Medical practices—both large and small—continue to show interest in defined benefit pension plans as well as cash balance plans. Practices generally find that these retirement plans offer a great way to increase retirement savings and reduce taxes while also providing a level of asset protection for doctors. In addition to reducing income taxes, the significant contributions are a great way to catch up if you have not saved enough in the past or if your retirement account balances are still lagging after market losses from economic turmoil.
Comparing Retirement Planning Options
In 2017, an individual under 50 years old may defer $18,000 into his or her 401(k) account. With matching and profit sharing plan contributions, the total may be increased to $54,000. If the individual is over 50, they may defer an additional $6,000.
In comparison, a doctor in his late 50s could contribute and deduct nearly $210,000 in a properly designed defined benefit or cash balance plan. This allows you to turbo-charge your retirement savings. You may accumulate close to $2.5 million in the plan by age 62, which is at least double what you would accumulate outside a tax-qualified plan. So if you plan to withdraw only the earnings each year after you retire, you’ll have twice the annual income.
Pension Protection Act of 2006
Defined benefit and cash balance plans have become more popular since the Pension Protection Act of 2006. The Act made these plans more appealing in several ways. First, the Act clarified the legality of Cash Balance Plans. Second, the Pension Protection Act explained how a company, such as a medical practice, might be able to sponsor both a 401(k) Profit Sharing and a Defined Benefit Plan to take advantage of the unique characteristics of each and benefit from the combination of the two. Third, the Pension Protection Act of 2006 (PPA) explained how to cross test the benefits from both types of plans and be able to weight the contributions more heavily toward the professionals/business owners if the demographics were right.
A sample case is provided above in Exhibit 1; showing a medical practice where a physician’s spouse is employed along with seven employees. When a Defined Benefit Plan is added to an existing Profit Sharing Plan, contributions can be significantly increased, while keeping financial obligations to non-owner employees to a minimum—as demonstrated in Exhibit 2 above. A comparison of “before and after” is provided below to illustrate improvement of plan design from one year to the next in Exhibit 3 at right.
Historically, defined benefit plans were thought to be fixed and inflexible. The PPA brought a funding method that gave rise to a range of funding options. The contributions in the range, from maximum to minimum, are all acceptable and income tax-deductible. With the proper plan design and the new funding method, there can be flexible year-to-year funding.
As a result of these changes, business owners, such as doctors, can now have larger retirement plan contributions that are income tax-deductible. The plan designs are doctor friendly, allowing a contribution level that fits the needs of the business. This increased funding flexibility can also allow more predictable contribution totals from year to year.
Another important change brought about by the PPA is the Inherited IRA. Prior to the PPA, in the event of a participant’s death, a spouse beneficiary could roll the account into his own IRA, stretch the benefits over his lifetime and pass them on to future generations that provided for the deferral of the income tax for possibly decades. If the beneficiary was a non-spouse, the taxation was either in the year of death or no later than the end of the fifth year following. Taking a lifetime of accumulations and taxing them over a short time was not a good result.
The PPA changed this and allows a non-spouse beneficiary to receive this “Inherited IRA” and stretch out the payments in a similar fashion to a spouse, putting non-spouse beneficiaries on a more equal footing. With a high rate of divorce or the possibility that your spouse might predecease you, this is an important change.w
If you want to find out if a Defined Benefit Pension Plan or a combination of plans is right for you or if your current plan provides for an Inherited IRA, call OJM Group and speak to one of their Retirement Plan Specialists. You might be very surprised at how a few changes can enhance your retirement and income tax planning.
To receive a free hardcopy of Wealth Protection Planning for Dermatologists, please call 877-656-4362. Visit www.ojmbookstore.com and enter promotional code PRDERM33 for a free ebook download of Wealth Protection Planning for your Kindle or iPad.
Jason M. O’Dell, MS, CWM (pictured) is a consultant, author of more than a dozen books for doctors, including Wealth Protection Planning for Dermatologists, and principal of the financial consulting firm OJM Group www.ojmgroup.com, where John Kelly, CLU, RHU is an investment advisor. Greg James, CPC, QPA, QKA is a Third Party Administrator and Consultant for pension and 401(k) plans. They can be reached at 877-656-4362 or firstname.lastname@example.org.
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This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized legal or tax advice. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes frequently, accordingly information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein. Some of the content for this article was developed by third parties and is provided for informational purposes only. While OJM Group deems such content to be reliable, OJM Group cannot guarantee its accuracy and disclaims any liability for reliance on any third party content. Sample cases above are for illustrative purposes only.