Physician in Private Practice: How Does the 401(k) Contribution Work?

Doctors and physicians have unique retirement planning needs. This is a result of their high income.

But physicians in private practice have the ability to set up 401(k) plans and even define benefit plans or cash balance plans.

This post we’ll talk about these different retirement structures and give you some thoughts when it comes to setting up your own plan. Let’s get started.

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Yes, a physician in private practice can set up a 401(k) retirement plan. While 401(k) plans are typically associated with large employers, self-employed individuals, including physicians in private practice, have the option to establish a solo 401(k) plan, also known as an individual 401(k) or a one-participant 401(k).

A solo 401(k) plan allows self-employed individuals to save for retirement and enjoy some of the same benefits as traditional employer-sponsored 401(k) plans. It offers the opportunity to make employee and employer contributions, providing potentially higher contribution limits compared to other retirement plans available to self-employed individuals.

To set up a solo 401(k), you would typically need to follow these steps:

  1. Eligibility: Ensure you qualify as self-employed with no employees except possibly a spouse.
  2. Choose a provider: Research financial institutions or investment firms that offer solo 401(k) plans. Compare their fees, investment options, customer service, and other features to find the one that suits your needs.
  3. Plan documentation: Complete the necessary paperwork to establish your solo 401(k) plan. This usually involves filling out an adoption agreement and other plan documents provided by the chosen provider.
  4. EIN and account setup: Obtain an Employer Identification Number (EIN) from the IRS if you still need to get one. Then, set up a dedicated account for your solo 401(k) plan with the chosen provider.
  5. Funding the plan: You can contribute as both an employee and employer to your solo 401(k) plan. You can make elective deferrals up to the annual contribution limit as an employee. As an employer, you can contribute a percentage of your business income or a flat dollar amount, subject to certain limitations.
  6. Investment selection: Determine how you want to invest the funds within your solo 401(k) plan. Most providers offer a range of investment options, such as mutual funds, stocks, bonds, and more.

It’s essential to consult with a qualified tax advisor or financial professional who can guide you through the process and provide personalized advice based on your specific circumstances. They can help ensure you meet all the requirements and take advantage of the available retirement savings options.

Cash balance plan option

A cash balance plan is an employer-sponsored retirement plan that combines features of traditional pension plans and defined contribution plans. It is a form of a qualified retirement plan that provides employees with a guaranteed income stream at retirement, similar to a pension plan, while also maintaining individual hypothetical account balances tied to their contributions and interest credits.

In a cash balance plan, each of the participants has a hypothetical account that grows with annual contributions from the employer and interest credits. The employer typically contributes a fixed percentage of the employee’s compensation or a flat dollar amount to the participant’s account. The interest credits are either based on a fixed or variable rate tied to an index, such as Treasury rates.

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The account balance is adjusted annually to reflect the contributions and interest credits, and it continues to grow over time until the employee reaches retirement age. At retirement, participants can receive the accumulated balance as a lump sum or even convert it into an annuity that provides a regular income stream throughout retirement.

Unlike traditional pension plans, cash balance plans provide participants with individual account balances, making them more transparent and portable. Participants can carry their cash balance plan benefits if they change jobs or leave the employer. This flexibility and portability make cash balance plans attractive for employees, including physicians, who may have career transitions or mobility throughout their professional lives. Additionally, cash balance plans offer higher contribution limits than traditional retirement plans, allowing participants to accumulate retirement savings more rapidly, especially for those with high earning potential.

Why can a cash balance plan be a great option for a physician?

A cash balance plan can be a great option for physicians due to its unique features and advantages that align well with their financial goals and circumstances. Here are a few reasons why a cash balance plan can be beneficial for physicians:

  1. Higher contribution limits: Cash balance plans allow for significantly higher contribution limits compared to traditional retirement plans like IRAs or 401(k)s. This can be especially advantageous for physicians who have high earning potential and want to maximize their retirement savings within a shorter time frame.
  2. Accelerated retirement savings: Cash balance plans combine elements of both defined benefit and defined contribution plans. They offer a guaranteed income stream at retirement, similar to a traditional pension plan, while also providing a hypothetical account balance that grows with contributions and interest credits. This allows physicians to accumulate retirement savings at an accelerated rate, supplementing their other retirement savings vehicles.
  3. Age-weighted contributions: Cash balance plans allow for age-weighted contributions, meaning older participants can make higher contributions. Since physicians often start earning a substantial income later in their careers due to extended education and training, this feature can enable them to catch up on retirement savings and make larger contributions as they progress in their professional journey.
  4. Tax advantages: Contributions made to a cash balance plan are tax-deductible, helping physicians reduce their taxable income and potentially lower their tax burden. Additionally, the investment gains within the plan grow on a tax-deferred basis until retirement, allowing for potential tax savings and a more efficient accumulation of wealth.

It’s important to note that the establishment and administration of cash balance plans can be more complex than other retirement plans, and they may require professional guidance from actuaries and financial advisors. Therefore, it’s advisable for physicians to consult with a qualified retirement plan specialist to evaluate their specific circumstances and determine if a cash balance plan is the right fit for their retirement goals.

Final thoughts

Retirement planning is crucial for physicians due to the unique nature of their profession and the financial considerations that come with it. As medical professionals, physicians often spend years acquiring extensive education and training, which can result in a delayed start to their careers and a significant amount of student loan debt.

Additionally, physicians typically have high earning potential but may also face the challenge of variable income due to factors like private practice income fluctuations or changes in employment status. Therefore, proper retirement planning becomes even more important to ensure financial security and a comfortable retirement.

Furthermore, the demanding nature of the medical profession can lead to long working hours and a delayed focus on personal financial matters. Neglecting retirement planning can have long-term consequences, including inadequate savings, a shorter time horizon for investments to grow, and limited options for a comfortable retirement lifestyle.

By starting retirement planning early, physicians can take advantage of the power of compounding and create a solid financial foundation that can withstand the challenges of their profession. It allows them to make informed decisions, maximize tax advantages, and build a diversified investment portfolio that aligns with their goals, ultimately providing peace of mind and the ability to enjoy a well-deserved retirement after a fulfilling medical career.

Paul Sundin

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