead of $500 per month means an extra $500,000 of retirement age savings over 30 years, assuming 10 percent annual returns.

2. Go to www.burzenski.com resource center for retirement calculators to help you project your future needs.

3. Be an informed and prudent investor, since the compounding of your money over time accelerates the benefits of higher rates of return. In the example above, having a 7 percent return instead of a 10 percent return would cost you over $200,000!

4. Save as much as possible in your 401(k) or other plan. Maximizing this benefit can literally create millions in retirement savings, and is critical for a comfortable retirement. For example, saving $2,000 per year from age 22 to age 29 (8 years) and making no additional contributions, you'd have over $399,000 at age 60 assuming 10 percent growth). If you wait until age 30, then contribute $2,000 per year until age 60 (30 years) you would have only $328,000! If you save $3,000 per year from age 22 through age 60, you would have over $1,000,000!

The following thoughts represent good financial planning

1. Spend less than you earn, and pay your debts on a timely basis. When possible, pay down your credit cards in full, not just the minimum payment.

2. Cut your expenses because, without reducing expenditures, there is little to allocate to important long-term goals like retirement and college planning. Most can always cut discretionary expenses in the areas of travel and entertainment, clothing, cars, and other luxuries.

3. Pay yourself first each month for a systematic savings program. Capitalize on forgotten or automatic investment plans, and increase your rate of investing as you move forward. Do not wait until you get married to start saving and investing.

4. Cover all assets before assuming greater risk. Disability, death, liability, malpractice, property damage are all insurable risks which veterinary professionals can easily accommodate.

5. If possible, do not be the owner of your life insurance. Owning your insurance will increase your estate value and possible your estate tax. Also, don't name minor children as beneficiaries of life insurance. Children need a trustee and custodian.

6. When investing, seek first a return of principal, before your return on principal. But remember that no risk, equates to no reward. Maintain both liquidity and marketability in your investments for greatest flexibility.

Always be aware of the eroding effects of inflation on any investment. Invest more aggressively for the long haul, and more conservatively for the short term.

7. Diversify your investment portfolio. Don't invest in a stock or mutual fund just because it had a great return last year. Consider the risks taken to achieve that rate of return? Do you already have similar investments such that an addition to that sector would reduce your diversification?

8. No financial vehicle is without cost; keep transactions to a minimum. Assume a low rate of return on investments for an added margin of safety.

9. Minimize income, gift, inheritance and estate taxes to the extent possible. Keep more of what you make with tax-favored investments.

10. Start a pension plan, profit-sharing plan, or other retirement plan. If you are an employee, contribute and maximize any contributions to your employer's existing plans.

11. Make sure your will and trusts are up to date and drafted in your state of residence. Old wills should be revised. It would be complicated if your will had to be probated in a state other than where you live.

12. Assuming that home equity will bail you out in retirement is a mistake. Homes are where you live. They are not investments.

Financial planning in your mid-career years

Mid-career financial planning becomes more in depth. Issues expand with life's complexities. Typical mid-career planning issues revolve around family and practice life. It's at mid-career you might be considering a practice purchase or be considered for admission as a partner in your existing practice. Issues concerning children take on a greater emphasis. Many financial pieces you put in place early in your career should be reviewed. Some of these areas include:

Cash reserves

You should address adequate cash reserves to meet expenses not provided for in the family budget. Temporary unemployment, temporary disability, medical expenses not covered by insurance, investment losses, margin calls, investment opportunities, an unexpected vacation opportunity, and income tax deficiency, and property losses not covered by insurance are examples of events or circumstances that can cause a liquidity crisis. A general rule is to have between three and six months of current living expenses in a liquid (cash) position.

You may also be putting cash aside for a practice purchase, start up or associate buy-in. Normally a 20% cash requirement is necessary.

Practice purchase options

Practice purchase options include deciding if, at this stage of your working career, do you have an interest in being a practice owner? Options include

1) Purchase an interest in the practice you are working at (partnership)

2) Purchase a practice

3) Start a practice

If any of these are appealing there are important financial implications associated with a move in this direction. The first is there is usually a cash requirement to explore any of the above issues and it is prudent to seek proper council (lawyer and accountant) to guide you through the process. There are both major financial and tax implications associated with entering into a practice purchase arrangement. Also, remember the process to purchase is a negotiated process and is usually the seller who provides a package for your review and it's the seller who determines the asking price. A cash down payment for any transaction will usually be required with 10%-20% of the asking price normal. There are many sources for financing and all should be explored including:

1) Owner financing – usually least expensive and least restrictive

2) Local bank financing – conventional/SBA

3) Veterinary boutique financing – national lenders who lend to the veterinary profession

To start the purchase process, the package of information necessary to review a potential purchase should include:

1) Practice appraisal to support purchase price

2) Real estate appraisal to support real estate purchase

3) Compensation formula and rent payment to owner, if related to an associate buy-in

Disability insurance

Disability income insurance is designed to transfer the financial risk of lost wages due to an accident or illness to an insurance company.

