New Retirement Territory
Could there be retirement options you
don’t know about?
Explore the advantages of non-qualified and non-traditional
benefit plans.
Explore the advantages of non-qualified and non-traditional
benefit plans.
Believe it or not, two doctors of the same
specialty with similar incomes can have very different income
levels in retirement. There can be many reasons for this, but
three important causes of reduced retirement savings are:
• A devastating incident, such
as a lost lawsuit or costly divorce
• Poor investment, perhaps a
bad limited partnership, medical center, or real estate venture
• Lack of attention to taxes
Fortunately,
“qualified,” “non-qualified,” and
“non-traditional” planning can help you address
these three challenges in significant ways. Unfortunately, most
physicians only utilize traditional “qualified”
retirement plans, such as pensions and 401(k)s, which are
restrictive and burdensome. Most physicians ignore the more
flexible non-qualified deferred compensation (NQDC) plans and,
to an even greater degree, miss out on non-traditional benefit
plans.
Retirement plans
generally fall into one of four categories:
1. Qualified Plans
The term “qualified plan” (QP)
means that the retirement plan complies with Department of
Labor and Internal Revenue Service rules created under the Employee Retirement and Income Security Act
of 1974 (ERISA). These
plans may be in the form of a defined benefit plan, profit
sharing plan, money purchase plan, 401(k), or 403(b). Properly
structured plans offer a variety of benefits: You can
fully deduct contributions to a QP, funds within the QP grow
tax-deferred, and (if non-owner employees participate) the
funds within a QP enjoy superior asset protection. Despite the
benefits QPs can offer, there are a host of disadvantages that
physicians must understand:
• Limits on annual
contributions for defined contribution plans ($41,000 for
pensions and profit-sharing plans, $14,000 for 401(k) plans)
• Mandatory inclusion of all
eligible employees
• Potential liability for
mismanagement of employee funds in the plan
• Control group and affiliated
service group restrictions
• Penalties for withdrawal
prior to age 59 1/2
• Required distributions
beginning at age 70 1/2
• Full ordinary income taxation
of distributions from the plan
• Full ordinary income taxation
AND estate taxation of plan balances when you die (combined tax
rates on these balances can be over 70 percent)
Despite these numerous
disadvantages, nearly all physicians in the U.S. participate in
QPs. The tax deduction is a strong lure, and often it cannot be
resisted. For some doctors, this makes sense. But for many, the
cost of contributions for employees, potential liability for
mismanagement of employee funds, and the ultimate tax costs on
distributions to you and your family may outweigh the current
tax savings offered by QPs. Tax and business-savvy physicians
may find asset-protected after-tax investments more valuable
and flexible to their overall wealth-protection plans. This is
just another example of what we call “LCD
planning”—lowest common denominator
planning—that everyone seems to do, without a
sophisticated analysis of all the available options.
2. SEP-IRAs
Although SEP-IRAs are not officially QPs,
(they are custodial accounts) in many ways, they are similar.
You have the same restrictions on annual contribution amounts,
penalties for early withdrawals, mandatory withdrawal rules,
and taxation on distributions and plan balances at death as you
have with a QP. One big difference is that a SEP-IRA may not
enjoy the same level of asset protection as a QP does. The
protection is not federally mandated, but rather handled on a
state-by-state basis. For these reasons, a SEP-IRA is
financially equivalent to a QP, but may be less protected.
3. Non-Qualified Deferred
Compensation (NQDC)
Non-qualified plans are relatively unknown
to physicians, despite the fact that most Fortune 1000
companies make non-qualified plans available to their
executives. While many of these plans in public companies
involve company stock or stock options (which, of course, do
not work in a medical practice environment), many use
structures that a physician certainly could easily employ in a
practice.
Although NQDC plans
are not subject to the ultra-onerous qualified plan regulations
described above, they are subject to some government rules. In
fact, Congress recently passed legislation that further
regulates NQDC plans. However, these plans are still attractive
for many physicians when compared to a traditional qualified
plan pension or SEP-IRA. The benefits of NQDC plans for
physicians include:
• More generous contribution
limits
• No mandatory participation by
employees (you can choose who is offered participation and who
is not)
• No control group and
affiliated service group restrictions
• No penalties for withdrawal
prior to age 59 1/2
• No required distributions
beginning at age 70 1/2
One of the main drawbacks of NQDC plans is
that the assets in the plan are subject to the claims of the
company’s (or medical practice’s) creditors. For
this reason, many physicians looking for more flexible planning
structures as well as asset protection, look outside the
qualified and non-qualified planning options to non-traditional
plans that offer benefits for the physician in retirement.
