This question appeared in March 2002 Dental Economics' "Tax Q&A" column: Recently, I read that retirement-plan rules are changing and that in 2002 a participant can make an annual tax-deductible contribution of the lesser of 100 percent of pay or $40,000. However, I also read that the limit on employee deferrals into a 401(k) profit sharing plan is rising from $10,500 to $11,000 in 2002. Why can't contributions of up to $40,000 be made to a 401(k) profit sharing plan?
Dr. Charles Blair and John McGill correctly say that employees can defer up to $11,000 by salary deferral. After reading this question, Stu Sinclair, CPA, asked me if the 401(k) profit sharing plan limit is the lesser of $40,000 or 100 percent of pay. Since many readers are employers and businessmen, I would like to expand upon the authors' response.
A dentist who is also an employer can make both 401(k) contributions and discretionary profit sharing contributions to a 401(k) profit sharing plan. Three limits apply:
- The 401(k) contribution cannot exceed $11,000;
- The contribution allocated to a participant, including his 401(k) contribution, cannot exceed the lesser of $40,000 or 100 percent of his compensation;
- The total profit sharing contribution for the plan, excluding 401(k) contributions, cannot exceed 25 percent of the compensation of all participants.
Consider a dentist who runs his practice and sponsors a 401(k) plan. As an "employee," he can contribute up to $11,000 to the 401(k) part of the plan. The dentist also can make an additional profit sharing contribution. Assuming that our dentist has no employees, with $40,000 of compensation, he could contribute up to $21,000 - $11,000 401(k) plus $10,000 profit sharing (25 percent of the total of all participants' compensation of $40,000) - to a 401(k) profit sharing plan. A similarly situated dentist with a compensation of $116,000 will be able to contribute $40,000 - $11,000 401(k) plus $29,000 profit sharing (25 percent of $116,000).
For dentists who are in their mid-40s and older, contributions greater than $40,000 can be obtained by using a Defined Benefit Pension Plan.
Benjamin E. Feller, FSA, BA
President, PRS Administrative, Consulting, & Actuarial Services
Response from the author
Our prior question and answer correctly pointed out that doctors cannot receive the maximum annual contribution allocation of $40,000 solely by making salary deferrals or deferrals from their salary into a 401(k) profit sharing plan, since these are governed by a lower limit ($11,000 maximum in 2002). However, Mr. Feller correctly points out that doctors operating a 401(k) profit sharing plan who have sufficiently high compensation can reach the $40,000 maximum limit through matching and/or profit sharing contributions to their 401(k) plan, in addition to the salary deferrals.
We will be publishing an article describing retirement funding for the newly expanded tax-deductible retirement-funding options in more detail in the near future.
John McGill, MBA, CPA, JD
Blair/McGill and Company