FINANCIAL PROBLEM SOLVED!

"I need to choose a pension plan"

Problem

I'm a 52-year-old dermatologist. Because of my recent divorce and some prior overspending, I've saved almost nothing for retirement. I net about $300,000 a year and currently have a SIMPLE IRA. Should I switch to a 401(k) and profit-sharing plan, a traditional defined-benefit plan, or a 412(i)?

Solution

The SIMPLE IRA probably isn't your best choice, because it won't allow you to save the substantial sum you need. For 2003, you could contribute only $16,000 pre-tax and a $1,000 "catch up" contribution because you're over 50. You'll also have to match your employees' contributions (up to 3 percent of their total compensation).

A 401(k) and profit-sharing plan would allow you to contribute $42,000 this year (that includes a $2,000 catch-up contribution). A downside is that the administration of a 401(k) is more complicated and expensive. You may also need to make larger contributions for employees; depending on their ages relative to yours, you might have to contribute roughly 4 to 6 percent of their compensation.

A defined-benefit plan would let you put the most toward your retirement. The amount you can contribute isn't capped; instead, it's calculated annually, based on how much money you want to receive upon retirement. (The law currently allows annual distributions of up to $160,000.) For 2003, you could contribute roughly $126,000 pre-tax money to a traditional defined-benefit plan for yourself. That amount would increase each year, and by age 55 your annual contribution could reach $150,000.

But the traditional defined-benefit plan has some significant downsides, too. It's the most complex and costly type; you'd need to hire an actuary each year to calculate the contribution amount and prepare certifications to attest to its accuracy. Further, your retirement distributions might vary, depending on the performance of the underlying investments. And you'd have to fund the plan for at least three years to comply with rules established by the IRS and Department of Labor. Also, the required contribution for your employees might be somewhat greater, depending on their ages and compensation levels. (The younger your employees are, the lower your required contributions for them would be.)

The best choice for you might be the 412(i), a defined-benefit plan that uses life insurance and annuities. This plan requires less work from an actuary than a traditional defined-benefit vehicle, so administering it costs less. The benefits are guaranteed by the insurance company and aren't subject to the fluctuations in value that plans invested in the stock and bond markets face.

Most important, you may also be able to contribute significantly more for yourself than you could with a traditional defined-benefit plan, without having to do the same for your staff. If you die after establishing the 412(i), your beneficiaries will typically receive an income-tax-free death benefit. In addition, some plans allow for disability payments.

You can have a knowledgeable financial planner design a custom 412(i) plan that will let you increase your contributions for yourself (as well as your income tax deductions) while limiting the cost of funding your employees' contributions. But choose someone with tax-law expertise; the plan must be set up carefully to avoid running afoul of the IRS. Customizing a plan will probably involve higher fees.

This issue's problem solver is Joel Greenwald, MD, CFP (joel.greenwald@raymondjames.com), a financial adviser with Raymond James Financial Services in Edina, MN.

Do you have a question you'd like a financial adviser to address? Please submit it via e-mail to Solved@medec.com, or by regular mail to Medical Economics, 5 Paragon Drive, Montvale, NJ 07645. ATTN: Financial Problem Solved! If we select your query, we'll address it in an upcoming issue. Your name will not be used.

Leslie Kane. Financial Problem Solved!

Medical Economics

Jun. 6, 2003;80:89.