Retirement plans: six ways to reduce staff funding costs
Reduce the cost of staff funding while maintaining a satisfactory level of contributions for their benefit.
Reduce the cost of staff funding while maintaining a satisfactory level of contributions for their benefit.
John McGill, MBA, CPA, JD
The 1993 Tax Act reduced the maximum compensation that could be taken into account for retirement-plan purposes from over $235,000 to just $150,000. As a result, practitioners seeking to receive the maximum annual allocation of $30,000 to their accounts had to significantly increase their contribution percentage. This led to a dramatic increase in the contributions for rank-and-file staff members, with some practices reporting an increase of 30-50 percent or more. Here are six ways doctors can reduce these growing staff-funding costs.
Most advisers say that retirement-plan funding is not economically worthwhile for a doctor-owner unless at least 60 percent of the total amounts contributed go to the doctor`s own account. If more than 40 percent benefits the non-owners, instead, it may be better from a financial standpoint to take the full amount as a bonus, despite the taxes that are immediately imposed. As a result of the recent law changes, staff costs have risen to the point that the economic viability of continued plan funding has been threatened.
And, yet, retirement funding is a critical part of the doctor`s overall personal financial planning. The simple solution of terminating a pension or profit-sharing plan, or just of reducing the contribution level for everyone, including themselves, is usually not a desirable one. What the doctors and their advisers seek is a way to reduce the cost of staff funding while still maintaining a satisfactory level of contributions for their own benefit.
Six Cost-Saving Strategies
At a recent seminar, Joe Davis, president of Advanced Pension Systems, Inc., outlined six ways to reduce staff-funding costs, while continuing to fund the doctor`s account at the maximum level, usually $30,000. While each strategy will not apply to every practice, consider which of them will work for you.
1. Integrate your plan with Social Security. IRS regulations allow an employer to take credit, in effect, for the Social Security (FICA) taxes it pays on each employee`s wages when determining pension contributions or benefits, said Davis. Since those taxes are considered a contribution to the government-run pension program, stop at a moderate pay level ($62,700 for 1996), salaries over that figure can receive a somewhat-larger contribution than those below it. Hopefully, your plan (but only one plan, by IRS rules) is integrated already. If not, amending to provide for it boosts your contribution percentage by upwards of six or seven percentage points vs. that for your lower-paid staff.
2. Check your waiting period, vesting schedule and allocation requirements. Many plans cover employees almost immediately upon hiring, but you may provide for a one-year eligibility period (including until the next semiannual "entry date"). Perhaps, better yet, you can exclude all new employees until they have been employed at least two years. The trade-off: a two-year waiting period requires immediate "full vesting" of contributions for each participating employee, while a one-year wait allows a vesting schedule over as many as six years.
Evaluate which approach suits your circumstances best. We`ve seen many practices save thousands of dollars annually by changing to the other waiting-period/vesting schedule. The decision is particularly important if you`re hiring highly-paid employees like new doctors, hygienists, technicians or office managers, says Davis. Determining which approach is right for your practice is a function of employee salaries, loyalty and the average length of service (turnover).
2 (b) Use the last day and 1,000 hours accrual requirement. Another effective tool to reduce staff costs is to restrict contributions to only those participants who work at least 1,000 hours during a plan year and who are employed in the practice at year-end. The IRS allows doctors to use this cost-saving strategy, but only to the extent that 70 percent of eligible staff working at least 500 hours during the plan year actually benefit under the plan.
Once an employee has been terminated, there`s little sense in having to make additional contributions on his/her be-half, said Davis. Having this provision can save thousands of dollars each time an employee terminates.
3. Adopt (or convert) to a 401(k) plan. This is a form of tax-qualified, profit-sharing plan under which each employee can designate part of his or her salary as a tax-deductible retirement contribution. To the extent your staff contributes, the payments come out of these workers` pay rather than from your practice. The practice may, in turn, match the deferrals in whole or in part, in order to encourage participation. If your plan calls for such matching contributions, you can increase funding for your own (doctor-owner`s) account since you`ll probably elect to reduce your salary more than your employees will.
However, a 401(k) plan is not as great a panacea as it may appear, says Davis. You can only permit employees deferrals up to $9,500 during 1996, and there are difficult limits on what the doctors may contribute if the lower-paid staff don`t pay much into the plan. Plus, these plans require fairly complex record-keeping and administration.
