Reduce tax increases with increased retirement plan funding

By John K. McGill, CPA, JD, and Jason Arnold, QKA

The eleventh-hour compromise by Congress to avoid the fiscal cliff resulted in considerable tax hikes for high-income doctors. Luckily, most doctors can counterbalance some or all of the increased taxes through boosting retirement plan contributions to provide excellent tax savings. Increasing tax-deductible retirement plan funding reduces the federal and state income taxes paid at the doctor's highest marginal tax rate. Furthermore, contributions to retirement plan accounts, and withdrawals from plans, are not subject to the new 3.8% Medicare payroll tax on personal investment income. Finally, maximizing contributions in a retirement plan can in some cases reduce the doctor's taxable income below new tax hike levels.

Along with the benefit of immediate tax savings, retirement plan funding is an excellent wealth building tool, since accumulations in retirement plans and IRAs have a huge impact in helping a majority of doctors reach financial independence. Not only do the tax savings help, but investment returns are usually higher in retirement plans since the majority of funds within retirement plans are typically invested and professionally managed at much higher returns.

While most of the news is negative for high income individuals, some of the change is positive, including increased tax-deductible retirement plan contribution limits for 2013. Doctors sponsoring 401(k) profit sharing plans or other forms of defined contribution plans (money purchase pension, profit sharing, SEP-IRA, etc.) can achieve a maximum tax-deductible contribution (including salary deferrals) of $51,000, up from $50,000 in 2012. Doctors age 50 or older participating in a 401(k) plan can make an additional $5,500 "catch up" salary deferral to reach a maximum contribution level of $56,500. Doctors should maintain a salary of at least $255,000, up from $250,000 in 2012, in order to reach those contribution levels while minimizing staff costs.

To reap both the tax and non-tax benefits, the doctor participating in a defined contribution plan may also employ his or her spouse through the practice. Doctors sponsoring 401(k) profit sharing plans should generally employ their spouse at a salary of $19,000 ($25,000 if 50 or older) in order to provide the maximum possible salary deferral of $17,500 ($23,000 if 50 or older) while minimizing payroll taxes. Doctors should double check with their retirement plan provider to make sure that nondiscrimination testing will still pass with the spouse deferring at this level.

Moreover, if there is at least a 20-year age difference between the average age of the staff and the spouse, many times it's possible to gain a tax-deductible contribution of $56,500 on behalf of the spouse age 50 or older ($23,000 salary deferral + $33,500 profit sharing contribution), if the spouse's salary is increased to $51,000. While this result is subject to nondiscrimination testing, many doctors have achieved an excellent result.

Doctors wishing to make considerably higher retirement plan contributions than the amounts allowed for defined plans may fund a defined benefit or cash balance pension plan. These types of retirement plans are attractive options for many doctors since the contribution is determined by the promised benefit at retirement age and is not limited to a dollar amount like defined contribution plans. As a result, a defined benefit or cash balance pension plan should allow for much higher contributions and result in a dramatic tax savings.

Given the difficult economy, the uncertainty of the future of dentistry, and the possibility of tax reform limiting doctors' future retirement plan contributions, doctors should make a supreme effort in 2013 to maximize retirement plan funding to dramatically reduce their tax burden.

John McGill provides tax and business planning exclusively for the dental profession and publishes The McGill Advisory newsletter through John K. McGill & Company, Inc., a member of the McGill & Hill Group, LLC. Jason Arnold provides retirement plan design and administration services through PenSys, Inc., an affiliate of the McGill & Hill Group, a one-stop resource for tax and business planning, practice transition, legal, retirement plan administration, CPA, and investment advisory services. Visit www.mcgillhillgroup.com for more information.