In this blog, we’re going to talk about financial tips for therapists starting a private practice. We are thrilled to welcome our guest Gordon Brewer, a therapist, private practice consultant, and the host of the Practice of Therapy podcast.
- What should therapists know about finance if they want to start their own practice?
- How is being self-employed as a therapist different from working for someone else, financially?
- What are the mistakes therapists tend to make when they start their practices?
- How do you know if you should go into private practice?
- Tips for managing your income needs as you transition
- Setting up a retirement plan as a therapist in private practice
- How to pay yourself in private practice
- How do you stay organized?
- Financial tips for therapists in private practice
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We are financial planners for therapists. Before we get into the blog, it may be a good idea to check out the following blogs if you want to hear some financial planning tips for therapists, psychologists, and mental health professionals.
And having said that, let’s get on to the blog!
What should therapists know about finance if they want to start their own practice?
When he was in graduate school, Gordon’s dream was to own his own practice. After working for an agency for 10 years, he realized he didn’t know much about the financial side of things. But as he got into it, he did learn eventually.
Here is a summary list of financial tips for therapists starting a private practice:
- Learn how to use Quickbooks.
- Take a primer course on the basics of business accounting and how to keep financial records.
- Think about the best way to collect money from clients.
- You want to set up a separate legal entity for your practice. Talk with a lawyer about how to do that.
- Set up a separate checking account apart from your personal finances.
- Establish a cash fund to support your expenses for six to 12 months while you build up your client base.
- Put together a financial plan for you as a therapist and private practice owner
- Stay consistent throughout. It’s important to conduct ongoing financial planning as you progress through your trajectory in private practice, from starting a therapy practice, growing it, and eventually retiring from it
How therapists starting a practice should set fees and pay themselves
It’s important to think carefully about how to charge fees and how to pay yourself in private practice. When starting a private therapy practice, consider:
- What type of fees you charge
- What your hourly rate is,
- How you plan to pay yourself in private practice
We can’t emphasize this enough: how you pay yourself in private practice matters!
Check out this video interview with Miranda Palmer where we discuss how to set your fee as a therapist and more.
Managing your income needs as a therapist transitioning to private practice
Transitioning from an employee to owning a private practice is when financial planning is super critical for therapists. When establishing your fee structure, try to map out your personal and business expenses for the year.
As they move from being an employee to an entrepreneur, people tend to overestimate the amount of income they will need. Many times someone making $150,000 a year, for example, automatically assumes they’ll need that amount of take home pay as a therapist to support themselves. This may or may not be true when you set out to start a private practice in counseling.
For most high earning therapists who are working for someone else, taxes take a big chunk of your gross income. However, if you have lower income when you are starting your practice, you are paying lower income taxes. Your biggest personal expenses will likely be rent and health insurance. Look into ways to manage your personal expenses while you are transitioning to private practice to make this easier on yourself financially. For therapists who have just struck out and established their own practice, financial planning must be done properly and is of critical importance.
How can you save money once you have started the therapy practice?
Now for some quick input from Judd…
When starting your therapy practice, it’s important to think about what types of retirement plan you are going to have, because it impacts:
- How much money you and your employees can potentially put away for retirement
- How much and when you pay taxes on your earnings
- Administrative fees paid by your employees and yourself
- Time spent complying with regulations, which may put you on the hook for certain administrative fees on an ongoing basis
- The level of satisfaction your therapists will have as employees in your practice
- Your own and your employees’ financial wellness
- Your ability to retain highly qualified employees
Whether or not you have employees when you first start out, prudent decision making is critical. Far too frequently we see the owner of the group therapy practice be misled into simply establishing a SEP IRA, because that is what is commonly suggested. However, this may lead you to neglect other worthwhile options.
Think hard about this decision!
The retirement plan options you may want to consider for your therapy practice, once you’ve started it, are:
- SEP IRA
- Defined Benefit plan
Let’s go deeper into each of these, shall we?
SEP IRAs are easy, and are usually familiar to therapy group practice owners, and for that reason do see them as a popular retirement plan choice for therapy practices.
You can set up a SEP IRA for yourself and annually contribute the lesser of 25% of your annual compensation or $61,000 in 2022. These contributions are made on a pre-tax basis, meaning that you’ll pay tax when you take the distribution from the account at a later point, age 72 being the latest.
If you grow to the point where you have employees, you can also set up a SEP IRA for them and make contributions annually for them under the guidelines mentioned above. However, there are certain restrictions that apply:
- Employee must have earned more than $450
- Only applies to the first $205,000 of compensation
- Contribution percentage must be the same for all employees
- Employee can not be a nonresident alien
- Employee covered under a Collective Bargaining Agreement cannot be included.