The actual benefits may be received for as short a period as 6 months in some short-term group policies, to age 65 in both group long-term and many individual policies. The length of the benefit period is one of the main factors in determining the premium to be charged by the insurance company.

Elimination period

Another aspect used in the development of a disability income insurance premium is the waiting period, (i.e., that period of time that elapses prior to the payment of any benefits during which the insured must generally be continuously disabled.) This is also referred to as the elimination period and in individual contracts is usually specified as 30, 60, 90, 180, or 365 days.

The shorter the elimination period, the higher the potential premium. In short-term group policies, the standard elimination period is the first day for accidents and the seventh day for sickness. Long-term group policies traditionally begin after six months. Persons with ample savings should consider a longer elimination period in order to save premium dollars, but those with less savings should obviously choose a shorter elimination period.

Monthly benefit amount

Another aspect to be taken into consideration for developing the premium to be charged is the monthly benefit amount. The amount of coverage which can be initially purchased is dependent on the current level of pre-disability earnings. Insurance companies have usually been willing to insure 50 percent of current income (for the highest wage earners), to up to 70 percent of current income (for moderate to lower-income workers).

Inflation protection

When purchasing a disability income policy, it is strongly recommended that it include an inflation rider. In the event of disability, this rider will increase the benefit each year in an attempt to keep pace with inflation. Without this rider, if a young insured becomes totally disabled, their monthly benefit will certainly lose its purchasing power over the years. If the insured is young enough, a level benefit may become almost meaningless 20 to 30 years in the future. An inflation rider will cost extra, but is money well spent.

Renewability

The last major issue to be considered when purchasing a disability policy is the renewal feature of the policy. The typical renewal features are:

  • Conditionally Renewable

  • Guaranteed Renewable

  • Non-cancelable

Conditionally renewable policies allow the insurance company a limited ability to refuse to renew the policy at the end of a premium payment period. The insurance company may also increase the premium. Most policies sold to veterinarians will not contain this limitation.

Guaranteed renewable means the insurance company cannot cancel the policy, except for non-payment of premium, but it can change the premium rates for an entire class of policies. As long as the owner pays the premium in a timely manner, the policy will remain in force. Simply, you are guaranteed the right to renew the policy, but it may be at a higher premium rate.

Non-cancelable means the insurer cannot cancel the policy nor can it change the rates. This added level of security means non-cancelable policies are more expensive than guaranteed renewable policies.

Although redundant, many disability income policies specify that they are both "Non-cancelable and Guaranteed Renewable."

Disability insurance is most important to have. Almost everyone understands the importance of adequate life insurance, especially when they have children and a mortgage. But many overlook disability insurance.

Many fail to recognize that the chance of becoming disabled at least once during their lifetime and not being able to work for months, or even years, is greater than the chance of dying. For those working for someone else, ask this question: "Will my employer pay me if I am in a car accident and can't work for 6 months?" What if the disability is so severe that you can never work again and you're only 35 years old? Will your employer still pay you for the next 30 years?

Statistics

  • At age 30, long-term disability is 4.1 times more likely than death.

  • At age 40, long-term disability is 2.9 times more likely than death.

  • At age 50, long-term disability is 2.2 times more likely than death.

Life insurance

Life insurance transfers the financial loss resulting from death. A myriad of different families of life insurance policies exists, but they basically have two main types: term insurance and permanent insurance.

Term insurance

Term insurance is the simplest form of life insurance. Term insurance is exactly what the name implies: it provides life insurance coverage for a specified period of time, i.e., the term. At the end of the term, the policy is either canceled or continues, typically by paying higher premiums.

Renewable term

These policies have premiums which typically begin very low, but increase steadily each year. At the end of each year, the policy owner has the option to renew coverage at the higher premium, or cancel the coverage. By the time an insured reaches age 60, and the probability of dying becomes more pronounced, the premiums start to rise drastically. The increased premium is simply a reflection of the increased chance of dying combined with the obvious fact that there are fewer lives at that age to spread the risk over.

Renewable term insurance has lost much of its popularity recently since level-premium term products have captured more market share.

