How to Get Out of Debt

By Brian Hufford, CPA, CFP®

Do you have a goal to get out of debt? Recently, a dentist friend posted a blog on Facebook by author James Clear titled Forget Setting Goals. Focus on This Instead. The author stressed the critical differences between goals and systems in achieving meaningful outcomes. For instance, the author stated, "If you're a runner, your goal is to run a marathon. Your system is your training schedule for the month." The author stressed that systems are more important than goals.

My experience has been that a commitment to a goal without a larger commitment to the right systems simply creates stress, as any weight loss program will reveal. There are good systems and bad systems to achieve goals. A bad system for weight loss is anorexia. A bad system for getting out of debt is sacrificing savings to eliminate debt. In this column, I will focus on the best systems to eliminate debt for dentists.

The best system for getting out of debt has to accomplish two objectives: 1) eliminating all debt while 2) reaching your retirement age with adequate savings. Mathematically, it can be proven that a dentist who focuses on debt elimination between the ages of 35 to 50 by sacrificing savings of 20% of earnings each year, forfeits as much as $2 million of retirement savings at age 65. This is counterintuitive, but reveals the importance of running the numbers with something as important as your financial goals.

Anecdotal wisdom abounds with something as emotionally charged as a goal to be debt free. I once spoke at a national dental meeting with a dental financial icon who made the statement that "Eliminating debt is your best investment. Where else can you achieve a guaranteed investment return of 7%?" Embarrassingly, my presentation stated the importance of saving versus debt elimination, the exact opposite strategy. While it is true that investment returns from savings are not guaranteed, especially at a 7% return, it is also true that forfeiting 15 years of compound growth due to a focus on debt elimination costs most dentists a fortune at retirement age. I shared my numbers with my fellow speaker at lunch. He was shocked.

Unfortunately, a system that allows savings of 20% of income throughout an entire dental career has to embrace a compromise with debt elimination. Most dentists cannot eliminate debt rapidly while saving 20% each year. When the mathematics of income taxes are added to the equation, the lost wealth accumulation at retirement for rapid debt repayment is breathtaking.

For each $1.00 of principal repaid, a dentist must earn as much as $1.70 to pay $0.70 in federal and state taxes for the nondeductible principal. The implications are striking: a dentist could either maximize deductible retirement savings in a 401(k) plan at $51,000 or pay down $30,000 of debt. They are similar after-tax equivalents.

Following are the components of a debt elimination system we recommend.

First, you must save at least 20% of income each year of your career. If you are unable to save this amount each year, the most likely culprit is rapid debt elimination. To check your system of debt elimination, apply the following formula. List all the debt you currently owe, both practice and personal. Total how much you owe. Total the monthly payments on all of your debt. Divide the total debt payments by the total amount you owe. If the answer to this equation is more than 0.8% or .008, you are likely not able to save 20% of income.

As an example, let's say that you have $600,000 of practice and personal debt and that your monthly payments are $12,000. The monthly payments are 2% of the total amount owed. If the debt were structured properly, the monthly payments could be as low as $4,800 or 0.8%. This is a difference in after-tax savings potential of $86,400. If this amount were committed to a deductible retirement plan arrangement, the before-tax equivalent could be as much as $145,000 in the highest brackets. When we have run the numbers, the best system for debt elimination for these facts would be to save the $145,000 each year, invest conservatively, and simply pay off any remaining debt with the practice sale at retirement.

In summary, do not surrender your retirement goal with a debt elimination system that sacrifices saving 20% each year. You can eliminate debt only as quickly as your ability to save 20% allows.

Brian Hufford, CPA, CFP®, is CEO of Hufford Financial Advisors, LLC, an independent, fee-only planning firm that helps dentists achieve financial peace of mind. Contact Hufford at (888) 470-3064 or [email protected].