Retirement plan prime source of tax benefits
Almost 25 percent of AAOS members are contemplating fully retiring from or ending orthopaedic practice within the next five years. The 25 percent is an average of all responses from the not-quite 17 percent responses of members 35 to 39 years old to the almost 74 percent of members 65 and older. Retirement is clearly on the minds of AAOS members. Michael J. McCaslin, managing director Health Care Group, Somerset Financial Services, Indianapolis, Ind. prepared the following reports on retirement planning.
Whether a physician is just starting a practice, currently in solo practice, or is a member of a multi-physician group practice, a qualified retirement plan for the business remains one of the single greatest sources of tax benefits available to orthopaedic physicians.
The retirement plan arena is governed by the Internal Revenue Service Code, which addresses the tax qualification status of the plan and the tax deductibility to the business of the retirement plan contributions, and the Employee Retirement Income Security Act (ERISA) which governs and protects the rights of the employee beneficiaries of the plan. The complexity of the retirement plan arena and the ever-changing tax laws mandate that you use your legal and accounting advisors in analyzing and crafting the appropriate plan for you or your practice.
The fundamental reasons a physician would consider having a retirement plan are:
Here are some types of qualified plans seen in physician practices.
Profit Sharing Plan. The most flexible of all retirement plans, the employer is not obligated to make contributions to the plan, but each year can contribute any amount between 0 percent and 15 percent of the annual compensation of the covered employees.
A 401(k) Cash or Deferred Compensation Profit Sharing Plan. This is a type of profit sharing plan in which employees may elect to defer a portion of their compensation to the plan. For the year 1999, the amount an employee could defer was $10,000, and for the year 2000, the maximum deferral was $10,500. The amount the employee elects to defer from their compensation is exempt from federal income taxes. In a 401(k) profit sharing plan, the employer may make matching contributions based upon each employees elective deferral. In addition, the practice may also make nonelective contributions on behalf of the participants, and discretionary contributions on behalf of the participants.
In the standard 401(k) cash or deferred type of profit sharing plan, there are actual deferral percentage tests (ADP) and actual contributions percentage tests (ACP) that are calculated on a regular basis to ensure that the contributions are within the non-discriminatory ranges and percentages established by the Internal Revenue Service. Because of this discrimination testing, physicians often will not know until near the end of the plan year as to whether they can make the full $10,500 contribution.
One of the beauties of the 401(k) cash or deferred compensation type of profit sharing plan is that a physician who has a personal cash-flow shortage and therefore needs all of the money available to meet their living needs can choose not to elect to defer the $10,500 for the 401(k) element, and elect only to have the $19,500 that the corporation places in his or her account without impacting or preventing the other physicians from maximizing their contribution at $30,000 for the year 2000, and $35,000 for the year 2001.
Safe Harbor 401(k) Profit Sharing Plan. This plan can eliminate the administrative burdens of the nondiscrimination testing of the standard 401(k) Profit Sharing Plan by meeting the following requirements:
Meeting these two requirements eliminates the ADP and ACP testing identified in the standard 401(k) profit sharing plan and guarantees the highly compensated physicians can contribute the maximum amount allowable on their elective deferral to a plan (i.e., $10,500). The primary disadvantage of this plan is the 100 percent vesting of the 3 percent contribution made on behalf of the nonhighly compensated participants.
Money Purchase Pension Plan. This is a type of defined contribution plan in which contributions to the plan are fixed by the plan document, but the benefits are not fixed. The contributions are based on a fixed percentage of annual compensation for all plan participants.
Cross-Tested/New Comparability Plan. In this plan, the contribution percentage formula for one category of participants (i.e., the elderly physicians) is greater than the contribution percentage formula for the other category of participants (i.e., the young nonphysician staff).
To satisfy the nondiscrimination requirements of IRC Section 401(a) (4), General Test, participants are put into different rate groups and the rate groups are tested separately for nondiscrimination. A cross-tested profit sharing plan expresses each participants allocation of employer contributions and forfeitures as an equivalent benefit rate, rather than an allocation rate. Note the equivalent benefit rate is projecting a retirement plan benefit while the allocation rate deals with a current contribution and the corresponding allocation of that contribution to the eligible participants. This type of plan is most often used in a medical practice environment with a significantly elderly group of physicians and the corresponding very young group of non-physician employees.
A mechanism to enhance the contributions for physicians is a retirement plan that is integrated with Social Security. This results in a contribution calculation that contributes a certain percentage based upon all employees compensation up to the Social Security wage base (2001 - $80,400) and a second contribution for all wages earned in excess of the Social Security wage base. The purpose of utilizing Social Security integration is to provide an additional retirement plan contribution and corresponding benefit to those earning above the Social Security wage base, since Social Security does not provide retirement benefits on earnings above this wage base.