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The retirement fund shortfall, what is your solution?

Generations of investors have followed the timeless financial advice dispensed by Samuel Clason in his 1926 book, “The Richest Man in Babylon”.  According to Clason, it is easy to get rich: “Live frugally, save 10 per cent of your income, and start early.”

 

Yet doctors who follow this advice are often disappointed to find their actual net worth has fallen far short of their retirement goal.  Many doctors come to the painful realization this advice is far riskier than previously acknowledged. The reality is more like: “Save as much as you can and pray that your investments double in the last few years before retirement.”

Consider the young doctor who asks his or her financial planner to determine the amount needed to accumulate $3 million in 30 years, for retirement at age 60. The financial planner runs the numbers. Assuming a “reasonable” investment return of 8 per cent, the financial planner calculates that by investing $27,000 each year the doctor can end up with a comfortable $3-million nest egg.  However, the planner did not warn the doctor that his or her savings will accumulate very slowly over the first 20 years to reach only $1.2 million. Nor did the planner mention that investments must keep growing at 8 per cent each year for the last 10 years in order to generate the additional $1.8 million.

 

The Rule of 72 tells you the number of years required for your investments to double at a certain rate of return. For instance, with an 8 percent return, an investment will double in 9 years. However, if the investment return drops from eight to two per cent in the final 10 years before retirement, then the doctor will only have $1.8 million accumulated at age 60. That is $1.2 million short of the $3-million target.

 

So where does this leave you?

Here are several options:

  1. Put your funds into higher yield investments. In your efforts to make up a shortfall prior to retirement, you may be forced to make a tough decision. You’ll have to weigh placing your money in riskier, higher-return investments, against playing it safe and preserving the capital you have accumulated to date.

 

  1. Use the medical corporation or holding company as your investment vehicle. Take advantage of the low corporate tax rates by investing all surplus funds in the corporation and only draw funds for personal and living expenses. If you invest $30,000 of before tax income annually in the corporation for 30 years at an interest rate of 6 per cent, the corporate investment will grow to $2 million. If you invest the same amount personally, you will end up with only $1.3 million of investments (assuming a corporate and personal tax rate of 12 and 45 per cent, respectively). There are additional personal taxes to consider when drawing retirement income from the corporation, however, the tax benefit of corporate investments remains significant. If the corporate investment income gets too high, alternative investment strategies, such as the RRSP will have to be utilized to ensure that you are not affected by the new passive investment rules.

 

  1. Save more than the financial projections tell you. To protect yourself against poor investment performance later in your career, force yourself to save a bit more than the “Freedom 60” financial projection. For example, if a young physician invests $40,000 each year instead of the projected $27,000, he or she would have accumulated $2.7 million compared to $1.8 million at age 60.

 

  1. Borrow money to invest. If you are confident that your financial advisor is consistently producing above average returns for your portfolio, “leveraging” can give your wealth-building efforts a big boost. If you take out a 3 per cent mortgage on your house for $500,000 and invest it for 10 years at 8 per cent, you gain an extra $300,000 using the bank’s money.

 

  1. Postpone retirement. When all available strategies fail to provide you with the funds required for a decent lifestyle during retirement, you can either postpone your retirement for a few years or work part-time to pay for your living expenses. Instead of taking the time to find ways of achieving better returns, many physicians simply resign themselves to working long past their retirement date. It is easy at 50, when you are in the prime of your career and still full of energy, to believe you won’t mind working the extra five years to age 65.  But you may feel differently when you near 60, feel ready to quit and are locked into working another five years.  At that point you are likely to regret not having paid more attention to your personal finances when you were 50.
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