Age, Experience, Income, Debt Service and Retirement

January 23, 2017 News

by Bruce Bryen


Maybe you are a recent graduate from dental school or have been working as an associate. You may have acquired your own practice and wonder about what to do with your debt.  Either of these scenarios probably entails having obligations to pay for education.  Those owning a dental practice, or considering an acquisition face not only educational debt but also loans used for its transition.  That office will be used as the base generating the income for the standard of living desired for the dentist and his or her family and for the near future and retirement. Its earnings are used to pay what is owed from all sources, including educational borrowings. A house may be owned or under consideration for purchasing, which will probably require a mortgage. With the amount of money owed and the various reasons for it, certain points are reached during the career of how to approach the payment.  As the dentist matures, that aging will enhance experience and additional earnings should occur. With this additional income, dental advisors will discuss the implementation of a retirement plan. Let’s examine some approaches to these concerns and address a tax efficient manner in which to resolve these issues.

What comes first in this dilemma? (Is it the chicken or egg theory?)

Without the debt for the education to become a dentist, there would be much less income now and in the future. Without the income, there would be less money to amortize the debt and have the ability to save for retirement.  Neither appropriate housing nor a dental practice could be acquired.  The answer to the question to analyze is what is financially wise including the tax effect. A detailed explanation is needed to fully understand this theory but after its analysis, it should allow the dentist to think both short term and long term goal orientation.  Financing, investing and planning for current income taxes and the future will be accomplished with a better comprehension of how taxes sometimes should override interest rate concerns. Retirement plans can be used to benefit the dentist and explain how he or she can enhance the fruits of their labors now and when considering retirement.  There are hypotheticals that must be taken into account since each dentist’s situation is different.  We’ll begin with a set of circumstances and the dentist can factor in his or her own situation to determine how these explanations will impact them.

Experience, income, debt and the future

The circumstances are as follows: With experience comes better income. With better income, reputation is more of an accepted factor so that more patients, more income and a better lifestyle become a reality.  The ability to pay obligations with funds available or to proceed in other directions with these funds becomes a dilemma for the dentist. What course should be taken with these funds?  To pay additional payments to retire the debt or to use the funds in other manners is the question.  The following is an explanation of what each course of action may mean: The experience, income, debt and the future all impact each other.  Let’s first deal with the dentist’s experience and income.  There should be an acceptance that the dentist’s income will increase with experience.  A realization that is difficult to comprehend is that when a debt is paid, there are few sources from which payment can come that don’t affect income.  One source is that the loan may be refinanced.  This happens when an interest rate decrease is available or the term of the obligation can be shortened or the monthly payment reduced.  When the debt is refinanced, and hypothetically a $100,000, 8% loan is replaced with the same amount of debt but with a 5% interest rate, there is no tax effect. However, the only other approach to reducing a debt is that the principal payment must come from the obligor’s income.  This excludes inheritance, gifts and items such as those that are not in the normal course of business.  If the loan is amortized from income, there is a tax due that the borrower realizes at times too late.  An example is a mortgage. Most dentists don’t accept that the principal of the mortgage is not deductible since almost the entire mortgage payment for at least the first third of its life, is primarily interest, which is deductible.  Think about the principal portion of the payment.  That is not deductible. Where does the money come from to pay it? If the dentist has a salary, after paying taxes on that income, the money left is used to pay the principal.  The amortized portion of the educational loan is paid from income, if not refinanced. That part is not deductible. It comes from the dentist’s income.  Think of a dental practice loan. If the structure of the acquisition was not properly addressed, the principal portion of the debt comes from income and the dentist pays a tax on it.

Analysis of debt payment and the tax on that amortization

A hypothetical analysis of a dentist with taxable income of $118,500 and without a house is as follows. If the dentist owns his or her own practice, there is a self employment tax of double that of an associate that is equal to 15.3%, including medicare.  The personal federal income tax marginal rate, plus the 15.3% plus if you live in a state with an income tax, your total income tax rate for 2016 would be about 46%.  The wise dentist with an advisor providing this information may then discuss delaying additional principal payments and looking for an alternative.  Suppose the interest rate on the loan is 9%, and the tax rate is this hypothetical 46%. An additional $10,000 payment to amortize the loan would cost $4600 in income tax. The interest savings would be at 9%, or $900.  The dentist would have paid the additional $10,000 against the outstanding balance of the loan so that the $10,000 is no longer available.  He or she would have saved $900.  The tax on the $10,000 payment would be $4600 so that the total out of pocket amount from the dentist would have been $14,600 to save $900.

Is there an alternative?  

With careful planning and a good comprehension of the dentist’s overall financial approach to debt, taxes and retirement, a dental CPA can assist with a current plan. Something to brain storm is the implementation of a retirement plan for the dentist now, rather than waiting.  A hypothetical use of the $10,000 example available to pay into the retirement plan is the amount deferred in tax.  The $10,000 would be in a retirement plan for the benefit of the dentist and its earnings not taxed until withdrawn, leading to a more secure retirement.

What comes next?  

Whether it’s the chicken or the egg, a discussion with a dental CPA about age, experience, income, debt service and retirement should be addressed so the dentist’s knowledge can be increased about debt payment for his or her betterment.