Tax Qualified Retirement Plan Alternatives
By Michael W. Blitstein, CPA
As a business person, one of your goals is probably to ensure a comfortable, financially secure retirement. Maybe, up until now, you have been making IRA contributions. That's a good start, but you can do a lot better with a qualified retirement plan. These plans allow you to make much larger tax deductible contributions than you can with an IRA. And like an IRA, the contributions earn tax deferred income - you don't owe tax until you take distributions from the plan. Tax-qualified retirement plans are typically thought of as being either "defined contribution" plans or "defined benefit" plans.
Defined Contribution Plans
The most basic type of defined contribution plan is the profit sharing plan. Under this type of plan, the practice sponsoring the plan makes a contribution in an amount either set forth in the plan document or as determined by the practice owner(s) for the year. This contribution is allocated among plan participants in the manner described in the plan document - generally, in proportion to the amount of compensation earned by the participant.
The most common retirement plan is a form of profit sharing plan, the 401(k) plan. Under this type of plan, participants elect the amount they wish to contribute to the plan on their behalf for the year, subject to various limitations. These amounts are contributed on a pre-tax basis, with the employee being taxable when amounts are distributed. Under defined contribution plans there are general restrictions on distributions being made before the participant has a severance from employment, attains age 59½, dies, or becomes disabled.
The maximum amount that can be deferred under a 401(k) provision for 2014 is $17,500, with participants who are at least 50 years old during the year able to contribute an additional $5,500.
The maximum total amount allocable to a participant's account for 2014 is the lesser of $52,000 or 100% of the participant's compensation for the year. The maximum amount of compensation that can be taken into account in determining a participant's contributions or benefits for a 2014 plan year is $260,000.
Defined contribution plans are subject to requirements prohibiting discrimination in favor of “highly compensated” employees. A plan can be structured to satisfy these tests automatically on the basis of a "safe harbor" that requires a certain rate of non-elective or matching contribution to be made.
Tax qualification rules require that contributions made on behalf of participants be fully vested either within six years based on a graded schedule or three years if a cliff schedule is applied. In any event, a participant must always be fully vested in the portion of his or her account balance attributable to elective deferrals.
Defined Benefit Plans
Under a traditional defined benefit plan, a participant is generally entitled to a specified benefit at retirement. The benefit is typically based on a formula that takes into account the participant's compensation and number of years of service.
A different type of defined benefit plan is known as a "cash balance" plan. Under such a plan, the practice promises to contribute a certain amount each year to an account maintained on behalf of each participant. This account is then credited each year with a specified "earnings" credit. The amount ultimately payable to the participant is defined by the amount the plan specifies as the earnings credit.
The amount deductible by an employer for any year with respect to a defined benefit plan is the amount actually contributed by the employer to the plan, which amount is based on the calculations of an actuary, made by applying provisions of the plan.
What type of plan is best for me? Practices considering the creation of a qualified plan should consider the following factors when selecting between the plan categories:
Defined Contribution Plans
• Generally best suited for practices who want flexibility in determining their annual contribution requirement.
• Desirable to practices who do not want to bear the risk of the investment performance of plan assets.
• The 401(k) features are particularly useful for practices who want to reduce cost and/or make employees responsible for some or all of their saving for retirement.
• Matching and/or non-elective contributions allow practice owners to protect more from current taxes.
Defined Benefit Plans
• Generally far less prevalent than defined contribution plans, with the majority of new defined benefit plans being implemented by small practices.
• Desirable to practice owners who want to make larger contributions and derive greater retirement benefits than are available under a defined contribution plan.
• Generally produces a greater contribution deduction, thereby increasing a doctor’s deduction.
• Cash balance plans are typically favored by practices who want to provide greater benefits than are available under defined contribution plans.
• Because of the manner in which a participant's benefit accrues under a cash balance plan, this plan makes pension costs more predictable and easier to control than under a traditional defined benefit plan.
• Cash balance plans require a practice to have more stable cash flows than do defined contribution plans, because the contributions to the cash balance plan are mandatory, whereas those to a defined contribution plan are generally discretionary.
Planning for retirement is an essential part of sound financial planning. A plan usually can be designed to provide doctors the benefits they desire while keeping overall plan costs at a tolerable level. Having a company retirement plan also has many intangible benefits. It's easier to recruit and retain a quality staff if the practice has a retirement plan. Whether or not to go with a plan, and if so, what kind, requires an analysis of many factors. Having the counsel of an experienced professional is the best way to start.
Michael W. Blitstein, CPA is a partner with the firm of CJBS, LLC, in Northbrook, Illinois. For more than 30 years, Michael has worked closely with the dental community and is intimately familiar with the unique professional and regulatory challenges of creating, running and maintaining a successful dental practice. Michael advises his clients on tax, business and retirement planning, developing short and long-term strategic plans designed to achieve success for dental practice principals and their businesses.
He can be reached at firstname.lastname@example.org
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