physician retirement

Demystifying the defined benefit pension plan| W. Ben Utley CFP® writes for Orthopreneur

When it comes to money, there’s only one thing more complicated than the tax code, and that’s the rules surrounding qualified retirement plans. While they may be complicated, these plans are simply the best way for surgeons to beat the tax man at his own game.

No qualified plan is more powerful than a defined benefit plan, and no plan is more poorly understood. Here’s a primer to help you get started.

A defined benefit plan is an employer ­sponsored retirement plan that promises to deliver a specific or “defined” amount of money or “benefit” to an employee beginning at retirement and lasting for the rest of their lives. Traditionally known as “pension plans,” defined benefit plans have been around for decades. Actuaries—the bean counters who design and administer these things—refer to them collectively as “DB plans” and the most recent incarnation of the DB plan is called a “cash balance plan.”

No matter what you call it, the DB plan is a wicked sharp tool for deferring income, reducing taxes and protecting assets.

Every dollar that goes into the plan is a dollar that your employer (that’s you, if you’re self-­employed) does not pay out in profits, which means that income is not taxed today. If you’re a surgeon aged 45 earning $210,000 or more, you can receive contributions to your plan of up to $112,000 in 2014 (twice as much as you could contribute to a combination 401(k)/profit­sharing plan). At age 55, you can receive contributions of more than $200,000. Given taxation in the 35 percent Federal marginal tax bracket, surgeons taking advantage of a DB plan are deferring somewhere between $39,000 and $70,000 in taxes every year.

Note the use of the passive voice, here. We did not say “you can contribute.” We said “you could receive contributions.” This is one aspect that sets the defined benefit plan apart from the more familiar defined contribution plans (like 401(k), 403(b) and profit­sharing plans). You, as an employee, have precisely zero control over a DB plan. It all rests in your employer’s hands. They decide how much you can defer, how it will be invested and whether or not you can participate. If you’re not self­employed, you might as well stop reading here because there’s literally nothing you can do about a DB plan.

If you’re self-­employed, though, meaning you’re a partner, shareholder, LLC member or sole practitioner, there are a few things you need to know.

  • Contributions to your DB plan are based on your employee’s age and compensation. Older, more highly­compensated employees (typically the surgeon owners) will require greater contributions, while younger staff with lighter wages will get less.
  • You cannot game the system so that only the owner-­employee benefits. The IRS has strict rules about who must be covered and more rules that prohibit discrimination. A skilled actuary may be able to tilt the playing field in your direction, but you must know that your employees will be treated equitably by your plan.
  • A DB plan requires commitment. While there is no hard and fast rule about how many years you must keep your plan in operation, actuaries generally advise employers to keep their plans open for at least five years, and to keep those plans active/funded in at least three of those years. This means you need to have a reason to believe that your practice will have sustainable positive cash flows in the foreseeable future.

These general guidelines paint a picture of which practices should, and which should not, adopt a DB plan.

The best fit scenario we have seen was a group of four radiologists who had no employees. Two of the physicians were in their early 60s, with one junior partner in her mid ­40s and one newly ­hired physician on track to become a partner. They all earned mid-­six-­figure incomes. Collectively, they could have socked away more than a half million dollars a year.

The worst fit scenario typically involves younger physician owners with highly-­compensated physician extenders, a plethora of older support staff and a hazy or fragile bottom line.

However, some scenarios that seem like a poor fit for a DB plan might be salvageable. Particularly in situations where the employer has a safe harbor defined contribution plan, like a combination 401(k)/profit sharing plan where the employer is already making generous contribution to each employee’s account. In such a case, it might be possible to dramatically increase the overall contributions to owner-­employees while only slightly increasing the share of plan benefits received by employees.

Beyond the tax benefits, DB plans are hugely helpful for surgeons in subspecialties with high rates of malpractice. As entities governed by the Employee Retirement Income Security Act of 1974 (ERISA), they are exempt from the reach of creditors through bankruptcy.

If you decide to explore the option of adding a DB plan to your practice, there is no substitute for a consultation with a pension guru. It is customary for pension actuaries to run a complimentary analysis of your practice to let you know whether or not a DB plan might be right for you. This analysis is usually free of charge.