Strongly consider adopting a 401(k) plan or amending your existing profit-sharing plan into that format. A popular approach has been to have an integrated pension plan along with a 401(k) plan on top of that. It`s probably worth the fees to have your pension advisers evaluate that possibility, as well.
4. Adopt a "defined benefit" pension plan. These plans are highly complex for smaller employers, but they provide a hugh advantage. Contributions are based on age as well as compensation, resulting in larger contributions for older employees (usually the dentist-owners) than for the younger ones. They also allow contributions for older doctors even above the usual $30,000 limit, while still holding contributions for younger ones far below that level.
Davis says, "We have seen older doctors contributing as much as $100,000 annually to these type plans under the right circumstances. With an older (50+) doctor, who has contributed little in the past, but who has a younger staff, the opportunities are amazing."
5. Adopt a "target benefit" pension plan. This hybrid plan combines favorable features of the two basic traditional retirement-plan forms. It requires fixed annual contributions into each participating employee`s account (which a defined benefit plan does not), but it determines those contributions by reference to age as well as salary, thus providing greater payments for older participants, up to a maximum allocation of $30,000 annually. And, while it requires an actuarial calculation of the contributions in the beginning, the annual fees are significantly less costly than for a defined benefit-pension plan.
"We`re puzzled why more practices haven`t adopted target benefit plans over the years," says Davis. It`s not unusual to have a contribution of $30,000 for a 50-year-old owner-doctor, while the cost of covering a 25-year-old employee making $25,000 may be $1,000 or less. Target plans are approved routinely by the IRS, and administration is relatively straightforward. So, seriously consider adopting a target benefit plan in conjunction with a 401(k) plan. You may have to amend existing plans into each form, but experienced pension experts can handle that work fairly easily, says Davis.
6. Age weigh, or "cross-test," your profit-sharing plan. Tra-ditionally, profit-sharing plans required allocating contributions solely based upon each participant`s pay, and this led to relatively little distinction percentage-wise between what can be paid in for the higher and lower paid people. Finally, in the last few years, the IRS has relented and begun to approve plans with allocations based on age as well as compensation. The change opens up dramatic savings opportunities.
Among other features, you can retain the year-to-year contribution flexibility of a profit-sharing plan, while contributing the traditional maximum $30,000 for older doctor-owners and comparatively little for the young non-doctor staff members. Adopting one such plan may let you terminate, freeze or amend your existing plan(s) and realize substantial annual savings, says Davis.
Cross-tested plans provide even more room for creative plan design, says Davis. The IRS now allows for a plan design which allocates contributions among employees based upon several factors, including job classification and prior retirement-plan balances, as well as the traditional age and compensation factors. This sophisticated plan design requires that the benefit levels of staff members be cross-tested against those for the doctors until they fall within IRS-approved guidelines. As a result, the potential savings are even greater.
Davis cited one recent case as an example of the dramatic savings possible. The general dentist`s corporation had sponsored a traditional, but simple, money-purchase pension plan for over 10 years, covering the doctor ($150,000 compensation) and six staff members ($120,000 compensation total), whose ages ranged from 27 to 58.
Under the traditional money purchase plan, the corporation was required to contribute $50,000 in order for the doctor to receive the desired maximum allocation of $30,000 annually, or 60 perent of the total. Using the sophisticated, cross-tested plan design, Davis was able to create an IRS-approved formula under which the doctor still received the $30,000 annual allocation, while the staff-funding costs were slashed to only $3,615, for a tremendous savings of $16,385 annually.
Even though the initial-year fees were somewhat higher (around $3,000) due to the heavy IRS approval fee involved ($1,250), the client was elated to save over $13,000 the first year and over $16,000 each year thereafter, said Davis. According to Davis, the average practitioner switching from a traditional (non-age based) pension or profit-sharing plan to a cross-tested plan has been able to reduce his/her staff-funding costs by $10,000 annually.
The author is a tax attorney. He and Charles Blair, DDS, are editors of the Blair-McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes and protect assets. Contact Joe Davis at 4601 CharlottePark Drive, Suite 235, Charlotte, NC 28217; phone 704-529-5006 or fax 704-523-6112 for a retirement-plan study to determine the optimal-plan design for your practice.