Financial planning is an essential part of life
management as well as of practice management.
It must be instituted early in a career and given
Planning is facilitated by the setting of goals
(short- to long-term); for financial planning these
• retirement income
• estate planning
A beginning practitioner should institute a
financial plan with the same care as a
practice plan. There are 5 steps to be taken:
– current financial status must be calculated
– financial goals and objectives must be put into
– financial counselors must be selected
– financial goals must be prioritized and a plan
developed to achieve them
– periodic review of progress must be performed
The process of planning begins
with the calculation of net worth
on a financial statement. Assets
and liabilities are listed, and a
“bottom line” result is obtained
that, for many beginning
practitioners, is humbling.
However, this is a necessary step to recognizing where
priorities must be directed (e.g., payment of long-term
debt) and where assets are needed (e.g., cash for
purchase of a home).
Assets include cars (usually),
books, instruments and so
Other assets include whole
life insurance policies (cash
value), the income produced
by working spouses, any
scholarships or awards, and
any sources of contingent
income (e.g., the beneficiary
of a parent’s retirement plan
or insurance policy).
A first goal in financial planning is to develop a
budget; income should be monitored, as should fixed
and discretionary spending (limited to 6% to 8% of
monthly income); debt service (e.g., educational loans,
mortgage) should be less than 30% of income.
Once a debt is paid, that income should be directed at
savings or investments rather than at increases in the
standard of living.
Budgeting is the best way to ensure that income is
used as needed rather than wasted on unnecessary
The most important
budget item for
students is usually an
borrowed in school
and paid back within
5 years after
graduation still costs
150% as much.
Prompt payoff saves
Statistics show that repayment of educational
loans by students varies:
• within 5 years—49%
• within 5 to 10 years—20%
• more than 10 years—14%
• don’t know (!)—17%
Consolidation of loans, deferment during
residency training, auto-payment when
employment is obtained, and avoiding an
extended repayment period are steps that can be
taken to facilitate payment.
Be realistic about debt repayment. The average
indebtedness of UAB Optometry School graduates is
approximately $93,250 (Class of 2008).
Educational loan interest rate: 6.80%
If repaid in 5 years: $1,837 per month for a total of
If repaid in 10 years: $1,073 per month for a total of
Credit must be controlled. 75% of Americans have
a recorded credit history (that totals 225 million
There are three national credit bureaus:
Equifax: 800-685-1111 (www.equifax.com)
Experian: 888-397-3742 (www.experian.com)
TransUnion: 800-888-4213 (www.transunion.com)
The median credit score is 720.
The highest score is 850.
The individuals most likely to charge off debt or
file for bankruptcy have scores below 600.
The Fair Isaac Corporation (FICO) created
the first credit score in the 1950s, as a
measure of individual creditworthiness.
The FICO score is based on individual
credit history, calculated from 5 categories:
The FICO Score is adversely affected by:
• late payments
• uncollected debt
• high debt
• high potential debt
• frequency of applications for credit
• frequency of inquiries about credit
Another important goal is a solid debt-to-income
ratio (less than .40 percent). This is achieved by
paying debt and working full-time.
Goals: Knowledge of Tax Law
Every practitioner must have a basic knowledge
of taxes, both for personal and business needs.
Personal income is taxed at federal rates of
10%, 15%, 25%, 28%, 33% and 35%, with the
mean income for self-employed optometrists
($131,197) taxed at 28%.
Business income determines Social
Security/Medicare taxes, which are 15.3% for
self-employed individuals, and tax-deferred
retirement plans are tied to business income as
Federal and state income taxes and Social
Security/Medicare taxes are a major expense for
• For single, employed individuals, about 30% of
• For single, self-employed individuals, about 35% of
• For married, employed individuals, about 20% of
• For married, self-employed individuals, about 25%
of gross income
There are also tax issues that arise when making
gifts and that are imposed on estates at death, key
considerations for estate planning purposes.
Tax advantages may be made use of (e.g., credits),
while disadvantages may be avoided (e.g., non-
deductible expenses) by the knowledgeable
There is a basic level of understanding that every
practitioner must have, because tax planning
inevitably begins with an individual rather than a
Goal: Home Equity
In addition to retirement funds, the sale of a primary
residence can be used for retirement purposes, for
when children are grown a large house may no longer
be necessary and, if owned for many years,
substantial equity may have accumulated.
Current federal tax law permits a couple to sell a
primary residence and exclude from taxation the
gain, up to $500,000 ($250,000 each), and this income
can be used as needed for retirement.
Example: a couple who purchased their home for
$150,000 sell it 20 years later for $550,000; there is a
$400,000 gain that is excluded from taxation.