While the rules surrounding DB plans are painfully complicated, there is no reason to fear what you do not at first understand. The potential benefit is so enormous that you owe it to yourself—or at least you owe it to the next partner who brings this idea into your executive committee meeting—to ask questions and listen to the answers so that you can understand all the costs and benefits to know whether or not a DB plan is a good fit for your practice. 

W. Ben Utley, CFP®, is an attending advisor with Physician Family Financial Advisors, a fee-only financial planning firm helping physicians throughout the U.S. to make a plan and get on track with saving for college and invest for retirement.

This article originally appeared in Orthopreneur with the title "Demystifying the Defined Benefit Pension Plan".

Three ways to make the best of a bad (401k) situation | W. Ben Utley CFP® writes for Orthopreneur

We see the changes that physicians make to improve their financial security, but one item is usually beyond their control: their 401(k) plans. Unless you are self-employed, there is practically nothing you can do about your 401(k)’s underwhelming investment options, ridiculously low contribution limits or perverse tax consequences. If your 401(k) is your main (or maybe your only) investment vehicle for retirement, we have good news for you. It is possible to work around your 401(k) plan’s limitations, so that you can get back on track toward retirement.

Low Limits Many physicians operate under the mistaken belief that if they max out their 401(k) plan contributions, they will be set for retirement. But did you know that the maximum amount of money you can elect to defer into your 401(k) this year is only $17,500 ($23,000 if you will be age 50 or older by December 31)? That’s roughly $1,400 deducted from your paycheck each month ($1,900 per month if you are age 50 or older).

Have you ever met a physician who could live well on $1,400 a month? We haven’t. In fact, the physicians whom we serve are planning to spend more like $10,000 per month in retirement, and that’s after tax. It would take a miraculously high rate of return to turn $1,400 per month pre-tax into $10,000 per month after-tax. As you can see, many physicians are well on their way to a retirement disaster.

To improve your odds of reaching your retirement goal, you can save outside of your 401(k) plan. Even if you cannot deduct the contributions you make to a Traditional IRA, you can still contribute $5,500 this year ($6,500 if you will be age 50 or older by December 31), and if you max out your own IRA, your spouse can also contribute up to $5,500 to his or her IRA ($6,500 if he or she will be age 50 or older by December 31), even if they are not earning an income. Depending upon your tax situation, it might also make sense to convert these contributions to a Roth IRA, doing what is known as a backdoor Roth IRA contribution. Once the money is in a Roth IRA, it can grow tax-free for the rest of your life. Of course, this still might not be enough to allow you to retire comfortably, so you should consider investments outside of your 401(k) plan and IRAs.

Underwhelming Options You probably haven’t read the fine print behind your 401(k) plan, but you are betting that your practice manager has carefully vetted both your 401(k) plan provider and the investments offered inside your plan. Don’t believe it! We have found that busy managers either fail to read the fine print or lack the experience to understand what they have read. Despite new laws requiring plain English disclosures of investment-related fees, many employers continue to keep physicians locked into expensive plans with unpalatable investment options.

If your plan charges more than 50 basis points (0.50 percent) on top of mutual fund operating expenses, your plan’s costs are draining an unfair share of your retirement savings. To get this under control, you need to raise your voice, but carefully. We regularly see very expensive plans that persist simply because of office politics.

It’s more common to see an investment lineup consisting mostly, if not entirely, of actively managed mutual funds. This is a sign of ignorance on the part of your plan fiduciaries. At a time when most prudent investors recognize that passively managed index funds have been shown to have delivered better results at a lower cost than the average actively-managed fund, there’s no good reason that your plan should continue to limit you to subpar investment options.

To work around these issues, look at your retirement investments holistically. Think about your 401(k) plan, your Traditional IRAs and your after-tax accounts (mutual funds and brokerage accounts) as if they were all one retirement portfolio. Then use the least-bad investment options from your 401(k) and pair them with the best options available within other accounts that make up the balance of your portfolio.

