30 May 2021

The Four Foundations of Financial Success of Dentists 

I retired from Synstrat on 30th June 2020. The thoughts presented in this article are based on my 33 years advising dentists and other health professionals, mainly the owner-operators of successful practices. Over these three decades, I distilled down Four Foundations of Financial Success of Dentists. These are: 

1.     Home Ownership;

2.     Practice Ownership;

3.     Practice premises ownership with possible exceptions in country areas; and 

4.     Your Superannuation Fund. 

The “Holy” Quaternity 

 Overwhelmingly dentists, including dental specialists, who have concentrated on ownership of these four foundations to the exclusion of other investments have much greater net wealth as they approach retirement than have those who have become distracted by a variety of other investments. In particular, residential rental properties have invariably disappointed and I have not yet met a dentist who was talked into a timber plantation investment who didn’t subsequently regret the decision. I formed these conclusions after being privy to the financials of a vast number of dentist/dental specialists over the past 33 years. 

Optimum Home Ownership Strategy  

Many dentists routinely take advice on investments, yet many fail to take advice on what for many is among the biggest financial decisions they will take, being home ownership. Most dentists have a 2-step process.  

Purchase of their initial family home usually takes place while they are working as an assistant dentist and typically with a spouse working full- or part-time, but well in advance of their peak income which is years into the future. 

The key decisions are:

1.     Buy a property, which on present income, can be comfortably paid for using a 12- to 14-year repayment schedule; or

2.     Purchase a free-standing house on its own land which is far easier to resell than is a high-rise unit. This recognises that with housing, it is the land content which appreciates compared to the structure, which over a long period wears out unless well-maintained. Land content also provides options for potential buyers not available to unit dwellers. An extension or significant structural alteration is simply not achievable in a unit. The 12- to 14-year repayment calculation is based on present income and amount of savings. If at this stage you are purchasing a home where you can barely make the payments based on a bank’s loan repayment schedule over 30 years, you are buying too high in the market and will likely run into difficulties buying a practice. Even more importantly, your first home is almost never your “forever” home, so the 12- to 14-year repayment schedule will allow a trade up when: 

a)     Your equity in the first home has been substantially improved through repayment and capital appreciation; 

b)    Your dental income has improved; 

c)     You’ve secured ownership of a practice and appreciably increased your income; 

d)    You are now in a position of greater certainty concerning proximity to your long-term work location; and

e)     Your long term family housing need is apparent (children, elderly parents, etc) .

The optimal “forever” home purchase price also be based on the 12- to 14-year repayment target after factoring in the amount of capital released from net proceeds of sale of the first home. The first home should always be sold as the net proceeds are capital gains tax free as is the long-term home. Home loan repayments are a priority over repayment of debt on practice or practice premises loan repayment which should be maintained on an interest only basis. See below. 

Practice Ownership  

The best practices to buy have the following characteristics, so don’t believe a fair bit of what you are told by practice brokers whose income depends on selling what they have listed:

1.     Preferably you’re buying a practice in which you are working so there is minimal handover risk;

2.     The vendor is prepared to work for you for an agreed period but on a diminishing number of sessions per week so that your operatory is well-booked with good patients; 

3.     The vendor doesn’t announce to patients that they have sold, nor that you’ve bought. Rather a gradual, seamless transaction occurs without patients being given an excuse that might cause them to make an appointment with elsewhere. 

4.     If it’s a single owner practice, there are no more than three operatories. Having more than three is rarely more profitable as too much of the principal dentist’s time gets absorbed fixing other providers problems. Dental practice owners invariably make 85 per cent or more of their practice profit in their own operatory providing the most profitable treatments personally. Avoid the trap of having too many gaps in assistant dentist’s books. It’s far better to have them fully booked for say three days than utilising extra chairside assistant time treating the same number of patients over four days. Check booking patterns carefully when buying. 

