Like many physicians, you may have thought about retirement planning, but are too busy paying off student loans, buying a dream home or saving for your kids’ college expenses to do much about it. Well, those days are over. Certain tax-deferred financial products are available that offer you, as a physician, the opportunity to invest in your financial future. These plans are tailored for the self-employed medical practitioner, as well as the employee of a medical practice or healthcare organization, and are key to helping you build a solid financial foundation to reach your retirement dreams. Choosing the right plan for your practice, however, is not always easy and depends on many factors, namely your goals for establishing the plan, the size of the annual plan contributions you can comfortably commit to, as well as a wide range of issues specific to your practice.
Qualified Retirement Plans
Certain retirement plans are qualified for special treatment. These plans can serve as one of the most effective means for physicians to shelter their current income from taxes, grow their assets on a tax-deferred basis and provide a significant source of retirement funds.
There are two basic types of qualified retirement plans. One sets the amount of benefits the plan will pay out to the retiree; this is called a defined benefit plan. The other, known as a defined contribution plan, sets the amount of money the employer will pay into the plan each year for an employee. Understanding each plan and determining which one is right for you, is key to building a solid retirement nest egg.
Defined Benefit Plan
Conventional, employer-funded pension plans, known as defined benefit plans, are designed to pay a participant a fixed, predetermined benefit upon retirement. The benefit is based on a calculation that takes into account the participant’s age, years of employment and more. Under current laws, the maximum annual pension benefit payout must not exceed $130,000.
With a defined benefit plan, annual funding is greater for employees who are older at entry into the plan, since the time to fund the benefit is less in the case of an older participant. “This makes defined benefit plans attractive to many physicians because they often adopt retirement plans for their practices when they are older and wish to shelter a significant portion of their income from taxes,” said James D. Forcucci, CFP, a Senior Financial Advisor at American Express Financial Advisors, Inc.
Defined Contribution Plan
ined contribution plans are the most widely used retirement plans by physicians. These plans, often termed money-purchase pensions or profit-sharing plans, are less subject to government regulation and often provide the necessary plan contribution flexibility many doctors are looking for.
Under a defined contribution plan, an employer contributes a fixed amount into a fund for the participant. When the participant becomes eligible to receive benefit payments – usually at retirement or termination of employment – the benefit is based on the total amount in the account. With this type of plan, the employer does not have to guarantee the retirement benefit the participant will receive. Instead, the employer must make contributions to the plan under a formula defined by the plan specifications.
“Defined contribution plans are becoming more popular among physicians because they provide doctors with a greater sense of control, and the flexibility to build retirement assets and reach their personal goals,” said Mr. Forcucci. “They are ideal plans for younger physicians because they allow for greater accumulation of tax-deferred savings if funding is started at an early age.”
Money-Purchase Plan
Money-purchase plans are a type of defined contribution plan where funding is calculated according to a participant’s salary. The plan is relatively simple and inexpensive to administer, and provides a benefit based on the total amount of employer contributions in a participant’s account. Under this plan, the employer is obligated to annually contribute a specified percentage to each participant’s account. This contribution is usually 10 percent of a participant’s salary, although funding up to 25 percent is possible.
A common example of a money-purchase plan is a Keogh – a tax-deferred retirement savings vehicle sometimes referred to as HR 10. Keoghs are available to self-employed (non-incorporated) individuals and contributions are deducted from the participant’s gross income, making the plan particularly attractive to high-income professionals.
Profit-Sharing Plan
profit-sharing plan, unlike a money-purchase pension, is a defined contribution plan under which the employer determines the amount of annual funding based on a percentage of salary, rather than a stated contribution obligation. With this type of plan, employer contributions are optional and funding is limited to 15 percent of total employee payroll, or $30,000 per employee per year.
Age-Weighted Pension
age-weighted pension is a prime example of a discretionary profit-sharing plan. As its name suggests, this plan favors older entrants by allowing employer contributions to be allocated on an actuarial basis according to the participant’s age and years of service. This type of qualified retirement plan has two unique advantages: 1) like a traditional profit-sharing plan, age-weighted plans allow for year-to-year contribution flexibility; and 2) like a defined benefit or target benefit pension plan, age-weighted plans offer much larger contributions for older and higher paid owners and employees.
“An age-weighted profit-sharing plan is generally the ideal plan for older, high-income physicians, because it provides an adequate retirement benefit to older employees without all of the costs and complexities of a traditional defined benefit plan,” said Mr. Forcucci.
401(k) Plan
Another variation of a profit-sharing plan is a salary reduction plan, commonly referred to as a 401(k). Under a 401(k), employees can defer as much as 20 percent of their wages (up to $10,000) into an employer-selected plan, which may include money market instruments, deposit accounts, stocks or bonds.
The 401(k) is tailored toward the medium- to large-sized practices and offers employees an opportunity to voluntarily contribute to their retirement plan. 401(k) contributions are deductible from current taxable income and all earnings on the contributions grow tax-deferred until withdrawn.
“The 401(k) works best in a practice where the low-wage earning employees defer between 2 percent to 4 percent of their wages, thereby allowing the physicians in the practice to contribute at or near the voluntary contribution cap of $10,000 per year,” said Mr. Forcucci. “If the group is able to fund the maximum amount of $10,000 per doctor, then less employer funding will be required to meet minimum contribution requirements for non-physician staff.”
Comparability Plan
The new comparability plan is another type of defined contribution plan that has recently become popular in the medical marketplace. With a new comparability plan, employers can divide their workforce into two or more identifiable groups, according to job position, with a certain amount of disparity permitted in the contribution percentages paid for each group. IRS regulations provide a method, based on an analysis of projected benefits at retirement age, to ensure that benefits provided to highly compensated and non-highly compensated employees are comparable, and considered nondiscriminatory.
“Comparability plans are a new type of profit-sharing plan that allow substantial dollars to be funded for the highly paid and, on average, older physician, with a lower rate for the rest of the participant group,” said Mr. Forcucci. “These plans are ideal for middle-aged physicians who want to maintain a strong profit-sharing plan, while minimizing the cost of providing benefits for their staff.”
Consult a Financial Advisor
Retirement planning is a complicated process and one that often requires the guidance of an experienced financial planner. A qualified advisor will review your total financial picture, customize an appropriate plan and guide you on a path to economic security.
For information on how to find a financial planner in your area, contact the International Association for Financial Planning (IAFP) at 800-945-4237 and request a free consumer brochure titled the Consumer Guide to Comprehensive Financial Planning and Selecting and Interviewing Financial Advisors.