Qualified retirement plan rules are changing once again. Later this summer, retirement plans must disclose to participants all the costs of the plan. This will shine a bright light on the true costs of maintaining the plans that you likely have in place or new plans that you may start. It’s time for a cost vs. benefit analysis.
Once upon a time, putting money aside in a tax-deferred retirement plan was as easy as making a deposit at the bank. Times have changed. Today, choosing the right retirement plan for a physician’s practice is a daunting task. First it requires developing a whole new lexicon: defined contribution, defined benefit, SIMPLE, IRA, safe-harbor and age-weighted are just a few of the terms. Like most of the tax code from which they spring, the terms simply add complexity. Doctors are not immune to complexity—you deal with it everyday, but do you really need to bring more complexity into your life than is absolutely necessary?
Adding to the problem of terminology is the need to make a good judgment for your family’s future benefit as well as that of your employees. This is often a balancing act. Through regulation, the government wants to hold you responsible as a fiduciary to your employees. This article will admittedly only scratch the surface of this very complex, bewildering assortment of choices that you face. Hopefully, the strategic view will be helpful as you weigh your options.
First comes the question of need. If you made it through medical school, you probably don’t need governmental coercion/assistance in forcing you to save for retirement. The tax-savings incentive built into formal retirement plans is usually high enough to make it worthwhile to most practicing physicians. For most people, it boils down to this question: is the tax deduction today (combined with tax-deferred growth) really worth the sometimes high cost of establishing and maintaining a qualified plan? Sooner or later, the tax man cometh. And today it appears that if Congress is going to deal with some of our very real fiscal problems, the tax could be much higher in the future. There is not an easy answer to this question. It is a very individualized calculation and must be made with care, employing reasonable assumptions and sound judgment. Some take the stance that, even if the costs are high, it is worth it for the qualitative reason that it compels us to save in the first place; and due to the penalties for early withdrawal, it keeps our hands off the money until we really need it to replace our income.
Okay, if analysis reveals that a tax-advantaged retirement plan is the right thing to do, the next question becomes: which plan should be considered for your particular practice, its doctors and employees? The most prevalent first plan is an IRA. If tax-deferred savings is appropriate for you, we encourage making an IRA contribution—even if it’s not tax deductible, and even if you are covered by another plan.
Next, up the scale of complexity is SEP and SIMPLE (which incidentally, is anything but). The SEP should be considered by an employer or self-employed person with a maximum IRA contribution and few, in any, employees; the SIMPLE, by a smaller employer with low income, or an employer with side income.
Continuing up the scale is the defined contribution (DC) plan. These come in various types and are usually referred to as profit sharing plans, pension plans, 401k, or 403b plans. Essentially DC means that you predefine the method to determine the amount of contribution that can be made for each participant after eligibility requirements have been met. Some plans may result in required contributions each year while others allow for annual discretion by the employer. Along with this complexity comes additional cost. There must be a plan document (usually drafted by an attorney) that has to be amended as the laws change. Compliance is not optional. Disqualification of an existing plan’s tax benefits is a heavy price to pay. In addition to an attorney, you will likely hire an outside administrator and an investment manager. Admittedly, many providers bundle these services, but it is rare to see excellence in each of these areas from a single provider.
Every employer should at least consider a 401k plan. In many markets, they have become de rigueur to remain competitive as an employer. In addition to the plain vanilla 401k, there are several options that should be considered. For example, the plan could be age-weighted if you are an older owner of a closely-held business. It can have new comparability provisions, which are appropriate if there are multiple owners of a closely-held company. A profit sharing component could be added to the 401k, and should be considered by an employer with variable income, higher turnover, and young employees.
Finally, a defined benefit (DB) plan should be considered, especially by those who are older with a stable income. A DB plan is one that defines what the participants benefits will be during retirement and requires an actuarial calculation of the amount of contribution necessary to fund that benefit. Because of the complexity the cost goes even higher, but the benefits can be huge. Many actuaries will make the initial calculation without any fee to determine the viability of the DB plan.
Obviously, there is much to consider in designing a retirement plan that is right for you and your practice. It requires specialized skill to make a good call. The benefits of making a good decision, as well as the costs of making a wrong decision, can be substantial. Even those with a plan should consider reviewing the plan to ensure that it is still the right plan for your specific goals and objectives.
Scott Neal is President of D. Scott Neal, Inc., a fee-only financial planning and investment advisory firm. Submit questions and comments to him at scott@dsneal.com or 800-344-9098.