Written by Corey Janoff
This post was originally published in November, 2018 has been revised and updated to reflect 2021 contribution limits.
With expected changes to the tax code coming, utilizing tax-advantaged retirement plans is becoming even more attractive for highly compensated doctors. There are many different retirement plans for doctors that can be utilized. Typically, retirement plans for doctors will fall into two categories: plans available for employees, and plans for self-employed individuals. We will look at both sets of options and talk about how they can be utilized.
Retirement Plans for Doctors Who Are Employees
Retirement plans for doctors who are employees of a hospital or group are going to be determined by the company. Some employers may offer more than one retirement plan to pick from, but unless you are one of the decision makers for the company, you won’t have much say what the employer offers employees.
For profit entities and non-profit entities have different plans available, based on the parts of the tax-code they are governed by. Ultimately the options are pretty much the same, but we will look at them all.
Retirement Plans for Doctors at Hospitals
If you are employed by a hospital, you will likely have access to a 403(b) retirement account. This is a retirement account offered by non-profit entities. Similar to the 401(k), which is commonly offered at for-profit companies.
Believe it or not, most hospitals are non-profit businesses. How they maintain their non-profit status is a discussion for another day.
Your employer may also have a 401(a) account and possibly offer a 457(b) account too.
A 403(b) account is a retirement account that allows you to make elective salary deferrals. This means you can elect to have a certain amount withheld from your paycheck and deposited into the account.
You are allowed to contribute up to $19,500 in 2021. That income adjusts for inflation in $500 increments and will potentially be higher in 2022.
Deposits can be made on a pre-tax or Roth basis. If you make pre-tax contributions, money is deposited before taxes are taken from your paycheck. For example, if you earn $250,000 in a year, and deposit the maximum $19,500 into your 403(b), the IRS will only tax you on $230,500 of income. Pretty cool! Nice government we have. It’s like the government is giving you a fist-bump for saving for retirement.
Once in the 403b, any investment gains are tax-deferred, meaning you don’t pay any taxes as long as the money stays in the account. You have to wait until you are 59.5 years old before you can withdraw the money, otherwise you are penalized and pay extra taxes. In retirement, when you withdraw the funds from a pre-tax account, the amount withdrawn is treated as earned income in that year and taxed accordingly.
Related: How Does Tax Loss Harvesting Work?
If you make Roth contributions, the opposite happens. Money goes into the account after taxes have been withheld. So if you make $250k in a year and make a Roth contribution to the 403(b), you are still taxed on $250k of earnings for the year. No incentive on the front-end to save. Money still grows tax-deferred and you still have to wait until you are 59.5 to touch it. Once eligible, qualified withdrawals are tax-free! How big is that! Tax-free money in retirement! Boo-yah!
Important note: there is no income limit on being eligible to make Roth contributions into employer retirement plans. The income limit is only for Roth IRA’s. Hence why the Backdoor Roth IRA is so popular amongst physicians.
Within a 403b, the employee gets to choose how to invest the money within the account. This is considered a “participant-directed” account. The retirement plan will have a menu of mutual funds to pick from that you can invest in.
403(b) account are also highly protected in most states and it is hard for creditors or litigators to go after money in those accounts.
Not all employers offer a 401a, but many hospital systems do. The employer sets the contribution rules for this account and it is mandatory. The employer could make all the deposits into this account, or they could mandate the employee deposit a percentage of his or her paycheck as well. Whatever the amount is, it will be fixed….until the employer decides to make a change.
For example, the employer may have a 401(a) plan that dictates you will deposit 6% of your paycheck pre-tax into the account and the employer will also deposit the equivalent of 6% of your salary into the account.
Contributions are made on a pre-tax basis (no Roth option available). Participants get to decide how to invest the money within the plan, similar to a 403(b). You also have to wait until age 59.5 until you can touch the money.
Not all non-profit employers offer 457(b) accounts. If your employer does offer a 457(b) plan, it could be worth taking advantage of if you are already maxing out the 403(b).
The contribution limits are the same ($19,500 in 2021). Contributions are made on a salary-deferral basis – meaning the money is withheld from your paycheck if you elect to contribute to the plan. You can also choose how to invest the money from the menu of options. Some employers allow Roth contributions, in addition to pre-tax.
The main differences between the 457(b) and the 403(b) are the age restriction and the asset protection component.
With 457(b) accounts, you don’t have to wait until you are 59.5 until you can withdraw the money. Typically the employer only requires you to be “separated from service,” meaning you don’t work for the company anymore. When looking at retirement plans for doctors, the 457(b) can be attractive for people who do a good job saving for retirement and are in a position to retire early.
The major downside to 457(b) plans is the money isn’t as highly protected as other qualified retirement accounts. For example, if the hospital declares bankruptcy, they could potentially dip into the 457(b) plan assets in order to pay back creditors. This means they could potentially take the money you saved in your account. So you probably only want to use the 457(b) account if your employer is financially stable.
Lastly, 457(b) accounts are sometimes difficult to take with you when you leave the employer. Most can only be rolled to another 457(b) and not an IRA or other retirement account.
