Planning for Retirement: Part II
It’s never too early (or too late) to prepare for life after medicine.
In the July/August issue of Endovascular Today, we reviewed new and existing qualified retirement plan options, provided a quick reference table for your convenience, and gave general guidelines as to the best candidates for each plan. In this month’s column, we get even more practical and give three examples of various medical practices, the retirement plans each might choose, as well as the rationale and specifics of how that plan might work for them. In this way, we hope you can see how these retirement plans might work in your practice, and move from the theoretical to the application of these retirement savings options. We all would like the peace of mind that comes with financial security; utilizing a tax-qualified retirement plan may be one good way to help you achieve that security.
JUST STARTING OUT
• 2 physicians in their 30s, with net earnings of $135,000
• 3 full-time staff members of various ages, earning between $26,000 and $45,000
• 2 part-time staff members, both earning $8,000 per year
• Newer practice, with some ups and downs in receivables and cash flow
• Still acquiring expensive equipment
Total staff payroll: $118,000
Total physician/owner payroll: $270,000
The physicians recognize the need to start saving for retirement and to offer a basic benefits package to attract and retain staff. However, with all of their other commitments (eg, paying off their student loans, purchasing larger homes for their growing families, as well as the facility that they would like to purchase for the practice) they both want to save a portion of their resources for retirement, but not to the exclusion of all other goals. If they are each saving a total of 25% of their annual salary, but are only willing to lock up 5%, or $6,750, of that for retirement (defined by the IRS as 59.5 years old), the balance of their savings could be allocated for more current goals.
Given these facts, one option many small practices choose is the SIMPLE IRA. Each employee can set aside up to $8,000 in salary, and the employer is only required to match employee salary deferrals at 3% of pay for those employees who are saving at least 3% themselves. If both physicians save 5% of their pay, or $6,750, the practice will kick in an additional $4,050 for each of them (3% of their salary), allocating a total of $10,800 to each employee/owner’s account. In addition, if all staff members participated at a 3% level, the practice would have to kick in an additional $3,540. Of the $11,640 that the practice allocates to the retirement plan, the physicians receive 70% of the benefits.
In nearly every other type of retirement plan, the part-time staff could be made ineligible for the plan because neither one works 1,000 hours a year. In the SIMPLE IRA, however, the eligibility test is whether the employee earned $5,000 last year and is expected to earn at least $5,000 this year, making both of these employees eligible for the plan. Most likely, not every rank and file staff member would participate, so the staff contributions would likely be less, and the practice would only set aside resources for those employees who are willing to save for themselves. This is because employer contributions to the SIMPLE IRA are matching only; contributions are not made for those staff members who are not contributing. (In my experience, employees earning less than $30,000 rarely save into retirement plans.)
With the SIMPLE IRA plan, the physicians are able to start saving for their retirement in a meaningful way and can offer the staff a basic retirement plan. Also, each employee is able to direct his own account. The SIMPLE IRA that most custodians offer costs literally nothing to set up, and for each account the employer, or (more typically) the employee, pays a nominal IRA fee to the custodian each year (fees typically range from $20 to $50 per year). There is little if any tax reporting or administrative work; the employer sets up the plan, gives notice to the employees, has interested participants set up SIMPLE IRA accounts, and arranges for the payroll deductions (consult your payroll company on this issue). The SIMPLE IRA plan has no vesting, so the employer contributions become the property of the employee immediately. Keep in mind the SIMPLE IRA has to be set up in early October to be effective for the following year.
This is about as easy as a retirement plan can be. The physicians get $10,800 allocated to their individual accounts, and the tax savings alone on those contributions may save enough money each year to offset what the practice is required to put away for employees. The SIMPLE IRA allows for a maximum of $8,000 in salary deferrals for 2003 and, if you are over age 50, you can “catch up” with an additional $1,000 in salary deferrals. Down the road, employees could consider other plans that would allow higher contribution levels.
THRIVING AND GROWING
• 8 physicians in their 40s-50s, net earnings averaging $240,000
• 1 operations manager, earning $90,000
• 7 full-time staff members of various ages, earning between $28,000 to $55,000
• 3 part-time staff members, earning $12,000 per year
• Very strong cash flow and predictable profits most years
Total staff payroll: $406,000
Total physician/owner payroll: $1,920,000
This group has a high need for both income tax management and a method to retain and motivate their highly trained staff. Ever since a key employee left a short time ago, citing the lack of competitive benefits, the group recognizes that employees really want a competitive benefits package. With the diverse interests of their owner-employee physicians, the group also needs a high degree of flexibility and customization to adapt their plan to changing conditions.
