Qualified retirement plans offer pros and cons for practice owners and employees
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Key takeaways:
- Choosing the right qualified retirement plan is a pivotal decision in retirement planning.
- Well-designed retirement plans offer physicians a solid foundation for their financial future.
Retirement planning for physicians is a critical aspect of financial management, given the unique challenges and opportunities they face.
One of the pivotal decisions in this journey is choosing the right qualified retirement plan (QRP). In this article, we delve into the various options available to physicians, outlining the pros and cons for both practice owners and employees.
Retirement plan options
Physicians have several retirement plan options at their disposal, each with its own features and considerations:
Defined contribution plans: These plans, such as 401(k)s or 403(b)s, allow participants to contribute a portion of their salary into individual accounts, with contributions often matched by the employer. One advantage of defined contribution plans is its flexibility, allowing participants to adjust contributions based on their financial situation and retirement goals. In addition, these plans typically offer a variety of investment options, empowering participants to tailor their portfolios to their risk tolerance and investment preferences.
Defined benefit plans: Alternatively known as pension plans, defined benefit plans promise a specific benefit upon retirement, typically based on salary and years of service. While less common in the private sector than previously, defined benefit plans can provide a predictable and secure source of retirement income, particularly for physicians who anticipate long careers with a single employer. These plans are often appealing to employees seeking stability and guaranteed retirement benefits but may require significant employer contributions and can be complex to administer. Within this category, one specific type worth highlighting is the cash balance plan.
Cash balance plan
A cash balance plan (CBP) is a type of defined benefit plan that combines features of both defined benefit and defined contribution plans. The details of CBPs are beyond the scope of this article, but can be found in our latest book, detailed below.
CBPs offer several advantages for both employers and employees. For employers, these plans provide greater flexibility in benefit design and funding requirements compared with traditional defined benefit plans. Employers can contribute a fixed percentage of each participant's compensation annually, providing more predictability in retirement plan expenses and reducing the risk of large unfunded liabilities.
For employees, CBPs offer the security of a guaranteed retirement benefit, similar to traditional defined benefit plans, while also providing greater transparency and flexibility in retirement planning. Participants can track the growth of their hypothetical account balance over time and have the option to receive their benefit as a lump sum or as a lifetime annuity upon retirement, offering flexibility to meet their individual financial needs and preferences.
However, CBPs also have some drawbacks and complexities to consider. The calculation of benefits in a CBP can be more complex than in a traditional defined benefit plan, requiring careful consideration of factors such as interest crediting rates, vesting schedules and distribution options. In addition, the regulatory and compliance requirements for CBPs can be more stringent than those for defined contribution plans, requiring ongoing actuarial valuations and adherence to specific funding and nondiscrimination rules.
Despite these complexities, CBPs can be a valuable retirement savings vehicle for physicians and practice owners seeking to maximize tax-deferred retirement savings while providing secure retirement benefits for themselves and their employees.
Properly structured retirement plan
A well-designed retirement plan offers numerous benefits, providing physicians with a solid foundation for their financial future:
Tax deductible contributions: Participants in traditional QRPs can fully deduct their contributions, reducing their taxable income and potentially lowering their current tax burden. This tax advantage allows physicians to maximize their retirement savings while minimizing their tax liability, effectively leveraging pre-tax dollars to fund their retirement accounts.
Tax-deferred growth: Funds within the QRP grow tax-deferred, allowing for compounded growth over time. By deferring taxes until withdrawals are made in retirement, participants can harness the power of compound interest to accumulate wealth more rapidly, enhancing the long-term savings potential of their retirement accounts.
Asset protection: If structured with formalities dictated by the Employee Retirement Income Security Act, QRPs often provide robust asset protection from liability threats. This shield against creditors can safeguard retirement savings from potential legal claims or financial setbacks, providing participants with greater peace of mind and security as they plan for retirement.
Drawbacks of retirement plans
Despite the advantages, QRPs also come with certain drawbacks and considerations that physicians should be aware of:
Mandated contribution limits: Defined contribution plans have maximum annual contribution limits set by the IRS, potentially limiting the amount physicians can save each year. While these limits are intended to prevent excessive tax benefits for higher-income individuals, these can constrain retirement savings for physicians with substantial earning potential or those looking to catch up on retirement savings later in their careers.
Mandatory employee inclusion: Practice owners must include eligible employees who wish to participate in the retirement plan, which can increase administrative complexity and costs. This requirement may necessitate additional paperwork, compliance measures and employer contributions, adding to the administrative burden for practice owners and potentially impacting the affordability and feasibility of offering a retirement plan.
Management liability: There is potential liability for management of employee funds within the plan, introducing legal and fiduciary responsibilities. Practice owners who serve as plan administrators or trustees must adhere to strict fiduciary standards, ensuring that the retirement plan is managed prudently and in the best interests of plan participants. Failure to fulfill these duties can result in legal liability, penalties and reputational damage for the practice owner.
Regulatory restrictions: Controlled group and affiliated service group restrictions can limit the eligibility and scope of retirement plans for certain practices. These regulatory constraints aim to prevent abuse of retirement plan tax benefits by related businesses or entities, but these can complicate retirement planning for physicians with multiple practice locations, partnerships or affiliations.
Withdrawal penalties and required distributions: Early withdrawals from retirement accounts before age 59.5 years incur penalties, and traditional plans mandate distributions starting at age 73 or 75 years, subjecting participants to taxation. These withdrawal penalties and required minimum distributions are designed to discourage premature depletion of retirement savings and ensure that participants use their accounts for the intended purpose of funding retirement.
Tax implications: Distributions from traditional plans are taxed as ordinary income and, upon death, plan balances may be subject to both income and estate taxation. While QRPs offer valuable tax advantages during the accumulation phase, participants must eventually pay taxes on their withdrawals, potentially at a higher tax rate in retirement. In addition, estate taxes may apply to retirement account balances passed on to heirs, reducing the after-tax value of the inheritance.
Takeaways
While QRPs offer significant benefits for physicians, including tax deductions, tax-deferred growth and asset protection, these also have potential drawbacks, such as contribution limits, administrative burdens and tax implications. By understanding the pros and cons of QRPs, physicians can make informed decisions tailored to their unique financial goals and circumstances.
Reference:
Mandell and OJM Group partners are pleased to announce the 2024 publication of our newest book, Wealth Strategies for Today’s Physician: A Multi-Media Playbook. The playbook’s innovative format features more than 90 links to videos and podcast episodes to enhance important financial topics for physicians. To receive a free print copy or ebook download, text HEALIO to 844-418-1212, or visit www.ojmbookstore.com and enter code HEALIO at checkout.
For more information:
Sanjeev Bhatia, MD, is an orthopedic sports medicine surgeon practicing at Northwestern Medicine in Warrenville, Illinois. He can be reached at sanjeevbhatia1@gmail.com or @DrBhatiaOrtho.
David B. Mandell, JD, MBA, is an attorney and founder of the wealth management firm OJM Group www.ojmgroup.com, where Adam Braunscheidel is a partner and wealth advisor. They can be reached at 877-656-4362 or mandell@ojmgroup.com.
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