It’s also worthy to note that, unlike the contribution limit for the therapy group practice owner, the employee’s contribution is limited to the lesser of 25% of pay or $41,000.
You will have to fill out IRS Form 5305-SEP for each employee.
SEP IRAs are good for therapy group practice owners who:
- Are looking to save less than six figures for their retirement on an annual basis
- Desire simplicity and ease of set up and maintenance for their company’s retirement plan
- Are able to handle the administrative aspects of making contributions to each employee’s account on an individual basis
401(k) profit sharing plans
Most people know what a 401(k) plan is. But just in case you don’t, here’s a quick take: it’s a profit-sharing plan offered by an employer, where employees contribute to individual accounts on a pre-tax basis. These are called “salary deferrals” and they are usually made on a periodic basis as a percentage of your salary. Employers can also contribute to the employee’s account – this is called “matching” – which is a huge perk.
The limit for 401(k) contributions in 2022 is $20,500 which applies to all deferrals and matching contributions.
401(k) plans are great for therapy group practice owners who:
- Are able to handle administrative tasks related to compliance for the plan
- Wish to have the employee control how much they can contribute
- Are willing to be generous with employees and match contributions
If setting up a 401k plan for your therapy group practice is something you are considering, here are some great ways to increase employee participation in your 401k plan. It also may help to read our blog about how to comply with a 401(k) non-discrimination test.
If you decide to go this route, consider a Safe Harbor plan to reduce administrative complexity.
A safe harbor is a 401(k) plan with matching that is structured so it allows you to ignore all of the 401(k) nondiscrimination tests. In other words, the 401(k) plan can be completely imbalanced as long as you meet the safe harbor requirements.
Let’s say you go solo…can you still set up a 401k plan?
Actually – yes!
Also called a “One Participant 401k”, these 401k vehicles are for a group practice owner with no employees – so it may be especially applicable for you as you a starting your therapy business. You are limited to contributing $61,000 in 2022.
Here is where it gets a bit tricky. You are both the employee and employer if you run a business with no employees (kind of like how Social Security works for a one person shop).
- As employee, your contribution can be the lesser of 100% of compensation or $20,500 in 2022.
- As employer, you can contribute 25% of your compensation or your net earnings as a self-employed person. This is your net earnings minus one half of self-employment tax and all plan contributions.
- Solo 401ks allow a $6,500 catch-up contributions for people over 50, and contributions can be made on a post-tax basis.
How does this stack up to a SEP IRA, you ask?
There are numerous ways. The SEP allows you to contribute 25% of your earnings (or net profits), while the Solo 401k permits you to save $20,500 even if the business itself loses money. This is because you have the option to contribute both as an employee as the proprietor with a Solo 401k whereas with a SEP you can only contribute as the proprietor. This distinction is critical for a therapist going into private practice because you could be profit negative when you first start out.
When owners of group therapy practices think about what type of retirement plan to offer their employees, defined benefit plans usually aren’t the first thing to come to mind. The reason is that DB plans are often thought of as the kind of thing offered only by large corporation.
This is a myth!
Defined benefit plans can allow you to sock away a ton of cash – way more than you could in a 401k or IRA – and are worthy of consideration even for small to medium-sized companies. So don’t rule it out after you start your private practice!
A defined benefit plan provides a fixed benefit to the employee when they retire. The payout is determined by actuarial assumptions that are based upon age of participants, projected returns, etc.
Defined benefit plans are especially useful for high earning therapy group practice owners.
Let’s say you own a therapy practice and your annual income is $500,000 (which may be unlikely when you first start out – but who knows?).
- You could put $20,500 into your 401k
- You could put $61,000 into your SEP IRA
- You could put $61,000 into your Solo 401k
Let’s say you are a 60-year-old therapy group practice owner with three-year average income of $500,000 and zero employees and your business has been established for more than 10 years. In the first year, a maximum contribution of well over $100,000 can be made to the plan on a pre-tax basis.
In some cases, we have seen business owners be able to direct $250,000 into their defined benefit plans in one year. That’s not to say this applies to everyone – your individual situation may be different – but it can show you that there is a vast difference between the savings you can make in a defined benefit plan and the other options available.
However, on the flip side, defined benefit plans come with higher administrative fees. The hope is that the savings you reap by putting away more money on a tax-deferred basis will outweigh the costs.
Defined benefit plans are great for therapy practice owners who:
- Are comfortable with all risk resting on them. The company, not the employee, makes annual funding contributions each year. These contributions are invested in accordance with the risk and return assumptions set by the actuaries. The goal is to grow the funds to the required level so that payouts can happen as planned.
