What Really Makes Economic Sense?

Physician's Money Digest, September15 2003, Volume 10, Issue 17

Because economic uncertaintyhas dramatically affected physicians'incomes, many doctorshave either "frozen" and notfunded, discontinued, or decided not toimplement a pension and profit sharingplan for their practices because of thecosts associated with starting and administeringsuch a plan. However, there aremany instances in which implementing aplan makes good sense.

Case in Point

The example I am about to present isa current case I am working on and hopeto implement within the next couple ofmonths. The demographics of ABCSurgical Specialists, Inc, is as follows. It'sa surgical specialty group comprised of 6physician partners each having a salary ofapproximately $350,000. Five of the 6partners range in age from 40 to 48. Oneof the partners is age 66 and probablywill retire within the next 3 to 5 years. Inaddition, there are 46 other employees,some of which are part time, and some ofwhich will not be eligible for participationin the plan. Their annual salariesrange from $9000 to $51,000, and theyrange in age from 21 to 71. Also, in thepast the practice has experienced a fairamount of attrition among its employees.

The salaries and payroll for thepractice is $3.5 million distributed asfollows: the aggregate salaries of the 6physician partners are approximately$2.1 million; and the aggregate salariesof the other 46 employees are approximately$1.4 million.

The third-party administrator (TPA)who will manage the plan proposed adiscretionary employer profit sharingcontribution as follows:

  • 20% of compensation for each ofthe partners computed on the first$200,000 of salary, giving each of themthe $40,000 individual maximum;
  • The "gateway" contribution of5% of compensation for most of thestaff employees;
  • 6.25% of compensation contributionwas given to a few of theyounger employees to pass the nondiscriminationtesting; and

Implementation of the following 6-year graded vesting schedule:

  • 0% available at the end of the 1styear of service
  • 20% available at the end of the2nd year of service
  • 40% available at the end of the3rd year of service
  • 60% available at the end of the4th year of service
  • 80% available at the end of the5th year of service
  • 100% available at the end of the6th year of service (fully vested)

One of the reasons for choosing theabove-referenced 6-year graded vestingschedule is if an employee leaves thepractice prior to being fully vested,that amount which is not vestedreverts back to the practice, which willhave the net effect of reducing the followingyear's contribution.

Pondering Results

The results are as follows. It will costthe practice approximately $271,500annually to fund the plan. For each physicianto get a deduction of $40,000 annually,it will cost them approximately:($271,500 – $240,000) / 6 x (1 – 0.40) =$3150 (after taxes assuming a 40% taxbracket). At first glance $3150 mayappear to be exorbitant, but consider thealternative—not implementing the plan.

If a decision is made not to implementthe plan, the physicians could bonusthemselves the entire $271,500 annuallyor $45,250 each. However, if they tookthis avenue, they would obviously nothave to fund for the remaining employeesin the amount of $31,500 annually.However, because the bonus they wouldreceive is not tax-deferred, they wouldonly have disposable after-tax income of:$45,250 x (1 – 0.40) = $27,150. In otherwords, taxes of $45,250 – $27,150 =$18,100 would have to be paid annuallyon the bonus received.

The Bottom Line

The decision ABC Surgical Specialists,Inc, and its partners have to makeis: Should they implement the pensionand profit sharing plan thereby incurring$3150 annually to obtain a$40,000 tax deduction or not implementthe pension and profit sharingplan, bonus themselves what the planwould have cost, and incur an additionalannual tax liability of $18,100 to net$27,150 after taxes?

Obviously, for ABC Surgical Specialists,Inc, it makes perfect economicsense to implement such a plan. However,there may be other nonfinancial considerationsthat may enter into the decision-makingprocess. In addition, I might alsomention that each situation must beinvestigated on a case-by-case basis.There is no silver bullet for implementinga tax-deferred retirement plan foryou and your employees.

Thomas R. Kosky and his partner,Harris L. Kerker, are principals ofthe Asset Planning Group, Inc, inMiami, Fla. The company specializesin investment, retirement, andestate planning. Mr. Kosky alsoteaches corporate finance in the Saturday Executiveand Health Care Executive MBA Programs at theUniversity of Miami in Coral Gables, Fla. They welcomequestions or comments at 800-953-5508, orvisit www.assetplanning.net.