2017 Guide to Physician Retirement Planning
Physician retirement planning is tricky business since doctors get a late start on saving for retirement. Medical practitioners begin earning “real money” in their mid-30s but during their first ten years of practicing medicine—when the power of compound investment growth has the biggest impact on retirement accounts—doctors are strapped with student loan payments, childcare expenses and mortgage loan payments that make it challenging to contribute to tax-qualified retirement plans. And young physicians, fresh out of training and excited about a new career, seldom understand the burnout that causes almost half of mid-career physicians to wish they were better prepared for retirement.
5 Ways Physicians Can Save for Retirement
A successful plan for retirement means saving money and saving taxes. Doctors have at least five ways to save for retirement before considering other options like real estate, cash value insurance and other vehicles. Most of these retirement strategies receive a measure of asset protection via the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA).
1. Tax-Deferred Retirement Plans for Physician Employees
Physicians who receive a Form W-2 showing wages or salary may have a workplace retirement plan that allows them to defer income by making a contribution to the plan.
401(k) plans allow employees of for-profit healthcare organizations and self-employed doctors to defer up to $18,000 per year ($24,000 per year if age 50+) to the plan on a pre-tax basis. Account balances can grow tax-deferred. Qualified distributions are taxed as ordinary income when withdrawn. Other withdrawals, including those made before age 59½ are generally subject to income taxes and a 10% penalty.
403(b) plans work the same way that 401(k) plans do but they are offered by government and nonprofit healthcare organizations.
Government-sponsored 457(b) plans are offered by state and local government healthcare organizations. Physicians can defer up to $18,000 per year ($24,000 if age 50+) to the plan on a pre-tax basis in addition to the money they contribute to a 403(b) plan. Account balances can grow tax-deferred. Qualified distributions are taxed as ordinary income when withdrawn. Other withdrawals, including those made before age 59½ are generally subject to a 10% penalty and income taxes. Balances from these plans are generally available to roll over to IRAs or other employer-sponsored retirement plans, provided that the receiving plan allows for inbound rollvers.
Non-government organization 457(b) plans, or NGO 457 plans, present a special risk for unwary physicians saving for retirement. While these plans also allow for pre-tax contributions and tax-deferred growth, they only gain these tax benefits due to a “substantial risk of forfeiture” imposed by the Internal Revenue Service. Doctors who hold these plans can lose everything if the sponsoring employer goes bankrupt. While account balances from one non-government 457(b) can usually be rolled over to another non-government 457(b) plan, they cannot be rolled over to an IRA or any other type of plan.
401(a) plans are offered by nonprofit employers who may make contributions on behalf of physicians. Contributions by employees are usually mandatory deferrals based on a flat dollar figure or a percentage of compensation. 401(a) plan balances may be rolled over to an IRA or other qualified retirement plan.
2. Tax-Deferred Retirement Plans for Self-Employed Physicians
Physicians who receive income reported on Form 1099 (including doctors who “moonlight” or work locum tenens) and self-employed physicians have other options to help save for retirement.
SEP-IRA is a Traditional IRA established under a Self Employed Pension Plan document (often the Form 5305-SEP) that allows a physician to contribute more to a Traditional IRA than they could contribute outside the plan. Physicians with a SEP may still be able to contribute to a separate Traditional IRA or Roth IRA. Physicians can contribute the lesser of $54,000 or 25% of compensation (as adjusted for self-employment tax). Like other Traditional IRAs, account balances can grow tax-deferred, are taxable when distributed, and may be rolled over to other qualified plans.
One-participant 401(k) plan (as it’s described by the IRS) is also known as a “solo 401k” or solo-k for short. This plan works like a traditional 401(k) plan except that (1) it’s for a practice with only one owner or a practice that only employs an owner and spouse, (2) it is not required to perform nondiscrimination testing, (3) if it holds less than $250,000 at the end of the year, it is generally not required to file Form 5500-SF. Many brokerage firms and mutual fund companies offer off-the-shelf or “prototype” documents that physicians can use to establish a solo-k, though few of these firms are qualified to give advice regarding compliance with IRS, ERISA and DOL rules that govern their creation and maintenance.
