New tax-law provision could help doctors convert IRA to Roth IRA

Sept. 1, 2007
Q Recently, I heard a speaker say that I could set up a Roth IRA, regardless of my income level.

by John K. McGill, CPA, JD, MBA

Q Recently, I heard a speaker say that I could set up a Roth IRA, regardless of my income level. I thought that I could set up a Roth IRA only if my income was less than $160,000. Who is correct?A The law continues to prohibit doctors whose adjusted gross income exceeds $160,000 from contributing to a Roth IRA. In a Roth IRA, contributions are not deductible. However, earnings grow tax-deferred, and can be withdrawn tax-free at age 59 1/2 or in five years, whichever is later.

However, a new tax-law provision could help many high-income doctors establish a Roth IRA using a different approach. Under current law, individuals can convert a regular IRA into a Roth IRA in any year in which their modified adjusted gross incomes do not exceed $100,000. However, beginning in 2010, this income restriction is removed, and any doctor will be able to convert his or her regular IRA into a Roth IRA at that time. While tax will be due on any accumulated earnings within the regular IRA at the time of conversion, all future income will grow tax-free in the Roth IRA.

Q I am way behind in saving for retirement, since I just finished funding my children’s college-education costs. Fortunately, my practice income is up, and I would love to find a way to save more than I can do in my existing 401(k) profit-sharing plan. Is there another type of retirement plan that would allow me to substantially increase my savings for retirement on a tax-deductible basis?A According to Jason Arnold, East Coast District Manager of PenSys, Inc. - (888) 440-6401) - a nationwide retirement-plan consulting firm for dentists, a defined-benefit pension plan may be the answer for you. Under a defined-benefit pension plan, doctors can establish an accumulation goal at retirement age, subject to maximum IRS limits. Currently, the maximum accumulations are approximately $2,200,000 for a doctor wishing to retire at age 65, and $2,400,000 for a doctor wishing to retire at age 62, Arnold says. The doctor can then fund the plan to reach the desired accumulation goal at retirement. Obviously, the older the doctor is (and closer he is to his retirement age), the more funds are required to reach the desired goal at retirement. Since contributions to the plan are based on age as well as salary, this plan works best for doctors aged 40 or older who desire maximum retirement plan funding and have a younger staff.

Contributions for doctors often range from $50,000 to $250,000 annually, notes Arnold, All are tax-deductible. Unlike profit-sharing plans, contributions are required annually, so this plan works best for doctors with a consistent cash flow.

Q I am in my early 50s and am way behind in funding for my retirement. I just finished putting two children through college and paying off my home mortgage. I have heard about a defined-benefit pension plan that could work, but I have one or two older staff members, while the rest are fairly young. What type of retirement plan would work best for me?A Your situation is not uncommon. With slower practice growth and lower investment returns, many doctors are not accumulating enough assets to assure their financial security in retirement.

Many doctors need to put away more money for retirement than is currently permitted under 401(k) profit-sharing plans and other forms of defined-contribution plans (maximum contribution of $45,000 annually, or $50,000 annually if 50 or older).

As a result, more doctors are choosing to establish and fund defined-benefit pension plans, where annual contributions are set to achieve a specific funding goal at retirement, and the plans are not subject to those annual contribution limits. Doctors age 50 or older can usually contribute $150,000 or more each year to a defined-benefit plan on a tax-deductible basis, says Jason Arnold of PenSys, Inc.

In a typical defined-benefit pension plan, staff funding costs are determined individually, based on age and salary. As a result, contributions on behalf of your older employees may be double or triple the contributions required for younger, but similarly paid employees. This disparity in contributions can create practice-management problems.

However, Arnold says a new type of defined-benefit pension plan can help solve your problem. Using a “tiered” defined-benefit plan, employees are grouped into several classes, such as owner and staff employees, with each class benefiting at different levels, subject to IRS limitations. This can allow similar contribution amounts to be made on behalf of employees with differing age and compensation levels, helping to avoid the practice-management problem discussed above. Moreover, staff funding costs will generally be lower using a “tiered” rather than a regular defined-benefit plan, says Arnold. These plans require the services of a highly competent actuary to achieve the optimal retirement plan design. As a result, they are not available through banks, brokerage houses, or mutual funds offering traditional retirement plan documents.

Q Last year, I set up a health-savings account (HSA) after obtaining a qualified higher deductible policy. I was able to contribute and deduct an amount equal to my deductible into my HSA investment account on a tax-deductible basis. I plan to contribute the same amount this year, but I have heard that the rules have changed and higher contributions can be made. Is this so?A Yes. Many doctors looking to reduce premium costs have opted for these qualifying higher-deductible policies. To qualify, doctors must maintain a health insurance plan with a minimum deductible of $1,100 for individual coverage and $2,200 for family coverage.

Last year, tax-deductible contributions to an HSA account were generally limited to the amount of the doctor’s deductible. Recent tax-law changes have increased the maximum deductible contribution up to $2,850 in 2007 for employees with single coverage and $5,650 for employees with family coverage, and contributions will no longer be limited by the deductible amount. In 2008, the maximum tax-deductible contributions increase to $2,900 for those with single coverage and $5,800 for those with family coverage. In addition, doctors who are 55 to 64 can make additional tax-deductible “catch-up” contributions of $800 per spouse in 2007, $900 per spouse in 2008, and $1,000 per spouse thereafter.

Q For many years, I have been paying my son to work in the practice doing a variety of jobs, including maintaining the office building. Recently, I heard that the tax rules had changed and his salary would now be taxed at my rate rather than his. Is this correct?A No. Recent tax-law changes have affected only the taxation of unearned income (e.g., rents, interest, dividends, capital gains, etc.) under existing law. Unearned income above $1,700 for children under the age of 18 is now taxed at the parents’ rate, rather than the child’s. In 2008, the age limit is increased to children who are 18 or under 24 if the child is a full-time student. However, this provision will apply only to children whose earned income does not exceed one-half of the amount of their support.The new law does not affect the taxation of a child’s salary earned from working in the practice or elsewhere. Those salary amounts constitute earned income and continue to be taxed at the child’s rate. In 2007, a child can earn $5,350 free of federal (and, in most cases, state) income taxes. This remains an excellent method of funding a child’s educational costs with tax-deductible dollars.

John K. McGill, MBA, CPA, JD, is a tax attorney, CPA, and MBA, and the editor of “The McGill Advisory,” a monthly newsletter devoted to tax, financial planning, investment, and practice-management matters exclusively for the dental profession. The newsletter ($209 a year) and consulting information are available from John K. McGill & Company. Call (704) 424-9780, toll-free (888) 249-7537, or visit the company Web site at

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