One of the most important decisions any business owner makes is what kind of retirement plan to set up for himself and his employees. This is especially important for physicians because of their above-average compensation. The first step in making such a crucial decision is understanding what the options are.
In our blog series, “The Best Retirement Plans for Medical Groups,” we are examining the options available and their pros and cons. The most popular retirement plans that doctors establish in their practices are:
- Defined Benefit Pension Plans
- 401(k) Plans
- Defined Benefit/Defined Contribution Combination Plans
- Cash Balance Plans
Last week, we covered Defined Benefit Pension Plans. You can read that post here (LINK). This week, we’ll cover the strengths and weaknesses of 401(k) plans for physicians.
How is a 401(k) Plan Different?
A 401(k) Plan is a Defined Contribution Pension Plan (DC plan). Instead of defining the benefit to be paid at retirement as in a DB plan, a DC plan only specifies the contribution made into the plan and makes no promises for the plan participants’ retirement. Very popular among businesses today, 401(k) plans are not as appealing to physicians because of their contribution limits.
How Much Can a Business Owner Save?
For the year 2016, the maximum contribution is $18,000, with an additional $6,000 allowed for participants over the age of 50. For a doctor accustomed to making $250,000 a year, only contributing $18,000 a year will not grow enough to provide a similar level of income in retirement, even with stellar returns.
Other Factors to Consider
In conjunction with a 401(k) plan, many businesses also offer profit sharing plans. Profit sharing is when a business contributes towards their employees’ retirement out of their profits. It is very flexible, with no minimums and a maximum of the lesser of 100% of the employee’s compensation or $53,000. This is an excellent plan for businesses with inconsistent revenue, for they can contribute to employee plans when they have excess but are not required to in lean years.
What are the Drawbacks?
Even combined with profit sharing, a 401(k) is not as lucrative of a retirement plan as the Defined Benefit plan, because the maximum that can be contributed between the company and employee combined is only $53,000, regardless of the employee’s compensation.
In fact, the IRS limits the amount of compensation that can be taken into consideration when determining contributions, and for 2016, it is set at $265,000. For the 45-year-old plan participant in the example above, only being allowed $53,000 in total contributions is $25,000 less than would be contributed on his behalf in a DB plan.
For more information on retirement plan options for physicians, contact me today at 480.494.8992 or by email at firstname.lastname@example.org. Stay tuned for our next blog post covering the pros and cons of Defined Benefit/Defined Contribution Combination Plans for physicians.
About Kenny Phan
Kenny Phan is a Managing Partner at FinancialFocus Retirement Plan Services, a 3(16) fiduciary. He works as a pension specialist who partners with financial professionals to design and implement pension plans. His area of expertise is customized defined benefit, defined contribution, and 401(k) plans. Serving financial advisors and businesses in the greater Phoenix area, he is supported by FinancialFocus Retirement Plan Services. Together, they provide comprehensive plan design consultation, administration, document installation, compliance testing, as well as IRS and DOL reporting for qualified retirement plans.