Like other hard-working professionals, youprobably don't enjoy paying income taxes.And like them, you also probably find thatnavigating your way through the established rulesand regulations for retirement plans is tedious, ifnot dangerous. This being the case, what's a doctorto do? The key for all doctors is tofind a retirement plan that providesmaximum deductions with minimumcontributions for their employees.
Unfortunately, this can sometimespose a problem for physician-investors.Plans that allow for very large deductionsfor the owner (ie, over $50,000)usually require significant contributionson behalf of the employees. A 419 WelfareBenefit Plan is an excellent solutionto this problem, but, again, it requiresthat physicians pay benefits on behalf oftheir employees.
This doesn't mean that a 419 plandoesn't work; it just requires payingbenefits for employees. As long as thetotal salaries of the employees don'texceed the owner's salary, a 419 planshould still be considered. However, ifyou are an anesthesiologist with no employees(not even a spouse who is the office manager),you do not qualify for a 419. What are some ofyour other options then?
A basic 401(k) plan offers very little in the wayof annual deductions. In addition, there are "top-hat"or "top-heavy"rules that threaten your deductionsif a certain percentage of the employeesdon't participate in the plan. A money purchaseplan may offer you deductions of$35,000 to $40,000 per year, as long asyou pay 5% of each employee's salarytoward their individual account.
Generally, a defined-benefit planallows for much bigger deductions fordoctors who are getting a late start ontheir retirement planning (or who havelost their plan assets in a divorce orother lawsuit). For example, a 50-year-oldphysician who makes over $170,000per year and is just starting to makecontributions to a new defined-benefitplan, may make up to $69,500 of tax-deductiblecontributions per year.
Defined-contribution plans, like401(k) and profit sharing plans,restrict your contributions but do notput a cap on the potential growth ofassets. Of course, every doctor willhave a different amount available in their plan atretirement, which depends on investment results.Furthermore, there is no guarantee on howmuch will be available at retirement unless theinvestments inside the retirement savings planare all in guaranteed, fixed investments.
In a defined-benefit plan, the amount youretire with is based on your salary and year ofretirement. Then, under an IRS-approved andactuarially-reviewed assumption, you are allowedto put money away on a tax-deductible basis toachieve that goal. Of course, if the plan accountsfor 8% growth in your investments and you get6%, there will be much less available when youretire. To make up for this risk, the governmentallows you to alter the amount each year, basedon investment returns in the previous year.
If, instead, you exceed the assumed rate ofreturn, you will not be allowed to deduct asmuch in annual contributions in future years.Because of the annual costs of the actuarialreview, defined-benefit plans are more costlythan defined-contribution plans. However, if youare over age 50 and don't have much saved forretirement, the tax deductions will more thanoffset the additional $500 to $1000 annual fee—not to mention you will be able to save moremoney for your retirement.
RETIREMENT PLAN OPTIONS
A 412(i) plan is a type of defined-benefitplan. This plan works almost exactly the sameway as a typical defined-benefit plan. However,there is 1 major twist: The benefit inretirement is guaranteed. So, if yousit down and construct a 412(i)plan that will give you a benefit of$15,000 per month in retirement, itis guaranteed to be at least that highwhen you do retire. Let's take a lookat how this plan works.
The 412(i) plan purchases annuitiesfrom insurance companies thatoffer guarantees of 2% or 3%. Witha 2% or 3% return guaranteed, theIRS allows you to use the 2% or 3%return in your calculation of thefuture value of your plan. While regulardefined-benefit plans assume anonguaranteed return of 6% to 8%when determining the tax-deductiblecontribution amount and 419(i)plans use a much lower 2% to 3%return, 412(i) plans allow for significantlyhigher tax-deductible contributionsannually.
With a 412(i) plan you are notgetting lower returns, you are justguaranteed a lower amount, with theupside potential for greater returns.The annuities in the 412(i) plan maystill give you 6% to 8% or more peryear. In fact, the plan's investmentswill likely give you much more thanthe guaranteed 2% to 3%. However,you only have to use the guaranteedamount in your actuarial calculation.This is what allows some physician investorsto make $300,000 in tax-deductiblecontributions per yearinto their 412(i) plan.
The bottom line on a 412(i) plan:
you're saving significant incometaxes in your prime earning years,you're getting a guaranteed returnon your investment, you have theupside of the market, and you don'thave to have any employees to startone. Many specialists either work forthemselves or work in a larger groupand have no employees. If this situationapplies to you, you may want tomake your own individual professionalcorporation or professionalassociation a partner or member ofthe larger group. Then, you can createthe retirement plan that best fitsyour individual needs.
Christopher R. Jarvis and David B. Mandell
are coauthors of The Doctor's Wealth Protection Guide and Wealth Protection:
Build and Preserve Your Financial
Fortress (www.mywealthprotection.com). They
also started the financial firm, Jarvis & Mandell,
LLC, and work with clients nationwide. They welcome questions or
comments at 888-317-9895, or visit www.jarvisandmandell.com.