4. Non-Traditional Executive Benefit
Plans (NT Plans)
As the word “non-traditional”
implies, these are plans that sit outside the regulations
pertaining to qualified and NQDC plans. In this way, options
that exist vary greatly in structure and can be tailored to
meet the physicians’ individual goals. There are many
types of NT plans available, and we have outlined a couple of
options below. As a rule, these plans have all of the benefits
of a NQDC plan, plus the following:
• No mandated maximum annual
contributions
• Can be structured to be both
income tax and estate tax-efficient
Types of NT Plans
While we will discuss only a couple of
popular types of NT plans, it may generate more ideas about how
NT plans may play a role in your overall financial plan.
4 Compliant
Split Dollar Plans
Split dollar plans have been the primary
type of NT plans in the corporate work place for the last 40
years. Over the last three years, however, the IRS has changed
the rules significantly regarding split dollar plans.
Unfortunately, many advisers who do not practice in this area
on a daily basis operate under the misconception that split
dollar plans are now “dead.” Nothing could be
further from the truth. A compliant split-dollar plan is one
where the business transfers or loans funds to the key
executive(s) for purchase of a life insurance policy whose cash
values accumulate tax free. In most plans, the executive is
able to use these cash values during retirement and the company
is paid back its investment from the life policy death benefit.
Under the new rules,
it is certainly more difficult to implement a split dollar plan
for public companies. However, for private businesses,
including all medical practices, split dollar plans can still
be a viable option. In fact, given the low interest rate
environment that we currently enjoy, now is a perfect time to
implement a split dollar plan for a medical practice.
Physicians can take advantage of this low interest rate (which
affects the tax treatment of the structure) and enjoy
significant retirement wealth accumulation without offering it
to any employees. These types of plans can be structured to
handle many of the buy-out/buy-in issues between the younger
and older partners in a practice. If you want to have more
income in retirement and explore tax-efficient ways to
transition ownership of a practice, we highly recommend that
you look into the option of a compliant split dollar NT plan
before the interest rates change.
4 Asset
Protection NT Plans
In many circumstances, the central goal of
an NT plan may be protection of the practice’s assets. A
mistake by one of your partners or employees could cause a
lawsuit that would decimate all of your practice’s real
estate, equipment, and accounts receivable. The solution to
this concern can also offer substantial retirement and tax
benefits.
The most popular
solutions to this problem are those that protect the
practice’s accounts receivable (AR). However, in this
type of NT plan it is crucial that both asset protection and
tax issues be properly negotiated. In 90 percent of the plans
that we have reviewed, there are significant pitfalls lurking.
(See “Receivables at Risk” in the July/August 2003
issue of UO for more details on protecting your
practice’s accounts receivable. at www.uoworks.com)
4 Financed
NT Plans
Financed NT plans, when properly
structured, can provide the greatest after-tax investment
return to the physicians participating. Because an outside
lender puts up the initial capital to fund the plan, but takes
back a fixed return, the physicians gain the use of OPM (other
people’s money) compounded on a tax-deferred basis.
Further, the plans are typically structured for substantial
asset protection against the creditors of both the medical
practice and the individual physicians.
Every successful physician
should consider a NQDC and/or NT plan. Qualified Plans are
burdened with a host of restrictions, costs, and tax
limitations. This often makes them extremely expensive for the
physicians and does not allow for significant retirement wealth
accumulation. NQDC plans have much fewer restrictions and,
therefore, are relatively inexpensive to implement. NT plans
are the most flexible, provide asset protection, and can
provide the best return for physician participants. g
David
B. Mandell, JD, MBA is an
attorney, lecturer, and author of the book Wealth Protection: Build and Preserve Your
Financial Fortress. He is also
a co-founder of The
Wealth Protection Alliance, a
nationwide network of independent financial advisory firms. H.
Ryan Coker, CLU, ChFC, AEP is a principal of
The Benefit Company, in Atlanta, GA and provides business planning to physicians and corporations
nationwide. Reach him at 1-800-554-7233.
The Benefit Company, in Atlanta, GA and provides business planning to physicians and corporations
nationwide. Reach him at 1-800-554-7233.
