Could you retire early?
It’s tempting, so could your dream become reality? Martyn Bradshaw provides answers.
Over the last few years and the recent decade in particular, I have witnessed the age of dentists selling their practices prior to retirement come down, with the majority of my clients now selling between the ages of 50 and 55. While the increasing burden of administration and compliance has been a factor, most often their decisions are based on financial matters.
There are significant factors making people sell their practices earlier than they would have anticipated. First, owners realise the values of practices are at a record high. I have seen a sharp rise in values since the introduction of the new NHS contracts in 2006, although over the last few years the values appear to have stabilised at their peak.
Second, there is concern over the future of NHS contracts. Practice principals with higher than average UDA values worry that if/when new contracts are announced, their UDA value could drop. Where a practice receives £30 per UDA, for example, and pays £11 to an associate, a reduction of, say, £5 per UDA would impact directly on the profitability of a practice with 20,000 UDAs (20,000 x £5 = £100,000). Because valuations of practices are now calculated on a multiple of profitability, a six times profit multiple could reduce the value of the example practice by £600,000 (see Table one).
Effect on practice value of reduction in UDA value
|Practice with 20,000 UDAs||£30 per UDA||£25 per UDA|
|Associate cost (based on £11 per UDA)||(£220,000)||(£220,000)|
|Value assuming 6 times multiple||£1,080,000||£480,000|
While few people believe that new NHS contracts will be coming soon, when an announcement is made, and if it does confirm a lower (possibly national average) UDA value, this would start impacting on the values and sale prices of practices. A seller also has to consider that the average timescale for an NHS practice sale is between eight to 12 months – any announcement about reductions in UDA values during this process could impact on the sale.
Dentists seeking retirement often tell me their reasons for wishing to sell are to reduce or eliminate the hours of administrative work required or the staffing issues – recruiting, sickness cover and other more serious problems. However, the majority appear to still like the hands-on aspects of dentistry.
A good number of dentists who sell their practice wish to remain in the practice as an associate – to carry on the clinical aspects of dentistry, which they still enjoy. While this is not often a requirement from buyers, I have dealt with a number of dental practice sales in which the principal made it a requirement that he or she could stay on. As we are in such a buoyant market the vendor certainly has more choices than ever.
The sale of your business is likely to be a financial crossroads with decisions best made after detailed analysis of existing financial plans, NHS pension options, personal pensions and investment options. As a retiring dentist, you are likely to be encountering these issues for the first, and possibly last, time. Often the hardest decision is the timing of retirement and understanding when you can afford to do so. Finding out the value of your business should be a starting point to answering this question but is not the whole picture.
PFM Dental’s independent financial advisers regularly help dentists selling their practice to build a coherent financial plan in advance of the sale. This will leave you better informed on the timing of your sale and whether you can afford to retire completely. The practice sale can release a significant amount but it remains the case that the transition from earned income to ‘passive’ retirement income needs to be managed carefully, not least to ensure ongoing financial security. Informed savings and investment decisions can save large amounts of income tax annually.
Conversely, many individuals make the mistake of failing to use the available tax allowances and exemptions that some investments offer, such as the annual capital gains tax allowance (£11,300 per individual) and tax-free dividend allowances (£5,000 per individual) – a couple could have at least £32,600 tax-free income. Correct advice on the use of these allowances is especially important for those dentists whose NHS pension will absorb most or the entire basic rate tax band (up to £45,000 of income per annum).
Another common problem for dentists is making decisions on the NHS pension. Taking the pension before age 60 will usually result in an actuarial reduction of approximately 5 per cent per annum. For example, take your pension at age 55 and the income will be reduced by approximately 21 per cent per annum for life (see Table two).
Actuarial reduction applied to NHS pension and lump sum if you retire early (1995 scheme)
|Pension reduced by||5%||10%||14%||18%||21%||25%||28%||31%||34%||37%|
|Lump sum reduced by||3%||6%||9%||12%||15%||17%||20%||22%||25%||27%|
Can you defer taking the pension? Have other sources of income been quantified? Taking your NHS pension or cash from personal pensions trigger a test against the HMRC lifetime allowance (LTA) and penalties for exceeding the current £1.0m lifetime allowance are punitive. This is a complex area of advice but as a rule if your NHS pension is more than £43,500pa you will need to take some mitigating action to avoid a tax charge.
In summary, financial analysis by a suitable qualified and dentally aware financial adviser will be at least helpful and at best could significantly enhance retirement income. One satisfying outcome of such advice is that often practice owners can afford to retire earlier than they expected to do so ten years or so ago. Are you one of these practice owners?
Many of my clients are ‘cashing in’ on the high value of their practices and therefore eliminating the risk that these values may go down in the future. However, should they still need an income, they often agree to remain at the practice as an associate. This does not necessarily mean a fixed ‘tie in’ with ‘financial retentions’ (money held back from the sale proceeds) but secures a position for them to continue working until they are ready to retire.
While as a principal you’ll understand that your income will fall after the transition to associate within your former practice, the loss is often not as much as you think. For example, if a principal had earnings of £150,000 that reduced by £40,000 to £110,000, the net loss of income would actually be £24,000 per annum once tax liabilities are accounted for.
This net loss could be mitigated in other ways. The sale of practice proceeds may be used to clear any outstanding business loan, mortgage or other loans. This will reduce the amount of net income required. Other expenses such as surgery insurance, practice expenses (locum cover), life cover, income protection are often also reduced. Practice sale proceeds could be invested to generate a regular income to add to the associate earnings. Contributions to pensions could be stopped – although it would be vital to seek expert independent advice before doing so.
The above options would usefully form part of a personal financial review with an independent financial adviser. My colleagues say their clients are often pleasantly surprised by the outcomes from such reviews.
The practice sales market has been very active over the last decade and while there are no signs of this slowing down, should there be a reduction in UDA values in future, this could have a dramatic impact on the values of NHS practices, especially ones receiving an above average UDA value. Therefore, many principals are seeking to cash-in the value of their practice because if sale prices do go down it could mean them working for another 10 years to make up the difference.
If early retirement seems attractive, you should seek professional advice on the likely value of your practice and your potential income in retirement.
Martyn Bradshaw is a director of the PFM Dental Group. Information on pensions by PFM Dental Independent Financial Adviser, Jon Drysdale.