Picking the Right Retirement Plan for Your Medical Practice

Physician business owners may be able to adopt a retirement plan from a number of available plans, varying on types and specific features depending upon their objectives. A given plan design or type may also be more suitable than another depending upon the ages of the owner(s) as well as the disparity in ages between the owners and the other employees. 
Here is some information on the various types of plans available:

Defined Contribution Plans. The most common type of defined contribution plan is a profit sharing plan with 401K features.  This type of plan maintains an individual account for each plan participant that is paid out as each participant retires or terminates employment.   A participant’s account generally consists of the sum of all (actual) contributions and investment returns allocated to such account. An employer may make a total annual deductible contribution to a plan of up to 25 percent of the total compensation of all participants.  The account of a plan participant, in turn, may receive an annual allocation of its share of the employer total contribution, and the employee 401K contributions.  Such total annual allocation may not exceed the lesser of 100 percent of a participant’s compensation or $52,000 (for 2014).  An additional $5,500 401K catch-up contribution may be made by a participant age 50 or older.  Employer contributions to a profit sharing plan may vary from one year to the next at the discretion of the employer.  The plan document, however, specifies a method or formula for allocating the contributions to the individual account of each plan participant.  Profit sharing plans may be suitable for new companies or for companies with revenues that fluctuate from year to year. 

A profit sharing plan may or may not have a 401K feature.  Contributions to a profit sharing plan with a 401K feature may include employee salary deferral contributions, employer matching contributions, and safe harbor contributions as well as employer profit-sharing contributions.  Such a plan must meet specific IRS requirements and because of this, it is generally advisable for the sponsoring employer to engage the services of a third-party administrator.  These plans may also be suitable for companies that want more of the contributions to go toward the owner(s) who have much higher compensation than the other (rank-and-file) employees.

Defined Benefit Plans. The two most common types are the traditional defined benefit pension plan that provides a specific periodic retirement benefit, and a cash balance pension plan described below.  Most traditional defined benefit plans specify the retirement benefit for a plan participant as a percentage of average compensation prior to retirement.  Such retirement benefit generally is in the form of a periodic payment payable for life.  Contributions generally must be made to the plan (by the employer) each year as determined by an enrolled pension actuary.    The maximum annual retirement benefit that may be paid to a plan participant may not exceed the lesser of 100 percent of the highest three consecutive year average compensation or $210,000 (for 2014) for life.  Traditional defined benefit pension plans have become less popular nowadays due to the required contributions that must be made by the employer each year.  As the number of participants grows and if the investment returns of the plan assets fall below the enrolled pension actuary’s assumptions, the employer may then be required to make larger contributions regardless of whether the company needs tax deductions for the year.     The risk on adverse investment returns is usually borne solely by the employer (through higher contributions). These plans may be suitable for a company with older owner(s) and with stable profits  as well as in need of larger tax deductible contributions than can be contributed to a defined contribution plan. 

A cash balance plan specifies an individual account for each participant that consists of the sum of a defined hypothetical employer annual contributions and specific hypothetical annual interest rate credited to each account.  The amounts credited are “hypothetical” as they do not necessarily equate to the actual employer contribution and/or investment return, but rather are based on the amounts specified in the plan document.  It looks similar to a defined contribution plan, but like a traditional defined benefit plan, contributions annually usually must be made by the employer as determined by an enrolled pension actuary.  Required contributions to a cash balance plan may be higher than the contribution that may be made into a profit-sharing plan with or without a 401K salary deferral contribution feature.  Just like a traditional defined benefit plan, cash balance plans may be adopted in addition to a profit sharing plan with a 401K feature for a higher contribution.   These plans are potentially suitable to smaller practices (less than 20 employees) with high stable profits and with eligible employees consisting of older owner(s) and younger rank-and-file employees,  and to which the employer desires to make potentially larger tax deductions than may be made to a defined contribution plan.