5.     Premises are a critical consideration. Are the premises suitable and avail- able to purchase? If not available to purchase, a long-term lease at, say, no more than rent equivalent to 5 per cent of practice fees with suitable options is the next best. Say a 5-year interim lease with two more renewal options each of 5 years as being ideal. 

Associated Practice Ownership  

Buying an associateship has a significant extra risk dependent upon the number of associated dental owners. Two owners have one relationship A to B. Three owners have three relationships A to B; B to C; and C to A. Four owners have six relationships; five owners have 10 relationships. Hence the chance of serious conflict between associates multiplies with numbers. The result has been the best practice performers I have observed over 33 years have been sole owners or owners of 1-to-1 associated practices. 

The best associated practices have a total of no more than 4 operatories including those operated by the two owners. 

For most dental practice owners, their practice is classified as an active business asset meaning that in many cases, the small business capital gains tax concessions will apply when sold for the purpose of retirement. This also depends on overall financial structuring.  

Practice Premises 

Dental practice fit out means that if an existing fit out is of good quality or can be lifted to a good standard at reasonable cost, it is highly desirable to own premises rather than to have to do an expensive fit out in rented premises with the possible long-term costs of having to pay for another fit out in the future. Much of the fit-out cost is hidden from view in the form of plumbing, wiring and air lines which simply cannot be picked up and moved. 

However, there is also a significant tax reason for many dentists to own their own premises as they are also classified as an “Active Business Asset”. This means that for many dentists, they will pay no capital gains tax when they sell their premises and their practice for the purpose of retirement. 

It may go against the advice of many accountants but for a great many dentists, it is far better to own your premises in your own name and gear the purchase personally whereas owning them in a super fund can prove to be a serious mistake. See below. 

Superannuation Fund - Understanding Key Strategies 

Many dentists have a self-managed superannuation fund and can also employ and superannuate their spouses, within tax guidelines. Dependent on cash flows, they can make both concessional superannuation contributions, currently permitted at $25,000 each per year up to age 67 or beyond if a work test is satisfied.  

They can also make non-concessional contributions of $100,000 per year (which are not deductible but not subject to contribution tax) with the possibility of bringing forward two further years non-concessional contributions into a current year. Non-concessional contributions cannot be made once an individual’ s pension cap has been reached whereas concessional contributions can continue and indeed are mandatory by employers on behalf of employees. The key strategy is to reach both your and your spouse’s pension account limits many years before actual retirement. Those that do this continue to make concessional contributions of $25,000 per year and their fund continues to accrue investment earnings if they have kept their practice premises outside of their fund and qualify for the small business capital gains tax concessions, subject to some fairly generous tax guidelines they can: 

1.     Avoid paying substantial capital gains tax on sale of practice and premises; and 

2.     Rollover an amount of currently up to $1.3 million to their superannuation fund despite having passed their pension cap limit because this is under separate legislation. See further below. 

In retirement they may draw tax free pensions from dentist and spouse respective pension caps with their pension accounts being tax free on earnings from dates of pension commencement. The sur- plus capital in their super fund is held in their respective accumulation accounts, the earnings of which are taxed at a concessional rate of 15 percent and can be withdrawn at will once tax-free pensions are commenced. In practice, an actuarial calculation determines the average tax rate of the fund on an annual basis. For example, a fund which has 50 percent of its assets assigned to tax paying pension accounts and 50 percent remaining in accumulation accounts, the overall tax on earnings will average 7 percent. Having a huge proportion of assets held in a super fund at a very low overall tax rate in retirement is a key part of a successful career financial plan. 

Currently the pension fund cap per fund member is $1.6 million which is indexed every 3 or 4 years when CPI increases amounts to more than $100,000. 

Using Debt Properly 

Interest rates are presently low by historical standards but nevertheless, it is important to use it sensibly as follows: 

·      Pay down personal non-tax-deductible debts such as personal credit cards and aim to pay down the home at a rate which targets home loan pay out within 12 to 14 years. 

·      Prioritise concessional tax effective superannuation contributions over larger home loan repayments. 

