Retirement Plan Options for Physicians: The Race is On

As we enter the home stretch toward the year’s end a variety of plans are being pitched to physicians and their families with promises of year-end savings that require you to “act now before it’s too late.”

We are typically inundated with calls from clients at this time of year asking our opinion on the most exotic and speculative of these plans but not everything you can do requires a team of lawyers and salesmen. Sometimes a simple conversation with your CPA or financial advisor is all that’s required to hedge against the increasing taxation burdens that are bearing down on you. 

Below is a summary of the conventional plans currently available from a reliable source that does not want to sell you anything: the U.S. Dept. of Labor.

While this list is not complete it covers four of the most commonly used planning options implemented by doctors. I tell my clients only a few things about taxes: Pay every cent you legally owe but never leave a “tip” - use the law and the many opportunities for deductions and deferment available. Get a top-notch CPA - we’ve covered why a great CPA is a vital part of your practice  in a previous article. “Good Enough” is no longer good enough. Beware of tax scams targeting doctors and other professionals, at this time of year and especially after the election, the scammers are out in full force and preying on your fears and your wallet.

The Employee Retirement Income Security Act (ERISA) covers two types of pension plans: defined benefit plans and defined contribution plans.

A defined benefit plan promises a specified monthly benefit at retirement. The plan may state this promised benefit as an exact dollar amount, such as $100 per month at retirement. Or, more commonly, it may calculate a benefit through a plan formula that considers such factors as salary and service - for example, 1 percent of average salary for the last five years of employment for every year of service with an employer. The benefits in most traditional defined benefit plans are protected, within certain limitations, by federal insurance provided through the Pension Benefit Guaranty Corporation (PBGC).

A defined contribution plan, on the other hand, does not promise a specific amount of benefits at retirement. In these plans, the employee or the employer (or both) contribute to the employee's individual account under the plan, sometimes at a set rate, such as 5 percent of earnings annually. These contributions generally are invested on the employee's behalf. The employee will ultimately receive the balance in his or her account, which is based on contributions plus or minus investment gains or losses. The value of the account will fluctuate due to the changes in the value of the investments. Examples of defined contribution plans include 401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing plans.

A Simplified Employee Pension Plan (SEP) is a relatively uncomplicated retirement savings vehicle. A SEP allows employees to make contributions on a tax-favored basis to individual retirement accounts (IRAs) owned by the employees. SEPs are subject to minimal reporting and disclosure requirements. Under a SEP, an employee must set up an IRA to accept the employer's contributions. Employers may no longer set up salary reduction SEPs. However, employers are permitted to establish SIMPLE IRA plans with salary reduction contributions. If an employer had a salary reduction SEP, the employer may continue to allow salary reduction contributions to the plan.

A Profit-Sharing Plan or Stock Bonus Plan is a defined contribution plan under which the plan may provide, or the employer may determine, annually, how much will be contributed to the plan (out of profits or otherwise). The plan contains a formula for allocating to each participant a portion of each annual contribution. A profit-sharing plan or stock bonus plan includes a 401(k) plan.

A 401(k) Plan is a defined contribution plan that is a cash or deferred arrangement. Employees can elect to defer receiving a portion of their salary which is instead contributed on their behalf, before taxes, to the 401(k) plan. Sometimes the employer may match these contributions. There are special rules governing the operation of a 401(k) plan. For example, there is a dollar limit on the amount an employee may elect to defer each year. An employer must advise employees of any limits that may apply. Employees who participate in 401(k) plans assume responsibility for their retirement income by contributing part of their salary and, in many instances, by directing their own investments.