Level premium term insurance

Level premium term policies offer a cost that remains level for a specified period of time, usually 5, 10, 15, 20, 25, or 30 years. The most popular products have premiums that are guaranteed to remain level for the prescribed period.

At the end of the selected level-premium period, the term policy is typically canceled, although the owner may keep the policy in force by paying higher premiums. The premiums, however, may increase drastically.

The affordability (during the selected term period) and simplicity of these products have made them very popular.

Permanent insurance

Permanent insurance differs from term insurance in two major ways. First, it is usually designed to last to age 95 or 100 (commonly referred to as the maturity date) without any future requirement to re-qualify for the coverage by providing proof of good health. Second, permanent policies have some form of cash value accumulation.

One permanent insurance policy can cover a single life, two lives, or an entire family. Policies covering two lives can provide a death benefit either on the first death or the last death.

Generally permanent insurance has a predefined level-premium payable until a stated maturity.

How much insurance should I have?

Determining the appropriate amount of life insurance that you should carry is often a trade-off between the calculated need and the amount of premium you can afford.

Recommendations must consider your goals and priorities, the calculated needs for life insurance, the types of policies available, and your current financial situation.

Some rules of thumb for determining life insurance needs are the following:

a. Four to six times annual earning, or

b. Insurance, when combing with your current asset base, sufficient to replace 50% -75% of income.

While rules of thumb are nice check points, they are no substitute for a thoughtfully completed life insurance needs analysis. Nevertheless, when a quick answer is required, a method that will yield a useful result follows:

a. What was your after-tax income from compensation and investments last year?

b. How much money did you save last year?

c. Your after-tax cost of living last year is item 1 minus item 2.

Financial planning for retirement

As you move toward retirement, new issues arise. The financial planning consideration during this time centers on wealth accumulation, retirement, and estate and gift planning.

Practice sale

It is during this time, if you own your practice that you begin to think about the issues centered on transition of ownership. Considerations should be given to the practice sale as a:

1) Sale of partial interest over a long term period

2) Outright sale to a known party or through the use of a broker

3) Sale of the practice to corporate buyer

A properly structured transition plan should be started 5 – 7 years before an eventual sale. The first step in a good transition plan is to complete a practice appraisal, look for practice strengths and weaknesses and build to a value that will provide you your retirement objective. The one mistake many make is to believe their practice sale will provide all the funds necessary to provide the retirement nest egg. Don't put all of your eggs in one basket! Portfolio diversification is important in building a properly structured financial plan.

If the practice real estate is owned along with the practice, the question is when to sell the real estate. Most practice buyers will want to purchase the real estate with the practice and it may assist in the potential purchaser obtain financing. If the property is not sold at the date of the practice sale, plan that the practice purchaser will want to purchase it within a 5-10 year period after the practice purchase. Questions for the practice owner that revolve around the sale of the real estate are:

1) Can I get a better rate of investment return in the open market vs. the rent?

2) What is the amount of taxes due from the sale of the real estate which will leave a lower amount of investable dollars for an investment return?

3) Does a tax structured, Section 1031 Exchange, used to defer the taxes on the real estate sale make any sense?

Work with your professional team to complete a well organized sale that will provide the greatest sales price with the least amount of taxes paid. Taxes play a significant role and can be a burden if not well thought out.

Retirement planning issues

1) If you haven't already done so, it's critically important to do your retirement cash flow planning now. Without planning, you're making decisions in a vacuum that may mean a severely restricted lifestyle later.

2) This may be the time to consider long-term care insurance, depending on your financial situation. A good financial planner can guide you on the appropriateness of this insurance for your needs.

3) It's important to integrate both your estate and retirement planning, since the steps you take for one dramatically affect the other.

4) Don't procrastinate, since planning without action won't help you be financially secure.

Review your retirement plan to make sure it meets your retirement savings objective. Do you have the right plan?

Estate planning

The process of estate planning makes sure the forthcoming goals are met:

1) Maintain financial independence for a lifetime

2) Maximize the inheritance to chosen heirs or beneficiaries

3) Minimize estate taxes

4) Address healthcare issues the way you want them dealt with

The following are the basic documents required within an estate plan:

  • Will

  • Durable Power of Attorney

  • Living Will

  • Appointment of Health Care Agent

  • Trust

A sound estate plan will provide that the will be reviewed at least as often as any:

a. Major tax law change;

b. Change in marital status or any beneficiary;

c. Birth or death of or adoption by any beneficiary of fiduciary;

d. Move of principal residence to a different state;

e. Change in your financial status or principal beneficiary; or

f. Change in your health or competence or of a family member.

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