·      Finance practice purchase on long term interest only finance. Since most successful dentists have high marginal tax and Medicare rates consuming almost half of their marginal taxed dollar, a long-term interest deductible business debt at say 3.5 percent per annum is costing only 1.8 percent after tax. Use the same bank financier for home and practice purchase. Banks which finance practice and practice premises will, after some realistic negotiation, lend long term on practice-related assets if you undertake to improve their security by undertaking a rapid home loan repayment schedule which taxwise is what you want. If your practice is efficient and hence profitable, the bank will grow comfortable with your business debt and indeed eager to lend you money for your home upgrade which you will again pay down on a 12- to 14-year repayment schedule. 

In the very long term, well run practices grow their fees and profit while the practice premises and the dentist’ s long term home steadily increases in value and the dentist and their spouse’s superannuation fund increases through combinations of concessional and non-concessional contributions plus investment earnings. 

Rate of Doubling Net Wealth  

Hard working dentists who get their financial structures right commonly achieve growth in their net assets of about 14 percent per year compound, often more. At this rate, their net worth doubles approximately every 5 years as asset values increase, their home loans decrease, practice profitability at least keeps pace with inflation and their super fund grows with contributions and earnings. More importantly, they avoid inefficient investments like gearing into residential units. For competent hard-working dentists, being financially successful long term is not rocket science. 

Best Real Estate Investments 

Overwhelmingly, the best two real estate investments most dentists can make are their forever home, which is a capital gains tax exempt asset and their practice premises which for many dentists is an active business asset if owned outside of their superannuation fund and likely to give long term small business capital gains tax concessions. 

Misleading Housing Statistics 

Buyer can be seduced by faulty housing price statistics. This is because many long-term homeowners significantly improve their homes over lengthy periods of ownership. Capital improvements such as modern kitchens, modern bathrooms, modern en-suites, extensions, solar electricity systems, pools, landscaped gardens with automated watering systems, etc, when built into existing older homes, add to capital value but are not captured by statistics which only measure the changing value of title transfers measured by state stamp duty offices on sale. Not surprisingly, houses in suburbs which have become more popular with professionals and senior management executives grow in apparent value far more than the rate of inflation because there is a high incidence of capital improvement including demolition of outdated structures and their replacement with modern homes. However, because rental houses, which don’t enjoy the same level of capital improvement, are mixed into the house sale statistics, a significantly false illusion is created concerning their suitability as investments. Close observation has taught me that in the majority of cases which I have observed, their investment performance is in fact much worse than the accumulation index for the ASX 200 or ASX 300 share indexes if measured over a long period. Worst of all are the high-rise units purchased off the plan, which often value out at up to 20 percent lower than contracted purchase price when valued after completion. For many owners caught up in buildings with structural problems and many unhappy owners warring with the body corporate, far worse may be to come. 

The Best Real Estate Investments... Again... 

It is wise for a dentist to avoid residential property investment which provides an extremely poor net income after all the unavoidable landlord expenses and can expose you to peculiar tenanting problems, usually with state legislation drawn in favour of tenants. It reinforces the experience that for most dentists, their best two real estate investment options are their long-term home and their practice premises.   

About This Advice 

Having sold my equity in the accounting and financial services group which I co-founded in 1994 I no longer represent a financial services licence holder. This newsletter contains general advice only and those contemplating taking action should do additional research as necessary. 

Those who gain significant benefit from my newsletters may if they wish make a donation to the Delany Foundation, a registered charity, which I support and which contributes to schools in Ghana, Kenya and Papua New Guinea. The Delany Foundation address is C/o Holy Cross College, 517 Victoria Road Ryde, NSW 2112. The foundation is administered voluntarily by former staff and students of Patrician Brothers’ Schools. Money generated by donations goes directly to the work of Patrician Brothers, mainly in schools conducted in Papua New Guinea, Kenya and Ghana.

Best wishes to all readers,

Graham Middleton