Physician Retirement Planning Basics

As the tax year ends, it's time for physicians to think about retirement planning. To help, I asked wealth manager Scott Wisniewski to offer some tips.

Martin Merritt: What types of retirement savings plans are available?

Scott Wisniewski: The type of plan available to a physician will depend on his employment status.  For

those that are W-2 (taxes withheld by an employer), a 401(k) may be an option for saving for retirement.  Physicians that are self-employed and receive 1099 income as an independent contractor have more options for contributing to retirement such as a SEP IRA, solo/individual 401(k), profit sharing plan, and cash balance plans.

MM: What are the advantages/drawbacks of each, especially concerning the amounts available to contribute each year?

SW: Below are the IRS’ annual limits for contribution amounts in 2013 and 2014:

W2 employees:
401(k)/403(b): $17,500 (or $23,000 if age 50 or over)

1099/Self-Employed:
SEP-IRA: Lesser of 1) 25 percent of compensation, or 2) $51,000 (for 2013; $52,000 for 2014)
Solo 401(k): Combination of 1) 100 percent of compensation up to $17,500 for 2012 and 2014; or $23,000 if age 50 or over and 2) employer contributions up to 25 percent of compensation as defined by the plan (for self-employed individuals, compensation is defined as net earnings from self-employment after deduction both one-half your self-employment tax, and contributions for yourself). Total contributions, not counting catch-up contributions, cannot exceed $51,000 for 2013 and $52,000 for 2014. 

Cash Balance Plan:
Below are illustrative 2013 plan year contribution limits for combination plans under near optimum conditions:
 

*Different amounts will result for each plan combination, depending on normal retirement age, interest rates and credits, employee group demographics, and benefit levels for non-highly compensated employees.

A consideration: A business owner who is also employed by a second company and participating in its 401(k) plan should bear in mind that the limits on elective deferrals are by person, not by plan.

As you can see, the plan limits can vary.  The advantage of all of the plans is that contributions are made tax-free, therefore the higher the contribution the lower taxable income will be.  Also, the account grows tax-free.  On the other hand, you can’t access the funds before age 59.5, except for some limited circumstances, without paying a 10 percent penalty (plus the taxes due).  Also, depending on which plan you participate in, the calculations can be complex. 

Consulting with a tax adviser and financial adviser is recommended. 

The most complex of all is a cash balance plan.  The average physician probably won’t benefit from one simply because they don't make enough. 

For self-employed individuals establishing a plan, the investments held within the account must be self-selected or consultation with a financial adviser should occur.    

MM: How much should a physician contribute?

SW: It will vary based on a number of factors such as age, income, debt, risk appetite, current standard of living, etc. 

What is certain is physicians get a late start to the retirement game.  Because they typically do not start earning relatively higher levels of income until their early thirties, their retirement goals call for a higher contribution rate.  It is not rare for a physician to contribute more than 20 percent to 30 percent of her pre-tax income toward retirement. 

Attempt to build a portfolio that equates to 20 times your annual income pre-retirement.  We find many physicians are unaware of the considerations that must be accounted for when making retirement projections.  Most individuals aren’t armed with the information as to how much needs to be contributed and what end (portfolio) value specific assumptions will achieve (age, investment returns, volatility, contribution rate, etc.).  A competent financial adviseradviser should be able to compute different outcomes that will assign a probability to each scenario.

Be aware that the more that is contributed toward tax-deferred retirement accounts the lower taxable income will be.  If a physician’s federal and state marginal income tax rate is 40 percent, and his annual income is $250K per year, contributing $50K toward a SEP-IRA could knock $20K off his tax bill.