In today’s turbulent economic times, physicians are looking for solutions that provide tax deductions and the opportunity to save efficiently for their retirement. No matter whether you are self-employed, run a small medical practice, own shares in a large surgical center, or are directly involved in running a corporation/tax-exempt organization, you have the ability to establish a qualified retirement program for you and for your employees.
However, how do you create a retirement program to maximize your tax-deductible contributions without “breaking the bank” on employee costs? This article presents plan design concepts successfully used by others in the medical community, to help you better understand the elements that go into a well-designed and well-executed retirement program.
What is a Qualified Retirement Plan?
The term “qualified” generally indicates that the plan must meet statutory requirements under the Employee Retirement Income Security Act of 1974 (ERISA), regarding issues such as participant eligibility, benefit coverage, vesting, funding requirements, and employee communication. Qualified plans are subject to the most stringent regulation, but, as a result, receive the most favorable tax treatment. Two of the biggest benefits are (1) immediate income tax deductions, and (2) creditor protection.
Defined Contribution versus Defined Benefit Plans
As with any project, there is usually more than one way to accomplish your objective. The same holds true for retirement plans. Most people have heard about 401(k) plans, where you can defer a portion of your salary and the employer makes a discretionary contribution as a match or as a percentage of your compensation. These plans are called Defined Contribution Plans and function as a savings account that is affected by investment gains and losses. The contribution going into such a plan is “defined,” but not the end benefit. The reverse of this is the Defined Benefit/Cash Balance Plan, in which an actuary determines the annual employer contribution that will provide a specific benefit payable at retirement.
Participants who begin saving later in life are at a distinct disadvantage in Defined Contribution Plans, because they have fewer years to accumulate funds for retirement. Conversely, Defined Benefit/Cash Balance Plans, for these same employees, allow them to accumulate considerable retirement assets in a relatively short period, because the end benefit has been predetermined.
It is common for a medical practice to combine a 401(k) plan with a profit-sharing component. The 401(k) plans have become one of the most popular types of employersponsored retirement plans. The purpose is to permit you to defer a portion of your salary, up to $17,000 ($22,500 for those aged 50 years or older) annually, on a pretax or posttax (ie, Roth) basis. In addition, when there are ample funds, the employer can make a discretionary contribution that could increase the business owner up to $50,000 ($55,500 if aged 50 or older) in annual contributions. As your money grows in these plans, all income taxes are deferred until you take distributions at retirement.
This all sounds good, but is there a catch? The catch is that if you have employees, you must also provide them with a benefit and prove to the IRS that your plan encourages and benefits those rank-and-file employees. Although every organization’s demographics are different, some of the best design tools include the following features:
- The Safe Harbor 401(k) plan is a 401(k) plan that eliminates all compliance testing. With this type of plan, employers with low-to-very-poor 401(k) participation by staff can safely defer their full $17,000 ($22,500 for those aged 50 or older) contribution, without fear that the plan will fail nondiscrimination testing and that part of their deferral will be refunded at the end of the year, creating a taxable event. Based on the design chosen, the employer will provide either a matching benefit (ie, 100% on the first 3% deferred, plus 50% on the next 2% deferred) or a nonelective benefit (ie, 3% of salary) for all participants. The “cost” for using this plan design is that all employer contributions are immediately vested.
- When additional benefits are desired, many business owners augment their 401(k) plan with a profit-sharing feature. Offering such a plan helps to attract quality employees and reduces employee turnover. The best part about the profit-sharing contribution is that it is discretionary in nature, and you are not required to make a set contribution (or any contribution) in any given year. This flexible standard allows medical practices considerable latitude in budgeting, especially for those with varying or uncertain profits. And with a properly designed program, the majority of the contributions will be allocated to the key employees in your practice.
What is a properly designed program? This is typically a plan in which the key staff members, inclusive of the owner(s), receive more than 60% of the total dollars going into the plan. One of the best ways we have accomplished this goal is by using a New Comparability Profit-Sharing (NCPS) design. An NCPS plan will allow you to place all participants in the appropriate group and to provide them with different contribution percentages, as long as you pass discrimination tests. For example, a profit-sharing allocation for the following participants could include:
- Senior physician (owner): 20% of compensation
- Junior physician (owner): 10%
- Office manager: 7%
- Remaining staff: 5%.
The employer contributions are usually made after the end of the plan year (but before filing your taxes), and when you have determined your ability to make the contribution. Each year, working with your retirement consultant, you determine the percentages to allocate to each group. If your demographics do not work well with this type of design, there are many other variations to choose from, including pro rata, age based, service based, and integration with Social Security wage base. However, regardless of the design chosen, the maximum contribution any one person can receive, inclusive of the 401(k) component, is $50,000 ($55,500 for those aged 50 or older) per employee.Combination Program
For some business owners, the benefits provided through a 401(k)/profit-sharing plan are just not enough. They are looking for programs that will provide tax-deductible contributions for themselves in excess of $100,000. In these cases, the solution is the combination of a 401(k)/Profit-Sharing and Defined Benefit/Cash Balance Program. Like an NCPS, the Defined Benefit Plan can be structured to provide greater benefits for the key employees and minimize overall costs for the staff. With a De fined Benefit Plan, after 10 years of participation and retirement at age 62, you could amass an account balance of approximately $2.5 million in addition to the account balance in your 401(k) profit-sharing plan. Please note that unlike the profit-sharing plan, the contribution to the Defined Benefit Plan is not discretionary and must be made for at least 3 to 5 years.
Multiple Plans: An Example
In this hypothetical medical practice listed in the Table, there are 4 high wage earners looking for ways to defer additional sums of money in excess of the $50,000 permitted under a 401(k)/profit-sharing plan. The solution was to use the Combination Program, including a 401(k)/profit-sharing plan and a Defined Benefit/Cash Balance component. By adding on the Cash Balance Plan, the physicians’ taxdeductible contributions increased by more than $150,000 each, while still maintaining a reasonable cost for the staff. As a result, the owners are able to collectively contribute more than $1 million for themselves and receive more than 93% of all dollars going into the plan. In addition, if any of the physicians did not want such a large benefit, this could easily be modified.
When it comes to choosing an appropriate retirement program, there are many choices available, often too many. What we say to all our clients is, “Pretend there are no rules and regulations, and you can do whatever you would like. Now tell us how you would like to design your specific program.” You should never be presented a solution before you have been able to communicate exactly what you would like from your plan. More often than not, a customized retirement program can very closely mirror the objectives of your practice. Working with an experienced third-party administrator and financial advisor, you will be able to craft the right tax-efficient program for your practice.
Lawrence B. Keller, CFP®, CLU, ChFC, RHU, LUTCF, is the founder of Physician Financial Services, a New York–based firm specializing in income protection and wealth accumulation strategies for physicians. He can be reached at (516) 677-6211 or
Peter M. Coleman, ASA, EA, FCA, MAAA, MBA, is the Managing Partner of The Benefit Practice, a firm specializing in pension consulting, administration, and related actuarial services to clients nationwide. He can be reached at (203) 517-3502 or