As you grow in your medical career, your income will rise and the need to plan for your financial future becomes even greater. If you’re considered self-employed or work as an independent contractor who receives 1099 income, you’ll need to decide the best type of retirement plan for your practice.
There are several options, but in deciding, you’ll need to consider how much you’re willing to contribute, whether you have employees and how much time and maintenance the plan requires. Here are four types of retirement plans for self-employed physicians:
SEP (Simplified Employee Pension) IRA
A SEP IRA is a type of traditional IRA that allows small business owners to save for retirement (read more technical details from the IRS here.) Contributions are tax deductible and grow tax deferred until needed in retirement, where all withdrawals are taxable as income. For 2016, the maximum contribution is 25% of net self-employment earnings or $53,000, whichever is less.
Pros: Setting up a SEP IRA is fairly simply and doesn’t require much paperwork and does not have annual filing requirements. The annual deadline to contribute to the plan is the business’s tax filing deadline.
Cons: This plan may work best for businesses with few employees. Only employers can contribute to the plan, and they must contribute the same percentage of salary for all eligible employees. However, you aren’t required to contribute to the plan each year, and you can change the amount you contribute from year to year.
SIMPLE IRA (Savings Incentive Match Plan for Employees)
A SIMPLE IRA is another type of traditional IRA that has lower maximum contribution limit than a SEP IRA (IRS details here). Unlike the SEP, you are able to contribute as an employer and an employee. For 2016, the limit for an employee contribution is equal to 100% of your net self-employment earnings, up to $12,500. You can make an additional employer contribution equal to 3% of your net self-employment earnings.
Pros: This plan is also fairly easy to set up, and there are no annual filing requirements. A SIMPLE IRA is largely funded by employee contributions though limited employer contributions are required.
Cons: Employer contributions of up to 3% of an employee’s pay are required even if your practice has a bad year financially. You could also face stiff penalties if you need to rollover the account within 2 years of opening the plan. The contribution limit of $12,500 plus the 3% employer contribution is much lower than the SEP IRA limit, so it could be a good choice for a small medical practice with employees.
A solo 401(k) is for a solo practitioner with no employees, though a spouse who earns income from the business can be included (IRS details here). The maximum employee contribution for 2016 and 2017 is $18,000 ($24,000 if you are age 50 or older). Additionally, you can contribute up to 20% of your net self-employment income as an employer with the maximum contribution as an employee and employer cannot exceed $53,000 ($59,000 if you are age 50 or older).
Pros: The high contribution limits can make this type of plan attractive to the self-employed physician with no employees. A solo 401(k) plan is not required to perform nondiscrimination testing, and provides flexible funding contributions year on year. (Nondiscrimination testing is a requirement of large 401(k) plans to ensure that they do not favor highly compensated employees).
Cons: A solo 401(k) can be more complicated to set up than a SIMPLE or SEP IRA, and likely to cost more in administrative and maintenance fees. Once a plan has $250,000 or more in assets, you are required to file form 5500 annually which adds to your annual tax burden.
A defined-benefit plan is a pension plan that guarantees a certain level of income or lump sum payout when you retire (IRS details here), so it’s not designed around the amount you contribute, but around how much of a benefit you’d like to receive. Each year an actuary must calculate the amount that needs be contributed to the plan in order to achieve a future payout.
Pros: Contribution limits are high. For 2016, the maximum annual benefit is $210,000, which means you may contribute more than this amount to meet the funding requirements. This can lead to significant deferral of income for high-earning doctors and substantial income tax savings.
The ability to receive a stable income in retirement that is not dependent on market performance is another attractive feature of a defined-benefit plan. Some plans also allow the feature of being rolled over to an IRA at some point in the future, allowing for these funds to be invested as well. This type of plan may work well for a small medical practice with a consistently high level of income.
Cons: A defined-benefit plan can be very expensive to establish and maintain and has to be funded each year. You also have to offer the plan to employees so it can get expensive for larger practices.
Planning for retirement is crucial, but deciding which retirement plan to establish for you and your business can be cumbersome. It’s crucial that you talk to a tax professional about the tax implications of your retirement plan as well as consulting with a financial planner to determine how much you need to save for retirement. Whichever retirement plan you decide establish, the most important thing is that you start saving for the future now.