Retirement Plans: A Doctor’s Best Tax Shelter Various Models Offer Physicians Both Advantages And Disadvantages

Individual and group practice retirement plans are the single most valuable tax-planning vehicle available to doctors today. Changes in ERISA and tax legislation signed into law by the Bush Administration have made these plans more flexible and cost-effective than ever before.
In 2003, the annual individual funding limit for defined contribution plans is $40,000, an increase of $5,000 over prior law. In addition, if you have a 401(k) deferral plan and you are over 50 years of age, you can increase this by another $2,000. In 2004, these limits increase to $41,000 and $3,000, respectively. The annual individual funding limit for defined benefit plans is $160,000 in 2003, an increase of $20,000 over prior law. This funding limitation increases to $165,000 in 2004.

A company retirement plan not only reduces current taxes at the practice level, but defers taxes at the individual level until retirement and possibly beyond. It makes good business sense as well as tax sense because employees have an increasing awareness of the importance and value of this benefit. It also provides financial security for doctors and staff alike. Another unique feature of practice retirement plans is the ability to accrue and deduct the amount of the current year’s contribution while not having to actually fund it until two months after the tax year-end, or the due date of the practice tax returns, including extensions.

The new legislation also offers more flexibility in plan design, which increases the percentage of total contributions that are allocable to doctors. While certain income and discrimination-testing criteria have to be met, these changes allow doctors to meet their maximums while reducing overall plan contribution costs. This may require amendments to the current plan documents. A qualified plan design consultant can run various alternative illustrations from your employee census data, which will enable you to make a clear, informed choice. The costs are minimal compared to the overall benefits.

Retirement plans fall into two general categories — defined-benefit and defined-contribution. Here’s a brief overview of common plans in each category:

Defined-benefit Pension Plans

These plans spell out the amount of the benefit to be received at retirement. Contributions are based on age, years of employment, and other factors. These types of plans diminished to near-extinction in medical and dental practices in the ‘80s and early ‘90s when they became too costly as compared to defined-contribution plans. However, the extraordinary stock market decline since 2000 had such a devastating impact on the value of many retirement plans that some doctors nearing retirement have opted for this type plan to make up for the losses over the next five to 10 years.

Advantages:
• A defined benefit plan may be suitable if you are nearing retirement since contributions can be larger than other types of plans, thereby shielding additional income from taxes.
• A large amount of assets can be accumulated over a short period of time.

Disadvantages:
• An actuary or other professional usually must calculate the contribution.
• You may be required to make contributions in loss years or years when cash is tight.
• Poor investment returns may necessitate higher contributions to the plan.
• Older support staff employees can cause this plan to be very costly to fund.

Defined-contribution Plans

These plans spell out the amount you will fund annually. The benefit received at retirement is not guaranteed and depends on the investment performance of funds contributed. They are the most widely used plans today. The following are various types of defined-contribution plans.

Money-purchase Plans

These plans are defined-contribution plans which require you to contribute a fixed amount to the plan for yourself and your staff as specified in the plan document, usually as a percentage of payroll.

Advantages:
• The contribution percentage is determined at the time you establish the plan and is generally based on salary.
• Contributions are deductible from gross income.

Disadvantages:
• You must make annual contributions.
• Employee contributions are not permitted.

Profit-sharing Plans

These plans also fall under the category of defined-contribution plans. Though these plans are designed to share practice profits with employees, you do not have to make contributions from the net profits.

Advantages:
• Annual contributions are optional.
• The amount of your contribution can be fixed or discretionary.

Disadvantages:
• Contributions must be regular and substantial.
• Poor investment performance adversely affects the retirement benefit employees will receive.

Comparability Plans

These are profit-sharing plans that allow you to divide participants into classes, such as principals, officers, and other employees.

Advantage:
• Contributions can differ among the classes.

Disadvantage:
• Administration costs may be high due to the complexity of the contribution calculation.

Age-weighted Plans

These are profit-sharing plans that take into consideration age as well as compensation when determining the contribution for each participant.

Advantages:
• Older doctors can be eligible for higher contributions.
• You have flexibility in determining contribution amounts.

Disadvantages:
• Administration costs may be higher than for other plans.
• Older support staff employees can cause this plan to be very costly.

401(k) Plans

These are profit-sharing plans that allow employees to make contributions in addition to employer contributions.

Advantages:
• Employees may deduct their contributions.
• Employer can match none, part, or all of employee contributions.

Disadvantage:
• Contributions for highly compensated employees may be limited.

Simplified Employee Pensions (SEP) Plans

These are individual retirement arrangements for employees, including owner-employees.

Advantages:
• SEP plans are relatively easy to establish.
• They have no IRS reporting requirements.

Disadvantage:
• SEP plans don’t provide a retention incentive because participants are immediately 100{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} vested.

Savings Incentive Match Plans for Employees (SIMPLE)

These are also individual retirement arrangements.

Advantages:
• Administration costs are low.
• You aren’t required to make annual reports to the IRS.

Disadvantages:
• You can have no other employer-sponsored plan.
• As with SEP plans, employees are 100{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} vested immediately, so they have less incentive to remain with your practice.
• Contributions may be less than with other types of plans.

In addition to the above, you can also contribute to your own individual retirement account (IRA) up to $3,000 annually, and if you are over 50 years of age you can contribute an additional $500. If you are a participant in a company retirement plan, the IRA contribution will most likely be non-deductible, but you will still accumulate earnings and growth on a tax-deferred basis and can recover your original contributions tax-free when you withdraw at retirement.

If you believe your current plan is too costly and/or does not meet your current objectives, it is time to have a professional analysis performed by a consultant experienced in retirement plan design and administration. Simply choosing an investment broker or mutual fund manager who offers to ‘do all’ for you is putting the cart before the horse.
“Brokers and representatives of insurance and mutual companies who offer bundled services often deliver bungled results,” said Peter K. Riggins, director of Pension Benefits Consulting Group in Longmeadow.

Determining which plan offers the most benefits for your practice involves analysis. Your age and the age of your staff, administrative costs of the plan, and the amount you choose to contribute are all factors that will affect your decision.

Other factors to consider include the employees who must be covered, minimum coverage requirements, contribution limitations, and vesting schedules. This is one of the most important decisions you will make for yourself and your employees. It should be done in a professional, competent manner.

James B. Calnan, CPA is partner-in-charge of the Health Care Services Division of Meyers Brothers, P.C. in Longmeadow; (413) 567-6101