Choosing the Right Retirement Plan for Your Practice

Physicians in private practice should be aware of the wide variety of retirement plan possibilities available to them. Many physicians are not utilizing strategies that allow them to maximize pre-tax contributions to qualified plans.

A recent study suggests that when a typical physician retires, 80% of his or her overall wealth is tied to their retirement plan. Many high-income physicians put more than $150,000 a year into qualified plans. Why not learn the best ways to maximize these wealth building/asset protection tools?

Here are a few options to consider, as well as the scenarios in which they may be most appropriate:

• SIMPLE-IRA or Basic Salary Deferral 401(k) Plan. These options work well for physicians who are either establishing a new retirement plan for an existing practice or who have recently formed a new partnership. Setting up a SIMPLE IRA or 401(k) plan can be a great option to put away a little more money than a standard IRA allows, while keeping administrative costs and company contributions to employees low.

• 401(k)/Profit Sharing Plan or Roth 401(k)/Profit Sharing Plan. For mature, established physician practices with between one and 10 staff members, either a 401(k)/Profit Sharing Plan or Roth 401(k)/Profit Sharing Plan can be the best option. These plans are for those looking to maximize deductible contributions using salary deferrals and/or employer contributions, where an employee base of part-timers, contractors, or relatively low-paid staff can help lower plan administrative and funding costs. The Roth version is similar, but allows for after-tax salary deferrals where earnings can potentially be withdrawn tax-free.

• Defined Benefit Plan/Cash Balance Plan. A defined benefit plan/cash balance plan is a qualified retirement plan in which annual contributions are made to fund a chosen level of retirement income at a predetermined retirement date. Contributions are made according to an actuarial formula to meet the target retirement income benefit. In 2010, the annual benefit payable at retirement could be as high as $195,000 per year. The annual contribution into a defined benefit plan could potentially be even larger than this number in order to meet the targeted level of retirement income for the employees involved. A number of factors are involved with this calculation, including a participant’s age, years of service, planned retirement age, and income.

All of these factors, including plan administrative fees, should be part of any analysis prior to considering this type of retirement plan. The goal is to maximize pre-tax contributions, build a retirement plan that allows employees to accumulate substantial wealth within a tax-deferred environment, and to provide a form of asset protection. Plan sponsors should understand that defined benefit plans are expected to be managed in a conservative to moderate fashion — this type of plan should not be invested aggressively. Additionally, the actual performance of the portfolio can impact the required annual contribution amount, so having a portfolio that minimizes volatility is prudent. Lastly, because of the actuarial science required, annual administrative fees are higher than other play types.

• Roth 401(k)/Profit-Sharing Plan Combined with a Defined Benefit Plan. For larger practices with more than 10 employees and large administrative costs, implementing a Roth 401(k)/profit-sharing plan combined with a defined benefit plan allows the combination of these plans to further maximize tax deductible retirement plan contributions. With these plans, you may even consider adding a new comparability profit-sharing allocation, which is a type of contribution formula that can reward highly compensated employees more favorably than lower-compensated employees, depending on the ages, years of service and salaries of the employees involved. This type of profit-sharing allocation will successfully pass the nondiscrimination rules applicable to all tax-qualified plans as long as it satisfies one of two minimum "gateway" requirements, or provides a "broadly available" allocation rate to all employees or a "gradual age or service schedule" option.

In Practice

Here’s an example of how to evaluate and choose the right plan: A plastic surgeon’s office has five practitioners in their 40s, and each earns more than $250,000 a year. The physicians want to maximize their contributions with pre-tax monies to a retirement plan, but are concerned about asset-protection strategies -- important with today’s high levels of malpractice litigation.

The plastic surgeons are interested in increasing pre-tax contributions to a qualified plan in order to defer current tax liability. My recommendation for these high net worth, high income small business owners would be to combine a defined benefit/cash balance plan with a Roth 401(k) -- combining these two qualified plan options can dramatically increased pre-tax contribution limits, while offering a Roth contribution feature, which is not available outside of a 401(k) format to high-income participants. These plans, when combined, offer the best of both worlds: higher pre-tax contributions along with a Roth feature.

High-net-worth individuals might look to these types of plans to make up for years of underfunding their plans, and/or for losses occurred during the recent financial crisis. Additionally, this option also offers a level of asset protection from bankruptcy or litigation.

Each practice has different needs and only a careful evaluation of the business can truly determine which type of plan or combination of plans is right for you. But that careful evaluation can make a significant difference in preparing you and your staff for retirement.

Cameron Short, CIMA is a Senior Vice President/Investments with Stifel, Nicolaus & Co., Inc. Member SIPC and NYSE. He and his team focus on the wealth-management issues and practice management of high-net-worth physicians across the country. For more information please visit CShortandAssociates.com or call (800) 223-8162.