Goals: Insurance Coverage
One of the fundamental requirements of financial
(and estate) planning is adequate, affordable
Life insurance can be used to pay debts or create
money for an estate in the event of premature death,
disability insurance can protect against loss of income
from long-term injury or illness, professional liability
insurance can provide coverage for malpractice
claims, and health, automobile, and homeowner’s
insurance can offer financial protection for families
and their most cherished possessions.
These and other types of insurance are necessary but
must be wisely purchased to be affordable.
Investments involve speculation with money, through
the purchase of capital assets (e.g., stocks, bonds,
mutual funds) that it is believed will increase in value
over time. Income from investments is used to
improve lifestyle or to support retirement.
There are also annuities, which are very popular and
are used to provide retirement income.
Conservative or volatile investments (e.g., high risk)
may be selected, depending on the willingness of an
investor to risk a large loss to hopefully achieve a
There is a simple way to determine the growth or
potential growth of investments.
The "Rule of 72" is a rule of thumb that is used to
compute when an investment will double at a given
interest rate. It is called the “Rule of 72” because at
10% interest, money will double every 7.2 years.
Example: If an investment earns 6% and that rate
stays constant, the investment will double in value in
12 years (72 ÷ 6).
A key reason for investing in stocks, bonds, mutual
funds, and the like is the preferential income tax
treatment that they can receive.
These assets can be used to earn capital gains.
If a capital asset is held for more than a year and is
sold for a profit, the gain on the sale is taxed at special
rates (0% to 15%), because it is considered to be a
Thus the gain on the sale of investments can be
substantial, because the capital gains tax is lower than
the tax on ordinary income.
Capital gains taxes are highly favorable at the moment
For taxpayers in the 10% and 15% brackets, the
capital gains tax is zero.
For taxpayers in the 25%, 28%, 33%, and 35%
brackets the capital gains tax is 15%.
Example: 1,000 shares of stock are purchased for $50
a share and held for more than a year by an investor
in the 28% tax bracket, after which time they are sold
for $60, a capital gain of $10,000; the federal income
tax on the gain is $1,500 (15%), not $2,800 (28%).
Goal: Retirement Income
If the goal of investing is to provide income at
retirement, long-term estimates of increases in the cost
of living and of inflation (which decreases the buying
power of money) will be needed.
A rule of thumb is that a retiree will need 80% to 100%
of the retiree’s current living expenses, adjusted for
inflation, to enjoy an equivalent standard of living.
Example: if $100,000 a year is thought to be needed at
retirement in 20 years, and annual inflation is estimated
at 4% over the 20 years, the retirement fund will need to
provide $220,000 per year for each year of retirement
(about 18 years on the average).
The usual means of estimating retirement costs is
the cost of living index. It measures changes in the
prices of goods and services over periods of years,
and thus is used to determine the amount of
money needed to maintain a specific standard of
living. Example: $100 in 1980 is equivalent to $263
in 2010 (a 163% change over 30 years).
A similar index is used to measure changes in
consumer purchasing power (the relative value of
money in relation to goods and services); it is
called the consumer price index. Example: $100
worth of goods purchased in 2000 cost $126 in
2010 (26% increase in 10 years).
Another important use of the CLI/CPI is to
determine “real” growth in income.
For example, the net income of optometrists increased
from $74,846 in 1990 to $138,846 in 2000. Although
this is an 185% increase, the cost of living increased
by 32% over this period, and thus by 2000 $98,611
had to be earned to equal the $74,846 of a decade
Therefore, the “real” growth in income was about
140%, which represents income growth after
increases in the cost of living have been taken into
Social Security is a large source of mandatory
contributions to retirement, but the viability of the
system has been questioned and its long-term outlook
is such that many financial planners do not include it
(in 30 years it is estimated that twice as many older
Americans will be drawing benefits as today). For
persons born in 1960 or later, full retirement age is
Retirement income under Social Security is based
upon the years of contribution and the amounts
contributed, but the current annual benefit for most
retirees is less than $20,000 per year. Therefore, it will
likely not be a significant source of income even if it is
viable in 30 to 40 more years.
Goal: Estate Planning
The ultimate goal of financial planning is to build an
estate, and the term estate planning is often used to
describe the means and methods devised to
Estate planning requires a stepwise approach to
financial goals, beginning with the four
fundamentals—an income, a home, a cash reserve,
and adequate insurance coverage.
When this is achieved, investments can be added, and
the gradual accumulation of an estate begins.
Tax issues are also a significant part of estate
planning, although recent changes in federal tax law
have greatly diminished the impact of estate taxes by
increasing the size of an estate subject to taxation
(for 2009) to greater than $3.5 million dollars.
Still, it should be the objective of anyone wishing to
build an estate to raise it to a level at which these
laws become a consideration.
Because estate planning includes the legal and tax
issues that affect the passing of an estate to another
generation, it is the ultimate endpoint of financial