Retirement Plans 101: What Dermatologists Need to Know

Many physicians identify their No. 1 financial goal as achieving a comfortable retirement on their terms.

For both practice owners and employed dermatologists, a qualified retirement plan (QRP) will likely be a fundamental factor in achieving retirement financial goals. This article provides an overview of QRP basics. For a more in-depth discussion, we encourage you to use the Dermatology Times code found at the end of this article to get a free copy of our latest book.

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Types of QRPs

There are 2 types of QRPs utilized in medical practices:

Defined contribution plans: These plans, such as 401(k)s or 403(b)s, allow participants to contribute a portion of their salary into individual accounts, with contributions often matched by the employer. One advantage of defined contribution plans is their flexibility, allowing participants to adjust contributions based on their financial situation and retirement goals. Additionally, these plans typically offer various investment options, empowering participants to tailor their portfolios to their risk tolerance and investment preferences.

Defined benefit plans: Alternatively known as pension plans, defined benefit plans promise a specific benefit upon retirement, typically based on salary and years of service. Although less common in the private sector than they once were, defined benefit plans can provide a predictable and secure source of retirement income, particularly for physicians who anticipate long careers with a single employer. These plans often appeal to employees seeking stability and guaranteed retirement benefits for long-term planning, but they may require significant employer contributions and can be complex to administer.

Example of a Defined Benefit Plan: Cash Balance Plan

A cash balance plan (CBP) is a type of defined benefit plan that combines several features of both defined benefit and defined contribution plans.

CBPs offer several advantages for both employers and employees. For employers, these plans provide greater flexibility in benefit design and funding requirements than traditional defined benefit plans. Employers can contribute a fixed percentage of each participant’s compensation annually, providing more predictability in retirement plan expenses and reducing the risk of large unfunded liabilities.

For employees, CBPs offer the security of a guaranteed retirement benefit, similar to traditional defined benefit plans, while also providing greater transparency and flexibility in retirement planning. Participants can track the growth of their hypothetical account balance over time and have the option to receive their benefit as a lump sum or as a lifetime annuity upon retirement, offering flexibility to meet their individual financial needs and preferences.

However, CBPs also have some drawbacks and intricacies to consider. Calculating benefits in a CBP can be more involved than in a traditional defined benefit plan, requiring careful consideration of factors such as interest crediting rates, vesting schedules, and distribution options. Additionally, the regulatory and compliance requirements for CBPs can be more stringent than those for defined contribution plans, requiring ongoing actuarial valuations and adherence to specific funding and nondiscrimination rules.

Despite these complexities, CBPs can be a valuable retirement savings vehicle for dermatologists seeking to maximize tax-deferred retirement savings while providing secure retirement benefits for themselves and their employees.

Potential Benefits of QRPs

A well-designed retirement plan offers numerous benefits, providing dermatologists with a solid foundation for their financial future.

• Tax-deductible contributions: Participants in traditional QRPs can fully deduct their contributions, reducing their taxable income and potentially lowering their current tax burden. This tax advantage allows physicians to maximize their retirement savings while minimizing their tax liability, effectively leveraging pretax dollars to fund their retirement accounts.
• Tax-deferred growth: Funds within the QRP grow tax-deferred, allowing for compounded growth over time. By deferring taxes until withdrawals are made in retirement, participants can harness the power of compound interest to accumulate wealth more rapidly, enhancing the long-term savings potential of their retirement accounts.
• Asset protection: If structured with formalities dictated by the Employee Retirement Income Security Act, QRPs often provide robust asset protection from liability threats. This shield against creditors can safeguard retirement savings from potential legal claims or financial setbacks, providing participants with greater peace of mind and security as they plan for retirement.

Potential Downsides of QRPs

Despite their advantages, QRPs have certain drawbacks and considerations that dermatologists should be aware of.

• Mandated contribution limits: Defined contribution plans have maximum annual contribution limits set by the Internal Revenue Service, potentially limiting the amount physicians can save annually. Although these limits are intended to prevent excessive tax benefits for higher-income individuals, they can constrain retirement savings for physicians with substantial earning potential or those looking to catch up on retirement savings later in their careers.
• Mandatory employee inclusion: Practice owners must include eligible employees who wish to participate in the retirement plan, which can increase administrative complexity and costs. This requirement may necessitate additional paperwork, compliance measures, and employer contributions, adding to the administrative burden for practice owners and potentially impacting the affordability and feasibility of offering a retirement plan.
• Management liability: There is potential liability for management of employee funds within the plan, introducing legal and fiduciary responsibilities. Practice owners who serve as plan administrators or trustees must adhere to strict fiduciary standards, ensuring that the retirement plan is managed prudently and in the best interests of plan participants. Failure to fulfill these duties can result in legal liability, penalties, and reputational damage for the practice owner.
• Regulatory restrictions: Controlled group and affiliated service group restrictions can limit the eligibility and scope of retirement plans for certain practices. These regulatory constraints aim to prevent abuse of retirement plan tax benefits by related businesses or entities, but they can complicate retirement planning for physicians with multiple practice locations, partnerships, or affiliations.

Withdrawal penalties and required distributions: Early withdrawals from retirement accounts before age 59.5 years incur penalties, and traditional plans mandate distributions starting at age 73 or 75 years, subjecting participants to taxation. These withdrawal penalties and required minimum distributions are designed to discourage premature depletion of retirement savings and ensure that participants use their accounts for the intended purpose of funding retirement.

Tax implications: Distributions from traditional plans are taxed as ordinary income, and upon death, plan balances may be subject to both income and estate taxation. Although QRPs offer valuable tax advantages during the accumulation phase, participants must eventually pay taxes on their withdrawals, potentially at a higher tax rate in retirement. Additionally, estate taxes may apply to retirement account balances passed on to heirs, reducing the after-tax value of the inheritance.

Conclusion

QRPs are popular tools for dermatologists to gain current tax deductions, achieve asset protection, and save to reach retirement goals. Nonetheless, they also have potential drawbacks, such as contribution limits, administrative burdens, and tax implications. By understanding the details of QRP options, dermatologists can make informed decisions tailored to their unique financial goals and circumstances.

David Mandell, JD, MBA, is an attorney and author of more than a dozen books for doctors. He is a partner in the wealth management firm OJM Group (www.ojmgroup.com).

Adam Braunscheidel, CFP, is a partner and wealth advisor. They can be reached at 877-656-4362 or mandell@ojmgroup.com.

Disclosure:

OJM Group, LLC, (“OJM”) is an SEC-registered investment adviser with its principal place of business in the state of Ohio. SEC registration does not constitute an endorsement of OJM by the SEC, nor does it indicate that OJM has attained a particular level of skill or ability. OJM and its representatives are in compliance with the current notice filing and registration requirements imposed upon registered investment advisers by those states in which OJM maintains clients. OJM may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration requirements. For information about OJM, please visit http:// or contact us at (877)-656-4362.

This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized legal or tax advice or as a recommendation of any particular security or strategy. Investment involves risk and possible loss of principal capital. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes frequently, accordingly, information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein.

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