Tax Time Bomb You already know that physicians pay more than their fair share of taxes. But did you know that you are probably setting yourself up to pay more taxes on your 401(k) than you really should? That’s right. There’s a perverse little wrinkle in the tax code that can turn your 401(k) plan into a tax time bomb.

To understand this trap, you need to know a little bit about how investments are taxed. Withdrawals from your 401(k) plan will be taxed at your marginal income tax rate, which may be as high as 39.6 percent for Federal income tax. At the same time, capital gains and qualified dividends from mutual funds held in taxable accounts outside your 401(k) plan are taxed at a maximum Federal rate of 23.8 percent (which is 20 percent plus the new 3.8 percent Medicare surtax).

This means that your 401(k) nearly doubles the tax rate you pay on capital gains and qualified income by effectively converting these tax-favored returns into tax-trapped ordinary income. Consider holding equity mutual funds in a taxable account, or better yet, own them in your Roth IRA or the Roth subaccount of your 401(k) if you have one.

If your 401(k) is a lousy place to stash your stock funds, what should you hold there instead? Consider low growth, income-producing investments, including bond funds and stable value funds. If you have an appetite for more aggressive fare, consider high yield (junk) bond funds or emerging market bond funds. Outside of your 401(k) plan, these investments may be taxed at your highest marginal rate, so it’s a good idea to protect your income by keeping it inside of the tax shelter of your 401(k) plan.

Again, the best workaround for this tax trap is to view your entire retirement portfolio, including your 401(k) plan, your IRAs and your other accounts that are earmarked for retirement, as one portfolio. Choose to own the best investments in the accounts that make the most sense from the standpoint of expense, risk, return and taxation.

Summary Even if you are stuck with a stinky 401(k) plan, you can still make the best of a bad situation. All you have to do is take a look at the big picture, think outside the box and make smart moves to put yourself on track for a solid retirement.

 

W. Ben Utley, CFP®, is an attending advisor with Physician Family Financial Advisors, a fee-only financial planning firm helping physicians throughout the U.S. to save for college and invest for retirement.

Lawrence B. Keller, CFP®, CLU®, ChFC®, RHU®, LUTCF, is the founder of Physician Financial Services. Based in New York. He offers income protection and wealth accumulation strategies for physicians nationwide.

This article originally appeared in Orthopreneur with the title "Overcome 401 (k) LImitations: Three Ways to Make the Best of a Bad Situation".

Should young physicians pay off debt or invest for retirement first?

Question:

"I am in the relatively typical position (for a physician) in that I have been in forbearance/deferment on all of my loans for many years, and I have not been contributing to a retirement fund. I am now faced with the question of how much money to use to aggressively pay down the loans, vs. how much to put in the retirement plan. Some of the loans are at relatively high fixed interest rates (4.5% - 7%), and the employer match for my retirement plan does not start immediately. What should I do?"

Answer:

As a financial advisor, I have at least one thing in common with you and the physicians I serve: I hate debt too.

I know you worry about how to pay off your student loans, you wonder how you will ever be able to afford a home, and the thought of taking out a six-figure loan to buy into your practice makes you want to barf.

I get it… debt sucks.

But aggressively paying off all your debt right now--before you begin investing for the future--might be the first financial mistake you make. Here are a few things to consider before you take a sledge hammer to your debt:

  • Leverage: Given that you're paying interest on student loans at up to 7% per year, it may be difficult to earn a greater rate of return by investing for retirement. But if you are an aggressive investor (which many young physicians either are, or could be) then you might be able to beat that interest rate with returns that are one or two percentage points higher. And many physicians can consolidate their student loans at much lower interest rates, making it easier to outpace the interest they pay with the returns they might earn. In the long run, using leverage means you give yourself a shot at having more money for retirement.
  • Vanishing opportunities: Each year, you have a chance to set aside a chunk of money for retirement and if you don't use this opportunity, you lose it. For 2013, you can contribute up to $17,500 to your 401k/403b ($51K if you're self-employed) and you can contribute up to $5500 to a Traditional IRA (and maybe convert that contribution into a Roth IRA if you're in the right situation). Don't let this chance slip away. Even if your employer is not matching you yet, contributions to these accounts can defer taxes and provide a layer of asset protection. Later, when you are earning more and have more money to save, you will wish you had taken advantage of them.
  • Tax Savings: While the tax savings on retirement vehicles may be temporary, most physicians have the opportunity for permanent tax savings by contributing to Health Savings Accounts (HSA's) and in-state Section 529 College Savings Plans. If you have kids or you are planning a family, you'll be saving for college some day anyway, so why not begin saving now? The annual tax savings that go with these vehicles are like free money, and these opportunities also expire on an annual basis.