3. Tax-Qualified Pension Plans of Physician Employers
Physicians who are self-employed may establish a special kind of retirement plan known as a defined benefit plan, and physician employees may be fortunate enough to work for an organization that has adopted one of these plans. Traditionally known as “pension plans,” defined benefit plans have been around for decades. Actuaries—the professionals who design and administer these plans—refer to them collectively as “DB plans.” The most recent incarnation of the DB plan is called a “cash balance plan” because the plan’s annual statement shows a 401k-like balance representing the present value of the plan’s future benefits, making it easy for doctors and other plan participants to grasp.
Contribution limits vary according to a physician’s age but younger doctors might contribute as little as $40,000 per year to a plan while doctors nearing retirement might contribute as much as $200,000 per year, all on a pre-tax basis.
Regulatory compliance is burdensome since these retirement plans must comply with the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Service code. Physicians who are interested in setting up a plan can consult a third party administrator (TPA) who generally handles the plan documents, the plan adoption process, ongoing testing and required filings. Most TPAs will neither manage the account nor act as a custodian for the plan’s assets. These services are typically provided by a brokerage and a registered investment advisor.
- A strong case for a defined benefit plan includes a stable medical practice with a small number of highly-compensated physicians who are substantially older than the average staff member (e.g. radiologists and anesthesiology practices).
- Layering a defined benefit plan on top of a defined contribution plan (401k or profit sharing plan) may allow physicians to substantially increase their own ability to save for retirement while costing very little in the way of required additional contributions to staff.
4. Tax-advantaged personal retirement accounts for physician families
Physicians who receive earned income from employment and their spouses who are under age 70½ are eligible to contribute to an Individual Retirement Account (IRA) even if their contributions may be non-deductible.
Traditional IRA allows doctors to defer up to $5,500 per year ($6,500 per year if age 50+) to the account. Physicians who are not covered by a workplace retirement plan may deduct pre-tax contributions while those covered at work can make non-deductible or partially-deductible contributions depending on their earned income and filing status. The non-deductible portion of the account, also known as “basis”, is tracked with each year’s tax return on Form 8606. Account balances can grow tax-deferred. Qualified withdrawals (excluding the basis) are subject to ordinary income tax while non-qualified withdrawals generally result in a penalty.
Roth IRA contribution limits are the same as Traditional IRA limits but most physicians earn income at levels exceeding the adjusted gross income (AGI) limitations, so they simply are not allowed to contribute directly to a Roth IRA. Doctors can make “backdoor Roth IRA contributions” by first contributing to a Traditional IRA and then converting the Traditional IRA to a Roth IRA. (Note: This tactic requires careful planning to avoid unnecessary taxation.) Roth IRA balances can grow tax-deferred and qualified withdrawals are free of income tax. For more details, see IRS Publications 590-A and 590-B.
Spousal IRA is a Traditional IRA or Roth IRA that receives contributions on behalf of a non-earning spouse. In order to contribute, the non-earning spouse must meet the ordinary requirements for making an IRA contribution but they are not required to have earned income. Instead, the earning physician must make enough income to cover the spouse’s contribution. Otherwise, the same IRA contribution limits apply to the Spousal IRA.
Health Savings Account (HSA) is not truly a “retirement account” but physicians may allow balances to grow tax-deferred and make tax-free distributions for qualified healthcare expenses in retirement. While contributions are tax-deductible, a doctor must first be covered by a High Deductible Health Plan (HDHP) in order to be eligible to contribute to the account. Physician families covered by a HDHP can contribute up to $6,750 while doctors with self-only coverage can contribute $3,400. For more details, see IRS Publication 969.
5. Tax-Efficient Investments in Taxable Accounts
Physicians that manage to max out contributions to all their tax-advantaged retirement accounts can still make use of a taxable account (a.k.a. Joint account, trust account or individual account) by investing in certain securities that are inherently tax-efficient.
Tax-exempt bonds and bond funds pay dividends or interest that can be federally tax-free or doubly tax-free when owned by a physician who lives in the state where the bonds were issued.
Low-cost index funds and other passively-managed mutual funds that have a low internal “turnover” seldom pay out capital gains distributions and, when they do, these distributions tend to be small and are taxed at favorable capital gains rates.
Stocks of US corporations, certain foreign corporations and mutual funds that own them may pay dividends that qualify to be taxed at favorable capital gains rates.