Planning for financial independence
Do it now, your future depends on it
By Joel M. Blau, CFP and Ronald J. Paprocki, JD, CFP
Planning for true future financial independence requires proactive planning and focuses on areas physicians are able to control—rather than focusing on retirement income sources they are unable to control such as Social Security.
This enables you to avoid surprises down the road.
As more orthopaedic surgeons become aware of their need to plan for future income security, qualified retirement plans (QRPs) remain the logical starting point.
A QRP can be viewed as a congressionally approved tax shelter that offers major tax advantages. Participation in a QRP can be very beneficial whether you are an orthopaedic surgeon employed by a large group, or a solo practitioner where you are considered to be an employee as well as the employer.
From the physician employer’s standpoint, plan contributions represent a deduction [for their practice] for income tax purposes.
For the physician employee, earnings on the plan’s investments accumulate on a tax-deferred basis. At retirement, the participants are often in a lower income tax bracket and pay less tax on the distributions.
Defined benefit plans
QRPs are generally classified as either “defined benefit” or “defined contribution.” Some plans combine features of both types to maximize contributions for the highest-paid employees. In an orthopaedic practice they typically would be the orthopaedic surgeons.
Defined benefit plans tend to favor older, highly compensated physician employees who are close to retiring. The employer must make higher contributions to this employee’s account to compensate for the short time before retirement.
Actuarial calculations are used to estimate how much must be contributed each year to accumulate the necessary future benefit. Interest rates, investment rates of return and the ages of the participants will affect the calculation. The investment risk rests solely on the employer who is required to fund the plan adequately each year—although the annual contribution can and will vary based on the plan’s investment results.
For 2004, defined benefit limits have increased to $165,000 per participant, creating the highest possible contribution of all of the qualified retirement plan options.
The future benefit received might be based on a flat percentage of compensation, a percentage that increases with the length of service, a percentage that changes at certain compensation levels or one of a number of other formulas.
Defined contribution plans
At the other end of the spectrum are defined contribution plans. The main difference is that specific contributions to these plans are set aside for the benefit of the employees. Future benefits are a direct result of investment return and the amount invested. Unlike a defined benefit plan, there is never any promise of a specific dollar amount during retirement.
Several variations of defined contribution plans exist, including the money purchase pension plan, profit sharing plan, age-weighted profit sharing plan and, for very small medical practices, the SIMPLE Plan (Savings Incentive Match Plan for Employees).
Except for the SIMPLE Plan—which is essentially an IRA the employer makes contributions to—all defined contribution plans include a vesting schedule. The number of years an employee is with the practice dictates what percentage of contributions will be forfeited if the employee leaves the employer before becoming fully vested.
Given the high turnover of office staff that many orthopaedic practices are experiencing in their practices today, these forfeitures—which are reallocated to other participants’ accounts based on income and contribution level—can be substantial.
For physicians who remain in the practice, these forfeitures serve to increase the contributions to their own retirement accounts and provide a greater benefit in the future.
For this reason, defined contribution plans tend to favor younger participants, particularly physicians, because they benefit from a greater number of forfeitures the longer they remain employed.
Contribution limits for all defined contribution plans have increased for 2004. SIMPLE plans now allow a maximum contribution of $9,000 per participant. The limit for all other defined contribution plans that fall under Internal Revenue Code Section #415 has increased to $41,000 per participant.
Additionally, employees covered by defined contribution plans that include a 401(k) employee savings element will now be able to contribute an additional $1,000 compared to their contribution in 2003.
The new 2004 401(k) limit is $13,000 per participant, but individuals age 50 or older may contribute an additional $3,000 to their plan.
Advantages and disadvantages
Both defined benefit and defined contribution plans have a number of advantages and potential disadvantages that must be considered prior to implementation. If you are a partner or owner of your practice, be sure to consult with a third-party administrator who can work with you, your accountant and your financial planner to determine which specific plan type best fits your goals and objectives.
Joel M. Blau, CFP, is president of MEDIQUS Asset Advisors, Inc. He
can be reached at (800) 883-8555 or firstname.lastname@example.org.
Ronald J. Paprocki, JD, CFP, is chief operating officer of MEDIQUS.