Creating Your Practice’s $1 Million Retirement Buyout
One of the most common complaints we hear from Doctors is that they are frustrated that their decades of hard work are not building anything of concrete financial value. In other words, Doctors are frustrated that their practice will not be “worth anything” when they retire. As a result, they cannot “sell it” and enjoy a lucrative exit from the practice of medicine the way other business owners can with their non-medical businesses.
It is certainly true that the days of an outside practice management firm coming in and purchasing a Doctor’s practice for millions of dollars are long gone. On the other hand, there are a number of tactics a Doctor can employ to create a $1 million “buy-out fund.” We are not talking about the funded Buy-Sell arrangement that applies to unforeseen circumstances such as a disability or premature death of a partner. The buy-out funds we will discuss here are mechanisms to exit a practice at the Doctor’s chosen retirement time and take over $1 million out at that point. Of course, this would also be in addition to whatever the Doctor has in qualified retirement plans and other personal assets.
Buyout Funding Options
As you will see below, each of these tools require periodic funding over time. With the compound growth over an entire career, a Doctor can create significant retirement buy-out funds over 10, 20, or 30 years. A nice bonus is that the funds can grow on a tax-deferred or tax-free basis in most of these arrangements. With all of these tools, Doctors have two potential ways of funding them:
A. Solo Practice Model
Here, the Doctor in question simply takes advantage of one or more of the tools below and funds them from the practice. This approach is certainly better than not funding them at all, thanks to the asset protection and potential tax benefits that many of these tools afford. These options force the Doctor to build the buy-out fund with dollars that might otherwise be spent on personal consumption. Therefore, any and all of these tools can be used in the one-Doctor model.
B. Group Practice Model
In this model, in addition to the potential tax, asset protection, and forced savings benefits, Doctors enjoy another crucial benefit described earlier on in the book. They get to use other people’s money (OPM) to achieve a long-term goal. OPM is involved here because each of these tools can be Leveraged in a way that older Doctors of the practice require the younger Doctors (partners or not) to contribute into these vehicles. While the contributions go partly to their own buy-out fund, part of it could also fund the buy-out of older Doctors. When these younger Doctors become more senior, they too will benefit from this arrangement and the funding by younger Doctors at that time. This “pyramid” model is common in professional firms outside medicine, such as consulting or law firms.
Buyout Funding Tools
As you will see below, all of the major buyout funding tools are arrangements that we have already described earlier in this Lesson. Let’s examine each of them again briefly and review how they apply to the goal of creating a buyout retirement fund.
1. LLC Lease Back
A valuable piece of equipment or the practice’s office can be transferred to an LLC and then leased back to the practice entity. As explained before, this provides asset protection for the practice (vis-à-vis claims from the property or equipment), the property/ equipment (from claims against the practice), and for the Doctors (from both).
The LLC lease back works as a buyout funding tool through the rent paid by the practice to the LLC. Each month the practice will pay tax-deductible rent to the LLC. In the solo practice model, the Doctor could utilize a gifting program for the LLC interests and, over time, get the benefit of lower tax bracket “borrowing” of children or grandchildren. Proceeds remain inside the LLC, asset protected at a (+2) level. They can be managed by professionals in a tax-favored way and build up over time to create a buyout fund.
Even better, in the group practice model, the Doctors gain additional shares in the LLC for each year of service. This way, the older Doctors have more of an interest in the LLC accounts as they remain with the practice, and the younger Doctors help fund their value (as the rent can be an expense they all share equally). When the Doctor retires, he or she can redeem LLC interests for cash. The cycle continues as new Doctors join the practice and become young partners.
2. Unrelated AR financing
In the unrelated lender AR financing structure, an outside lender (typically a bank) takes the security agreement against the AR. This is typically in return for a loan to the practice. Often, the loan proceeds are invested in a creditor-protected life insurance policy as part of a deferred compensation arrangement for the Doctors.
In the solo practice structure, the opportunity for a buy-out fund comes from the deferred compensation arrangement. However, as cautioned before, because loan interest must be paid to the bank, the investments of the plan should be conservatively structured to meet the loan interest and principal obligations. Sometimes, it is difficult to generate a return that exceeds the interest costs of the loan. Taking too much risk here in an attempt to generate income to offset the loan payments is extremely unwise and can lead to further negative financial consequences. Remember, the reason you are entering into this transaction in the first place is to reduce—not increase—financial risks.
For the group practice model, there may be more of an opportunity for a buy-out fund, even if the policy is a very conservative one. This is because of the OPM factor. If younger Doctors share the burden of funding the policy of older Doctors, there is a greater opportunity for buy-out funds accumulating beyond the loan obligations.
3. Related AR Financing
In the related lender AR financing structure, a related lender (often an irrevocable trust for the benefit of non-physician family members) makes the loan to the practice and the trust takes the security agreement against the AR. Because the trust and family members (spouse and children, typically) are being paid interest, the overall family economics are superior to the unrelated lender arrangement.
This buyout fund arrangement generally only works with solo or two-person practices because the lender is related to the Doctor. It becomes too complex to have multiple trusts loaning funds to a practice with more than one or two Doctors. However, in the small practice scenario, this arrangement can provide solid asset protection and create beneficial buy-out funds within an LLC or exempt life policy as well.
4. Non-Qualified Plan
Non-qualified plans are benefit plans not required to be offered to all practice employees. While the contributions to the plan are typically not tax deductible, the funds in the plan can grow tax-deferred.
The non-qualified plan works as a buy-out funding tool through the contributions paid by the practice to the plan. Each month or year, the practice will make contributions to the plan for each participant. The funds can then grow in the plan tax-deferred. At retirement (no age restrictions as with qualified plans), the Doctor can withdraw their plan funds. The tax at that time depends on the plan. In the solo practice model, the Doctor simply has the practice make contributions to the plan and enjoys the tax-favored build up over time to create a buyout fund.
Even better, in the group practice model, the Doctors gain additional benefits by using the practice’ contributions to fund the plan based on years of service. This way, the older Doctors have more of an interest in the fund as they remain with the practice. The cycle continues as new Doctors join the practice and become young partners.
5. Captive Insurance Company (CIC)
As explained in the last chapter, CICs are real insurance companies which insure the medical practice for a host of risks. In many cases, the Doctor’s CIC can be just as profitable over their career as the medical practice. Thus, whether the Doctor owns the CIC himself (solo model) or all the Doctors in the practice own it, the CIC can create an enormous potential buy-out fund when any Doctor retires. In fact, the superior structure is one where the CIC is owned from the outset by one or more Trusts for the Doctors’ families and the CIC establishes some type of benefit plan for the Doctors’ buy-out fund. This layers in estate planning benefits as well as buy-out funding benefits.
Doctors cannot simply rely on a “white knight” firm to come in and buy their practices for $1 million on the day they want to retire. On the other hand, the idea that they “can’t get anything for their practice” misses the point entirely. Doctors who plan for an exit can have a lucrative one—but they need to focus on the goal of creating a buy-out fund years before they retire and be diligent in their funding of one of more buy-out tools over time.
In this Lesson, you learned how not to structure your practice and how to utilize multiple entities to protect valuable real estate, equipment and accounts receivable. You also learned how retirement plans provide asset protection and why your practice MUST have a fully executed and funded Buy-Sell agreement. You also learned how successful practices benefit from captive insurance companies and million-dollar buyout programs. Now, we will focus our attention on personal asset protection strategies that every Doctor must consider.