New IRS rules separating employee salary deferrals from profit sharing contributions allow this group to consider a 401(k)/Profit Sharing Plan. This will allow each physician, as well as each employee, to determine what level of savings they would like to put away from their own salary, from a very low level of $4,000-$5,000, up to $12,000 or $14,000 if they are over age 50. This salary deferral amount is already written into the tax law to be increased to $15,000 (or $20,000 for those over age 50) by 2006. Because of the decoupling of the percentage of income that you can save via salary deferral, employees are not limited to a certain percentage of their income that they can save, only these maximum dollar limits.
In any 401(k) plan, there is testing to ensure that the plan does not unfairly discriminate in favor of the highly compensated employees, so this salary deferral amount for the physicians may be reduced if enough employees do not participate in the plan at a substantial level. To encourage employees to participate and help them build assets for their own retirement, employers often will use a matching formula, so that employees receive something from the company every year as a minimum employer contribution. For example, an employer might match dollar for dollar on the first 4% that the employee saves, and 50% on the next 4%; thus, if the employee saves 8%, the employer would match that contribution at 6%. This matching contribution could have a vesting schedule attached to it, so that the employee has to remain with the employee for a certain number of years to fully vest and receive those matching funds. If discrimination tests are not likely to be met, the employer would then be able to institute what is known as a “safe-harbor” match, giving all employees a mandatory 3% match, as opposed to just matching those who are contributing for themselves. Although this safe-harbor match is immediately vested, it gives the employer an immediate pass on the discrimination testing. In any event, employers are not required to offer a match, but may elect to do so to reward employees and encourage participation in the retirement plan.
In addition to the salary deferrals and matching contributions allowed in a 401(k) plan, there is also a discretionary profit sharing contribution that can be made each year, or not, depending on the profitability of the firm. Although this amount is generally limited to 25% of payroll, the overall combined 401(k)/Profit Sharing Plan is also limited to an absolute dollar maximum of $40,000. Thus, in good years, if the practice chooses to, they could allocate 10% of payroll as a profit sharing contribution. For example, a 10% profit sharing contribution would total approximately $232,600 of the $2,326,000 in total payroll. Each physician under age 50 could be saving $12,000 in the salary deferral program, and receive another $24,000 in profit sharing contribution, for a total of $36,000. For those over age 50, the salary deferral could amount to an additional $2,000.
CLOSING IN ON RETIREMENT
• 2 physicians in their early 60s (owner/employees), each earning $300,000
• 2 physicians in their 40s, earning $150,000 each (non-owners)
• 1 key employee, earning $75,000
• 4 additional staff earning $32,000 to 50,000
Total administrative staff payroll: $235,000
Total professional staff payroll: $300,000
Total physician-owner payroll: $600,000
The owner-employees each have a need to accumulate substantial additional funds for their retirement (approximately 5 years). In addition, the practice would like to offer a competitive retirement benefit for their long-term staff and the non-owner physicians.
Although retirement plans cannot discriminate in favor of any group of employees, it does not mean that benefits have to be identical for all employees. Many practices in this scenario would be advised to utilize a profit sharing/401(k) plan that is cross-tested or age-weighted in its allocation formula. This plan would allow all employees the ability to defer a portion of their salary through the 401(k) option, and the profit sharing contribution would be allocated in favor of the older, higher-paid physician/owners. However, this will still limit the physician/owners to total contributions of $40,000 each, plus an extra $2,000 for the catch-up salary provision.
As an alternative, the physician/owners may wish to set up two plans, both a defined benefit pension plan for themselves and a 401(k)/Profit Sharing Plan for the balance of the staff. Recall that the defined benefit plan promises to pay employees a certain percentage of their salary at retirement, and thus contributions for the older, higher-paid employees can be substantial. Under nondiscrimination testing prescribed by the IRS, it is possible to set up two different plans that offer substantially similar benefit percentages, but allow the physician/owners to put away substantially more than the $40,000 limit of the 401(k)/Profit Sharing Plan. In this case, the physician/owners could contribute $150,000 to $200,000 each, and possibly more given their income level, age, and the fact that they are only a few short years away from retirement. In this way, the practice is more likely to meet the needs of all parties: the staff can defer a portion of their salary into the 401(k) and receive a competitive profit sharing contribution, while the physician/owners can accumulate the necessary funds to retire in 5 years.
For every stage of life and every business structure, there should be a retirement plan option that allows you to meet your personal goals and your business needs. The key is finding the appropriate balance and then taking action to put those plans in place.
Michael P. Hatch, CFP, JD, is a Financial Advisor and Principal with The Sterling Group, a financial planning and fee-based investment manager, located in Southern California. The Sterling Group is affiliated with Linsco Private Ledger, (member SIPC), the largest independent brokerage firm in the US. Mr. Hatch specializes in working with entrepreneurs and professional practices, assisting them in defining and implementing their financial, philanthropic, and intergenerational planning strategies. He may be reached at (626) 440-5995; firstname.lastname@example.org.