Retirement plan dollars for you

March 21, 2012

Many dentists know there are different types of retirement plans available for their dental practices but have been stymied with the contribution levels allocated to the owner or key employees compared to amounts available for the employees.

Many dentists know there are different types of retirement plans available for their dental practices but have been stymied with the contribution levels allocated to the owner or key employees compared to amounts available for the employees.

The 401k, Simple IRA and retirement plans such as these have limits on the contributions paid into these plans whether through deferral or employer matching. The Internal Revenue Service defines the amount available for each employee, including what can be deducted and paid into the account for these plans. For a dental practice with high earnings and the high tax burden for the owner of the practice, these types of plans do not allow the large deferral that is attractive to the dentist. There are not many advisors to dental practices who know or understand the type of employer qualified retirement plans that are available that can defer amounts commensurate with the high earning dentist’ wishes.

What are these?

The highest amount of contribution required, in most cases, in an employer qualified retirement plan is found in a defined benefit plan. These are owner friendly in the sense that they allow a contribution in an amount of approximately $150,000 or more per year and that amount can be allocated primarily to the owner of the dental practice. Compared to a 401k where the deferral can not exceed $16,500 plus an additional $5,500 based on a catch-up provision based on the employee’s age, the defined benefit plan is many times that of a 401k contribution.

The Simple IRA deferral of $11,500 is even less attractive to a high end dental practice’s wish to fund a defined benefit plan. This plan formula and concepts are different from other plans, known as defined contribution plans. In a defined contribution plan like a 401k, Simple IRA or profit sharing plan, the amount of money allowed to be paid into the plan to defer taxable income is primarily fixed. The upper limits of deferral are set. The employee and employer are not allowed to pay more into the defined contribution plan that the amount approved by the Internal Revenue Service .The distribution of benefits to the participant at retirement are based on the amount of money contributed to the plan with their annual relatively low upper limits and the earnings accumulated in the plan based on those contributions.

Benefit plan formulas, concepts

The difference in determining the distribution at retirement for those employees, when adopting a defined benefit plan, compared to the defined contribution plan(s) such as 401k, Simple IRA and profit sharing plan, comes from the defined benefit plan distributions being based on a predetermined stated amount due to the retiree. The defined benefit plan document that states a benefit to be paid based on a formula calculated as an exact dollar amount, a percentage of employee’s compensation or an amount per year of service or similar type of guideline method.

The annual deductible contributions are determined based on what is needed to pay the retiree at the normal retirement age defined in the plan document. In this type of plan, the formula also includes provisions for determining the rate of return required to ensure the funding requirement for retirees is met. Age is a determinant because the formula is a guarantee that if someone is admitted into the plan at age sixty, for example, and the normal retirement age defined by the plan document is age sixty five, the employer has just five years to fund the retirement benefit for that employee, who is typically the owner.

An example of how it can work

Using the above example, and assuming the dental practice has excellent earnings, the owner and his or her advisor design customized documents for submission to the Internal Revenue Service -stating that participants are to receive a benefit equal to $150,000 per year based on a salary or earnings on a pro rata basis of their current earnings compared to the $150,000 benefit. The benefit is to be paid for a guaranteed term, that in this example, will give the employee (owner) $150,000 per year until age 80. Since the owner is now 60, and the contributions will stop at age 65 because that is the normal retirement age defined by the retirement plan document, the dental practice has five years to fund a benefit that will be $150,000 per year for 15 years ( age 65 to age 80 ). Fifteen years at $150,000 per year equals $2,250,000. That means that the dental practice must contribute on a pretax basis, an amount each year to guarantee that $150,000 per year distribution will be paid and that whatever that amount needs to be will have accumulated in the defined benefit plan for the owner. There are many twists and turns along the way and the projected earnings in the plan also contribute to the   funds available for distribution.

More on defined benefit plans

Remember the twists and turns. There are many things to consider when implementing a defined benefit plan. Here are some important points:
1. A multi practice situation will probably not work because costs for all the employees who need to be included in the plan would most likely be prohibitive.
2. The plans are designed where the older employees could create extra costs for the owner who is also at least approximately fifty years old.
3. The plan designs are very complex and usually cost much more than the defined contribution plans to customize and to administrate on an annual basis.
4. There is a minimum contribution that is required each year.
5. A minimum three to five year period of funding is needed to assure compliance with the department of labor guidelines and with the Internal Revenue Service.

The upside components are that the contribution level is high, the pre tax savings are enormous and if your practice has high earnings and can afford this type of plan, your retirement years are guaranteed to exist with a level of spending similar to what was enjoyed during your working years.