Also, some employers are quite restrictive with what you can do with the money when you leave the employer. Some require you to liquidate and distribute the entire account balance when you stop working. If you have a large balance, this could create quite the tax bill for you in that year. Be sure to check the distribution options of the plan prior to utilizing it - the more flexible the better.
Retirement Plans for Doctors at Private Groups or For-Profit Companies
Instead of the 403(b), for profit companies offer 401(k) accounts. For all intents and purposes, these accounts are identical. Same contribution limits. Most employers allow you to make both pre-tax and Roth contributions. You get to pick your investment from a menu of options.
The employer can make additional profit-sharing contributions into the employees’ accounts as well. The maximum amount that can go into a 401(k) in 2021 between employee and employer contributions is $58,000.
In special circumstances there may be other retirement plans offered, but these are less common unless you are an executive in the company.
Retirement Plans for Doctors at Small Groups
If the group is profitable and generating good revenue, the practice will likely want to implement a 401(k) plan. This will enable the owners to deposit up to $58,000 in 2020, plus an additional $6,500 if age 50 or over.
Now, maxing out the 401(k) at $58,000 requires the business to also deposit some money into the employees' accounts as well. Depending on the number of employees, this may create quite a cost burden for the company.
For the less profitable groups, or for practices that do not want to deposit very much into employees’ accounts, a SIMPLE IRA is a commonly used plan. SIMPLE IRA’s are, as the name implies, quite simple. Each employee, including owners, sets up his or her own account and can defer up to $13,500 of salary pre-tax in 2021 (plus $3,000 if over age 50). The employer is required to match contributions, usually up to 3% of wages in most circumstances. That’s it. Super easy. Very inexpensive for the business.
Often new practices will start with a SIMPLE IRA and then migrate over to a 401(k) as the practice grows.
Retirement Plans for Doctors Who are Self-Employed
If you are self-employed, you have a several options available to you.
If you want to keep things easy and only make pre-tax contributions, then a SEP IRA is for you. The math works out so you can make pre-tax contributions of 20% of your earnings up to $58,000/year in 2021. You can do less of course, but that is the limit. It’s like any other IRA in that you can set it up wherever you want and invest the money however you want.
The individual or solo 401(k) is similar to a company sponsored 401(k), except when you are self-employed, you are both the employee and the employer. As an employee, you can make either pre-tax or Roth contributions up to $19,500 in 2021 (plus $6,500 if over age 50). As the employer, you can also deposit up to 20% of earnings pre-tax into the account. A maximum of $58,000 ($64.5k if age 50+) can go into the plan in 2021.
A lot of people who utilize the solo 401k like the ability to make the Roth contributions in addition to pre-tax. This enables them to really build up an account that can be accessed tax-free in retirement. They will often do this in addition to Backdoor Roth IRA’s.
The catch with the 401(k) is there are additional tax-reporting requirements that go along with it. You are required to file an IRS form 5500-EZ for accounts with balances over $250,000. Not many accountants will do this, so you will likely need to do it on your own or set up the account with a company that will do this for you (for an additional cost, of course).
Cash Balance Pension
For the overachievers who are maxing out the solo 401(k) at $58,000/year and are looking to invest additional monies on a tax-advantaged basis for retirement, then the cash balance pension plan is for you.
Related: Cash Balance Plans Pros and Cons
Some employers do provide these for their employees, so you may have one if you are an employee at a company.
The cash balance pension plan is a defined benefit plan, as opposed to a defined contribution plan like all these other accounts we have been reviewing. The maximum contribution limit varies by age. More money can be added the older you are. Older participants can contribute upwards of $300,000/year pre-tax! If self-employed, or the owner of a small practice, the goal is to contribute as much as cash flow allows to help reduce your taxable income.
Contributions are made pre-tax. Technically, the employer (ie, you if self-employed) provides a guaranteed interest rate on the account. The money can be invested, but if you invest too aggressively and the account goes down in value significantly, the plan may be considered underfunded and you will be required to deposit extra money into it the following year.
Conversely, if the account outperforms the target return objectives, you may be limited in how much you can add in future years, restricting the tax-deductible contributions you can make.
Long-story short, if you are maxing out the 401(k) and wanting to save a lot of extra money for retirement, it could be worth looking at a cash balance plan.
There are many retirement plans for doctors out there. What is available to you will mostly depend on your employer. If you are disappointed in the retirement plan offerings at your employer, get on the retirement plan committee and lobby for a change.
If you own your own practice, you have some choices available to you. What you go with will depend on the size of the practice, how profitable it is, and how much you want to save for yourself and your employees.
As a self-employed individual, you can stuff a lot of money away in tax-advantaged retirement plans if you really want to. Because you are your own boss, you have a lot of flexibility with what you do.
Reach out to us for a complimentary review of your retirement plan!
Any investment involves risk of loss, including total loss of principal. Consult with a financial professional for guidance on which retirement plan in right for you. This is not to be construed as tax-advice. Consult with a tax-professional for tax-advice and implications for your particular circumstances.