Once you have considered all the angles and taken advantage of the no-brainer moves, then you might consider paying down your debt but until then, take a deep breath and think about making only the minimum monthly payments.

9 Questions Physicians Should Ask Before Enrolling in a Retirement Plan at Work

Physicians know there are only two certainties in life: death and taxes. But actually, there is a third: retirement. It’s that period right before death, and right after taxes.

And since you are going to retire some day, you might as well enroll in your employer’s retirement plan (or your retirement plan if you are self-employed).

But before you do that, you should get the answers to a few questions about each plan.

  1. What kind of plan is it? There are two main types of plans. The most common type are defined contribution plans that start with a “4”, like 401k, 403b, 401a, 457b and 457f. (All of these number/letter combinations refer to sections of the Internal Revenue Code.) Defined contribution plans limit the amount you can contribute. On the other hand, “defined contribution” plans limit the amount of money you can expect to receive at retirement. These may include “pension” plans like a cash balance plan.
  2. Can I control how much money goes into it? A no-brainer question, right? Wrong. If you have a 401a or 457f plan, your employer makes the contribution and they decide how much goes into the account.
  3. What is the maximum amount I can contribute each year? For most defined contribution plans, the limit will be $17,500 per participant in 2013 with a $5,500 “catch up” allowance for physicians aged 50 and over. Defined contribution plans, however, may allow you to contribute more than $100,000 per year.
  4. Does it have a Roth component? The answer to this question really depends on the language in your plan (see your Summary Plan Description) but many 401k’s and 403b’s have a Roth component. Generally speaking, it’s a mistake for physicians to contribute to the Roth portion of the plan, or to do an in-plan Roth conversion.
  5. Who is the custodian? The word “custodian” means “the company who is holding your money.” For example, your money might be with Fidelity or Vanguard or Principal or TIAA-CREF. Every custodian has strengths, weaknesses and idiosyncrasies.
  6. Who is responsible for the investment decisions? In some cases, your employer might appoint an advisor to manage your money. In other cases, the onus is on you to take care of it.
  7. What investment options are available? Some plans offer as few as six options, while others offer dozens or hundreds of options. Some will offer actively managed mutual funds while others offer low-cost index funds from Vanguard or even exchange-traded funds. Choosing the right options will help you earn a better return and save money on investment-related expenses.
  8. If I leave this employer, can I rollover my money to an IRA? Some deferred compensation arrangements, like Section 457 plans, may not allow you to make an IRA rollover and may require you to take all of your money with you when you retire or move on to another job.
  9. What happens if my employer becomes insolvent or goes bankrupt? Certain plans—including 457b and 457f plans—may have a “substantial risk of forfeiture” that puts your entire account balance at risk, regardless of how it is invested. In these situations, you could lose all of your money if the employer goes bankrupt, so read the fine print before you enroll in the plan.

 If you do a little due diligence before you invest, you can save yourself a lot of time and money after you have made the decision to enroll in the plan. Ask your H.R. person for a Summary Plan Description and read it before you sign up.

Top Strategies for Physician Wealth Building | Physician's Practice interviews W. Ben Utley CFP®

Healthcare author and financial columnist Janet Kidd-Stewart interviews Certified Financial Planner™ W. Ben Utley, several physicians and other financial planners to reveal the Top Strategies for Physician Wealth Building in this feature-length article for Physician's Practice. Discover tips and advice about saving for retirement, paying for college, buying disability insurance, saving on taxes and planning for a secure financial future.