What's new in retirement planning?

Defined benefit pension plans as well as cash balance plans are generating a lot of interest with medical practices, both large and small.

Medical practices find that these retirement plans are a great way to increase retirement savings and reduce taxes at the same time. As an additional benefit, the plans provide asset protection for doctors.

In addition to reducing income taxes, the significant contributions are a great way to catch up if you have not saved enough in the past or if your retirement account balances are down due to market losses during the recent economic turmoil.

Compared to 401(k)s and profit-sharing plans
In 2012, someone under age 50 can defer $17,000 into his or her 401(k) account. With matching and profit-sharing plan contributions, the total can be increased to $50,000. If the person is over 50, he or she can defer an additional $5,500.

In comparison, a doctor in his late 50s could contribute and deduct nearly $200,000 in a properly designed defined benefit or cash balance plan. This allows you to turbo-charge your retirement savings. You can accumulate upwards of $2.4 million in the plan at age 62.

“This could give you double the accumulation over what you would get saving outside a tax-qualified plan,” says Vince Spina, president of Harbridge Consulting Group of Syracuse, N.Y. “What if you were going to withdraw only the income? By saving in a tax-qualified plan, you could generate twice as much income. Sure, it would be taxable, but the income generated outside the qualified plan may be taxable as well. And the accumulation, and the resulting after-tax income, from outside the qualified plan would be only half as much.”

Company Name

ABC Company

First Plan Year End

12/31/2011

Normal Retirement

Age 62

Income Tax Rate

44.0%

Pension Formula

70.0%

Sex

Name

Age

Annual Salary

M

Dr. John Owner

51

$245,000

F

Jane Spouse

50

$25,000

F

Employee 1

28

$57,446

F

Employee 2

41

$47,262

F

Employee 3

48

$65,495

F

Employee 4

31

$83,655

F

Employee 5

28

$37,891

F

Employee 6

43

$34,453

F

Employee 7

24

$17,120

Exhibit 1

Defined Benefit PensionPlan with 401(k)
Profit Sharing Plan - Cross Tested Design

Participant Name

Plan Age

Ret Age

Total CB Plan Contrib

Total 401(k) Profit Sharing Contribution*

Grand Total Contribution

% of Total

Dr. John Owner

51

62

$139,000

$33,025

$172,025

72.07%

Jane Spouse

50

62

$18,825

$13,500

$32,325

13.54%

Sub-Total

$157,825

$46,525

$204,350

85.61%

Employee 1

28

62

$1,436

$4,308

$5,744

2.41%

Employee 2

41

62

$1,182

$3,545

$4,727

1.98%

Employee 3

48

62

$1,637

$4,912

$6,549

2.74%

Employee 4

31

62

$2,091

$6,274

$8,365

3.50%

Employee 5

28

62

$947

$2,842

$3,789

1.59%

Employee 6

43

62

$861

$2,584

$3,445

1.44%

Employee 7

24

62

$428

$1,284

$1,712

0.72%

TOTALS

$166,407

$72,274

$238,681

100%

Exhibit 2 *Combined plan tax deduction rules effectively limits employer contributions to defined contribution plan to 6 percent of total eligible payroll. To satisfy combined plan general nondiscrimination testing and other requirements, the exhibit shows employees receiving 3 percent safe harbor and 4.5 percent profit sharing, owner receiving 4.5 percent profit sharing and spouse receiving no profit sharing. Owner contribution also includes maximum 401(k) deferral of $16,500 plus $5,500 catch up contribution. Spouse contribution includes $8,000 401(k) deferral (subject to general nondiscrimination testing, assuming no employee deferrals) plus $5,500 catch-up contribution.

Pension Protection Act of 2006
Defined benefit and cash balance plans have become much more popular since the Pension Protection Act of 2006. The act did several things to make these plans more appealing. First, the act clarified the legality of cash balance plans. Second, the Pension Protection Act explained how a company, such as a medical practice, might be able to sponsor both a 401(k) profit-sharing and a defined benefit plan to take advantage of the unique characteristics of each and benefit from the combination of the two.

Third, the Pension Protection Act of 2006 explained how to cross-test the benefits from both types of plans and be able to weight the contributions more heavily toward the professionals/business owners if the demographics were right.

A sample case is provided showing a medical practice where a physician’s spouse is employed along with seven employees (Exhibit 1). When a defined benefit plan is added to an existing profit-sharing plan, contributions can be significantly increased, while keeping financial obligations to non-owner employees to a minimum (Exhibit 2). A comparison of “before and after” is provided to illustrate improvement of plan design from one year to the next (Exhibit 3).

ABC Company - Comparison of Plan Designs

Participant

Previous Year Design

Proposed New Design

Dr. John Owner

$49,000

$172,025

Jane Owner

$4,940

$32,325

Sub-Total

$53,940

$204,350

Employee 1

$5,745

$5,744

Employee 2

$3,781

$4,727

Employee 3

$5,240

$6,549

Employee 4

$6,692

$8,365

Employee 5

$3,031

$3,789

Employee 6

$2,756

$3,445

Employee 7

$1,370

$1,712

Sub-Total

$28,615

$34,331

Grand Totals

$82,555

$238,681

Increase in contribution to Dr. and Wife

$150,410

Increase in total contributions

$156,126

% of increase for Dr. and Wife

96.3%

Exhibit 3

Historically, defined benefit plans were thought to be fixed and inflexible. The Pension Protection Act brought with it a new funding method that gives rise to a range of funding options. The contributions in the range, from maximum to minimum, are all acceptable and income tax-deductible. With the proper plan design and this new funding method, there can be tremendous year-to-year funding flexibility.

As a result of these changes business owners, such as doctors, can now have larger retirement plan contributions that are income tax-deductible. The plan designs are doctor friendly, allowing a contribution level that fits the needs of the business. This increased funding flexibility can also allow more predictable contribution totals from year to year.

Another important change brought about by the Pension Protection Act is the inherited IRA. Prior to the act, in the event of a participant’s death, a spouse beneficiary could roll the account into his own IRA, stretch the benefits over his lifetime and pass them on to future generations which provided for the deferral of the income tax for possibly decades. If the beneficiary was a non-spouse, the taxation was either in the year of death or no later than the end of the fifth year following. Taking a lifetime of accumulations and taxing them over a short time was not a good result.

The Pension Protection Act changed this and allows a non-spouse beneficiary to receive this “inherited IRA” and stretch out the payments in a similar fashion to a spouse, putting non-spouse beneficiaries on a more equal footing. With a high rate of divorce or the possibility that your spouse might predecease you, this is an important change.

Conclusion
If you want to find out if a defined benefit pension plan or a combination of plans is right for you or if your current plan provides for an inherited IRA, call OJM Group and speak to one of its retirement plan specialists. You might be very surprised at how a few changes can enhance your retirement and income tax planning.

Terry Allman is a qualified plan expert at OJM Group where he also serves as co-director of Wealth Management. Jason O’Dell is a financial consultant, lecturer, and author of books for physicians and a principal of the financial consulting firm OJM Group, LLC where John Kelly is an investment adviser. They can be reached at 877-656-4362.