Retirement Plans
The major goal of a pension plan is to put money away for retirement without having to pay taxes on it until you withdraw it at retirement. However, if you set up a plan in an office with highly compensated owners of the business and several not so highly compensated employees, you will have an additional goal, goal #2: to maximize the amount of money that you and the other physicians can put away every year while minimizing the amount of money you must put into the plan for your employees.
Figuring out how to accomplish the second goal is one major area of savings you can realize in optimizing your medical practice. You can save on taxes by being able to put more away for yourself, and on expenses by contributing less for employees or paying less for your retirement plan fees.
Whatever plans you choose to use to maximize your own tax-deferred contributions, such as standard defined benefit plans, “carve out” plans, or cash-balance plans, you will usually utilize a 401(k) for your office in addition. So we will use the 401(k) to illustrate how you may be able to save on medical practice expenses, including untangling actual fees.
Typical Setup for a 401(k) Plan
A 401 (k) plan is usually set up and administered through an insurance company, a banking institution, a mutual fund family, a benefit consultant, or a brokerage. Before you set up your plan, you must make a number of decisions that will have an impact on the success of your plan, especially with respect to goal #2:
How long should the waiting period be before a new employee can participate? Generally the answer is one year.
When will a new employee start vesting in the plan? In other words, when will an employee get to keep your contributions? Most companies set up a sliding scale, with an initial waiting period before vesting starts, and then vesting in increments of 20% per year. If your employee leaves before he or she is fully vested, you get to keep the unvested portions of your contributions to their account.
What is the maximum contribution an employee may make? Generally the upper limit is between 10% and 15%, usually with a ceiling at a certain amount, for example $15,000.
Will the employer match the employees’ contributions? With some plans, your ability to maximize your own contributions to the plan depends on the amount of employee participation. And since matching contributions usually inspire greater participation, you may want to include a matching provision, with a ceiling. You should discuss this issue with your pension consultant.
Moreover, it is very important to set your plan, whether a 401(k) or a profit sharing plan, in such a way that it will allow you (and any other physicians in your office) to put away the maximum amount of money for yourself while minimizing what must be contributed for the employees.
In addition, you will need to determine which investment options will be available in the plan. Remember that you will be held legally responsible for providing sound investment options. Then again, with the 401(k) option, an increasing part of the fiduciary responsibility is shifting to the employees since they are able to make some of their own decisions about their investments.
In connection with the investment choices question, you will also need to determine how much the administration of your pension plan will cost, and what the fees and other charges will be for the actual investment options.
Unfortunately, it is often very challenging to get straight answers when it comes to that last question. Primarily, there are administrative or record keeping fees, and then there are the investment related fees. However, some of the plans are very good at hiding the true extent of their fees and expenses.
Especially in so-called bundled plans, which do have major administrative advantages because they will relieve you from most administrative obligations, it can be almost impossible to find out exactly how much it will cost you.
And you will need to know that in order to make prudent decisions. For much more detailed information on where to look for hidden fees and the kinds of questions to ask, and how to make wise choices among the various investment options, you should consult The Doctor’s Wealth Preservation Handbook, and also get the advice of an experienced pension specialist.
Meanwhile, here is an example to illustrate the importance of knowing all the fees and expenses in a particular pension plan set-up:
Example:
Assume you have $2,000,000 in pension plans A and B.
Plan A uses a fully bundled product with a “wrap” fee and Plan B uses an un-bundled product.
Plan A uses mutual funds offered by an insurance company which are “in-house” funds.
Plan B uses a variety of name brand funds like Fidelity, T-Rowe Price, Vanguard, etc. Assume that the “in-house” funds give the same return on investments as the name brand funds.
Plan A has average investment management fees/internal expense ratios of 1.8% for their funds.
Plan B has average investment management fees of 1.2%.
Plan A has a “wrap” fee of 1.2% to pay for the complete administration of the plan.
Plan B pays an outside TPA $6,000 a year to administer the plan.
The difference in costs will amaze you. Plan A has total costs for the year of approximately $60,000. Plan B has total costs for the year of approximately $30,000. It is difficult to quantify exactly how much more Plan A will cost over a 20-year period due to the fact that, as the assets grow, the amount saved on administering the plan will be greater every year for Plan B.
Now assume that Plan A has an average rate of return on investments of 7% and Plan B has an average rate of return of 9%. The amount of extra money earned for Plan B the first year will be $40,000.
While it is important to have a plan where fees are low, it is always better to pay a little more in annual expenses if the additional return on your investments will be more than those extra expenses. For example: If Plan A returned 2% more a year in average investment returns then Plan B, the first year the extra investment income (collectively) for plan A would be that same $40,000, which actually makes Plan A $10,000 less expensive in the first year.
It’s a serious hassle to take the time to figure all this out, but examining the real fees of potential retirement plans (and especially figuring out how to put away more for yourself) is usually a high yield area in which to optimize your medical practice.
Last but not least, it is important to be aware of possible pitfalls when funding your 401(k) plan so you won’t lose money through stiff penalties. The most important one: be sure to send your required contributions to your pension plan provider within a few days after the paychecks have been distributed. There are huge penalties if you should fail to do so.So once your retirement plan is in place, be sure you’re familiar with all of its requirements and follow them religiously.
Once again, The Doctor’s Wealth Preservation Guide will be enormously helpful in helping you maximize your tax savings and your practice expense reduction, and don’t hesitate to contact our office if you have questions.
