Medical professionals generally have high-income. But most importantly, they have consistent income. For this reason, defined benefit plans for physicians and doctors can make a lot of sense.
Medical professionals always aim to accelerate their retirement savings as well as take advantage of tax deductions. That’s why these plans can make so much sense for them.
In this post, we will discuss how these plans work and take a look at a few real-life examples. Let’s get started!
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Defined benefit plans, including solo plans, will allow high income physicians and doctors to make substantial tax-deductible contributions as high as $300,000 annually.
An Anesthesiologist aged 52 married and with two kids has been saving and has about $550,000 in his retirement account. Based on his age and profession, this is basically not enough. With his high income, he has better ways to maximize his retirement savings.
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He owns an S corporation where he works as an independent contractor with no employees. He pays himself $220,000 as salary and has a 401k plan that has allowed him to save the above amount. His solo 401k allows him to contribute $19,500 plus a $6,000 catch-up provision, profit sharing. Profit sharing plan also allows him to contribute 6% of his W-2 salary towards his retirement.
The best way for him to supercharge his retirement saving is combining the plans he already has with a defined benefit plan. Defined benefit plans allow individuals with high incomes to get sizeable amounts into retirement. Subject to contribution limits and age, one can save as high as $250,000.
For the Anesthesiologist above, he makes a contribution of $24,000 to 401k employee deferral and $12,000 into a profit sharing plan (limited to a 6% contribution as a result of testing limitations). With a defined benefit plan, he contributes $188,000 towards his retirement.
This, therefore, allows him a combined contribution of $224,000. If we subject this to say a 45% federal and state tax bracket, he saves about $101,000 on tax deductions.
Defined Benefit Plan for Doctors: A 35-year-old Cardiologist
Dr. Morrison owns an S corporation where he works as an independent contractor, he has no employees. The business generates $305,000 as business income after expenses; he then pays himself a salary of $200,000. He wants to reduce the balance of $105,000 which is the net profit as they will pass to him and increase his tax payable. The only way to reduce this profit is to maximize tax-deductible contributions towards a retirement plan.
We will consider two options; the first option is a combination of a defined benefit plan together with 401k profit sharing plans. His contribution will be as follows:
$19,500 – 401k (Contributed from W-2 salary hence tax deductible on personal tax return)
$12,000 – Profit Sharing (tax deductible as a business expense)
$48,000 – Fully Insured Defined Benefit Plan (Tax deductible as a business expense)
$78,000 – Total Contributions
The other option is a SEP IRA, where he can contribute $50,000 or an individual401k, where his salary of $200,000 can allow him a contribution of $54,000. The first option, therefore, allows Dr. Morrison a higher tax-deductible contribution as compared to the second option; Dr. Morrison will contribute $28,000 higher.
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Other benefits under the first option include:
- Increased savings towards retirement.
- Increased tax deduction which is usually the most important concern for physicians. Using a 33% marginal tax bracket on the $78,430 tax deductions made, Dr. Morrison saved $25,881 on federal taxes.
- By the age of 65, minimum guaranteed policy value for an annuity as Dr. Morrison retires will be $2,494,272. This is based on the annual defined benefit plan contribution of $48,000.
- Ability to combine 401k, profit sharing, and a defined benefit plan.
Defined benefit plans are therefore the best tool not only for significant retirement savings but also provides tax saving benefits. The benefits accrue to both the contributions and earnings on those contributions.
|Pros ⏩||Cons ⏩|
|Tax Deductible Contributions||Conservative Investment Profile|
|Flexible Plan Set-Up ✅||Not Best with Many Participants|
|Simple Funding Range||High Set Up & Administration Fees|
|Creative Plan Design ✅||Permanent Plan Requirement|
Advantages and Disadvantages of Defined Benefit Plans
The primary advantage of a defined benefit plan is the ability to accumulate large amounts for older key employees. The physician or doctor can make deductible contributions to ensure that the benefit is in place no matter what the market conditions are.
Therein also lies the primary disadvantage of such plans: low market returns can cause an increase in contribution requirements at a time when the employer may not be able to meet those requirements.
Employee perception of this type of plan can work for or against the employer. If the defined benefit plan is presented as a way to protect employees from market fluctuations and guarantee benefits, the plan may be well accepted.
The current down market would make the plan even more desirable to them. On the other hand, as benefits are generally illustrated as monthly pensions payable at a future retirement date, employees may have difficulty putting a current value on the benefit accruing to them.
How to decide if a plan is right for you?
Here are the five steps to deciding if a plan is right for you:
- Physicians looking for large contributions
As we get older, our income typically increases and so does our motivation for retirement contributions. That’s why these plans can be such a home run. Small business owners (sole proprietors and S-corps) who want to deduct more than $50,000 for each owner make the most sense.
- Reliable income stream
Having consistent income is critical with these plans. Companies that have large reliable sources of income and are able to contribute at least the minimum contribution limits make the most sense. But if you are close to retirement and looking for tax deductions then you may be able to justify it.
- Consistent contributions
Are able to consistently make contributions for their employees’ year over year, along with a relatively decent interest rate. If you have employees, it still might make economic sense. The employer can exclude part-time employees and certain other employees but must contribute approximately 5 to 7% for the remaining employees to pass the rules.
- Catch-up on retirement
Small business owners who don’t have a large amount of retirement savings set aside and who want the ability to “turbocharge” their contributions to fund their retirement. Employers are free to structure their plans to accomplish their business objectives–subject to the Internal Revenue Code’s tax qualification rules and actuary sign-off.
- Combo plans
Don’t forget that you have the option to combine these plans with a few other retirement structures. The most common add on plan is a 401(k). Small business owners who want to combine the benefits of a 401(k) and defined benefit plan simultaneously.
Under current regulations, a lump sum payout to a terminated participant must be calculated using two methods. The first calculation uses and, in a well funded plan, would come close to the funds that have been put away for the participant over time with interest.
However, the benefit must then be recalculated using IRS mandated rates which are based on 30-year Treasury bills. This can result in a payout to a terminated participant that is as much as 250% of the amount funded. These inflated payouts then lower the overall funding of the plan and cause higher contributions for the doctor.
These regulations, combined with current low Treasury bill rates, have caused many plans to become significantly underfunded. There are several legislative changes being considered to minimize the impact of this problem, but a plan currently in existence can find itself paying out amounts far greater than anticipated to terminated participants.