- Is willing to shoulder the administrative fees and outsource the maintenance of the plan to a third party.
- Has income high enough that it’s possible to save high amounts – six figures – on an annual basis
- Are solo practitioners
- Have practices with a vast difference between their earnings and their employees
Retirement may be far off and may not be the first thing on your mind when going into private practice as a therapist. However, having the right savings vehicle in your practice does have a huge potential impact on your financial security – both for yourself and any employees you may potentially add on after you start the practice.
Remember it’s not as much about what you earn as how much you save! Think about that as you consider both these retirement plan choices and also how you pay yourself in private practice.
How is being self-employed as a therapist different from working for someone else, financially speaking?
There are a variety of new things, such as self-employment taxes, that came into the picture once Gordon became self-employed. It takes self-discipline because you have to be able to track everything. You also need to know about cash flow, how much money is coming in, what the profit margins are, and if you move into group practice you need to know how to pay your employees.
One mistake people make when opening a private practice is they believe that if you build it, he will come. In reality it doesn’t exactly work that way. You have to be able to build the business and some referral sources, and in the meantime you need to pay yourself. Being prepared financially before you go into it is important.
When Gordon went from part time to full time private practice, he spent a year building a reserve for himself. One of his fears was if something were to happen which would prevent him from getting clients. He wanted to make sure he had enough money to survive if he had a slow time.
What are the mistakes therapists tend to make when they start their practices?
Gordon feels that one of the mistakes he made early on when he started his private therapy practice was not seeking out enough mentorship. He is now involved with several mastermind groups allowing him to talk to other people who have been there before and gotten coaching. He feels it’s upped his game tremendously.
How do you know if you should go into private practice?
Starting your own private therapy practice isn’t for everyone. You really have to know yourself well. You have to have a bit of entrepreneurial spirit and be able to take some risk. You do have to be willing to put yourself out there and make that leap.
What makes it less scary is getting some coaching and mentoring along the way, and learning from those who have come before.
How can you expand the practice beyond the therapy room?
For most people who go into private practice, they want to be a solo practitioner. You can quickly get your practice full and have lots of clients. But there is a limit to that. You can hit a ceiling because there is only so many clients you can see in a day. There’s also a limit to how high you can go up in your rates.
Once you hit that point, look for ways to diversify your income streams that aren’t necessarily within the therapy room. A lot of the skills that therapists have can translate in other ways. That was why Gordon started coaching other therapists.
Look outside the therapy room to find other ways to create income.
- You could go from the one-to-one way of providing therapy to the one-to-many. With group therapy you get a larger volume of clients for your time committed.
- Offer workshops and seminars that you charge for
- Offer online courses (anger management, parenting)
- Going from solo to group practice
- Coaching other therapists
It’s important to diversify your income stream because we all hit slow periods in our practice. So many of us took a hit back in March of 2020 due to the pandemic. Many people didn’t know what to do.
How much of a lift does this provide financially at first?
Like with anything, you have to adopt an attitude of being consistent and persistent. Gordon’s podcast started off pretty slowly, but he was constantly publishing content and it started to grow.
Once you gain some momentum, it kind of rolls from there. But you’ve got to put in the work by putting small things into action over time.
How do you stay organized?
Gordon uses Google Workspace as a practice platform. He uses a paper-based planner called Full Focus Planner. He uses TherapyNotesTM for electronic health records.
He’s also learned how to outsource instead of trying to do it all himself. Many practice owners hang on to answering the phone calls and handling intakes, setting appointments, and referrals. That ends up eating up a big chunk of their day. For a therapist, the best use of your time isn’t this; it’s sitting in the therapy room with your clients.
Gordon recommends Getting Things Done by David Allen and Free to Focus™ by Michael Hyatt for therapists who want to improve productivity and workflow.
Summary of financial tips for therapists starting a private practice
We hope that you enjoyed this article on financial tips for therapists starting a private practice.
As financial advisors for therapists, psychologists, and private practice owners, we believe that mental health is a noble profession, and a successful career in this field, if managed correctly, can be enough to take of your financial needs.
If you are a therapist looking for financial advice, a therapy group practice owner thinking about setting up a retirement plan, or just plain thinking about retirement, contact us for a chat.
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This article serves as an overview of some of the financial choices that you may have when starting a therapy practice. Just to be clear, none of this may serve as a recommendation specific to any one individual or company. For customized recommendations specific to your situation, please consult with a financial and/or tax advisor.
About Gordon Brewer
Gordon Brewer helps clinicians find success in their private practices and if you’d like to learn more about him please visit the Practice of Therapy website.