Timothy J. McNeely, CFP, CIMA
Unfortunately, most dental professionals don’t have a defined benefit plan in place, yet it’s one of the most powerful wealth management strategies for avoiding tax exposure.
The age-old maxim that the only certainties in life are “death and taxes” is absolutely true, but it really only tells part of the story. While everyone faces the same fate of passing on from this world, the degree of impact taxation has on us depends greatly upon income and wealth. The fact is that the greater your personal success, the bigger a bite Uncle Sam wants to take from your hide.
Dental professionals with strong revenue flowing into their practices, and consequently higher-than-average personal income, obviously should take this issue seriously. As a wealth manager who works with dentists, it’s become clear to me that one of the biggest challenges of accumulating personal wealth is exposure to taxes. In fact, minimizing taxes is the second most pressing area of financial concern for successful dentists.
It’s also been my experience that dentists who do wisely shelter their income from avoidable taxes are more likely to be motivated by unselfish, altruistic goals than simply seeking a higher net worth. In research I’ve help underwrite, we found that a large percentage of dentists strive to minimize taxes and build wealth outside their dental practices so they can take care of the people they love and better support the causes they care about. In other words, dentists who are passionate about their profession are often driven to excel in their personal lives and as good citizens contributing to society. Maximizing personal wealth and minimizing taxes can help them and you accomplish these worthwhile aspirations.
The appeal of the defined benefit plan
Also known as pension plans or qualified benefit plans, defined benefit plans provide a fixed, pre-established benefit for employees upon retirement. For this reason, the way a defined benefit plan works and the advantages it provides set it aside from other plans. It may hold great appeal to you as the owner of a successful practice because you can contribute and deduct more than other programs, such as what is possible under the defined contribution 401(k) profit sharing plan.
Many employees like the predictability of the benefits they will receive, and you’ll notice how impressively large benefits can be accrued quickly. However, once the benefits are locked in, you cannot retroactively decrease them for any reason. On the downside, the effort and costs associated with establishing and maintaining a defined benefit plan are worth considering carefully. For example, you will need to hire an enrolled actuary to determine the funding levels and to sign the annually filed Schedule B when included with your tax return. Furthermore, because the employer (you) is guiding the investment decisions of the plan, you assume all the investment risk. You will most likely want to ensure that a financial advisor or wealth management professional works with you in structuring, rolling out, and administering the plan.
Many employees like the predictability of the benefits they will receive, and you’ll notice how impressively large benefits can be accrued quickly.
Once instituted, many businesses leverage their defined benefit plans to attract top-notch talent by making subsidized early retirement benefits part of the compensation package. There is considerable flexibility in scheduling the vesting of the defined benefit plan, from immediate full vesting to a period of up to seven years. Also note that the IRS will levy an excise tax if the minimum contribution requirements are not met and, conversely, if excess contributions are made.
Two partners in a successful dental practice decide they’d like to maximize the contributions they can make toward their retirement. They also want to continue providing retirement benefits to their four employees. After reviewing a traditional defined-benefit retirement plan on top of a 401(k) with a profit-sharing option, they discover that they and their employees together can reach a cap after contributing a maximum of $397,926 in the first year, resulting in tax savings of $198,963. Of the total contribution, 79% would be made by the business owners.
Not satisfied with this level of contributions and tax savings, the partners instead chose to use a benefit-focused defined-benefit retirement plan along with the 401(k) with the profit-sharing component. Under this plan, their contributions and resulting tax savings would be far higher. They and their employees could make a total contribution of $1,143,556 in the first year (with 85% coming from the practice owners), resulting in $571,778 in tax savings.
Their choice of a benefit-focused defined-benefit retirement plan was also effective in locking in advantages beyond the amount of their contributions and tax savings. Because the plan includes life insurance as part of its funding mechanism, not only do the owners benefit by getting life insurance using pretax dollars, but the proceeds of the insurance when they die are income tax free, and can even be estate tax free. This will help the practice owners with both their succession and their estate planning.
If you truly are committed to maximizing your personal wealth outside your business, it’s essential you find and work with a high-caliber wealth manager. The good news is that we’ve noticed that many successful dentists do a good job recognizing when something feels wrong—or at least not quite right—about the professionals with whom they are working.
One of the best ways to deal with a possibly economically destructive situation in which you’re just not completely sure or you feel a little uncertain is to get a second opinion—either about your current financial situation and how it is being managed, or about a particular strategy or product you are considering.
Not only can it be a wise move to get a second opinion before acting, but it’s probably also a wise move to go this route even if you have taken action already and you are a little bit unsure and anxious. This gives you the opportunity to correct mistakes or use solutions and products that can do a lot more to help you accomplish your goals. Simply put, second opinions often make a lot of sense.
Timothy J. McNeely, CFP, CIMA, is CEO of the LifeStone Companies. He has found that most dentists are unsure whether they are getting financial advice that actually makes a difference. He has helped hundreds of dentists implement a wealth management process that has assisted them in making progress toward their most important goals. He can help you achieve all that is important to you at Lifestonewm.com or firstname.lastname@example.org.