The new tax law has greatly expanded the opportunities for retirement savings. Every veterinary practice should have a business retirement plan by 2002. The right retirement plan costs nothing because it allows funds that would be lost to taxes to provide retirement benefits for long-term employees.
But what plan is best for your practice? Each practice and practice owner is unique, and plans are so diverse that the wrong decision could waste thousands of dollars in needless fees or substandard investment results. Because this is a complex area, you should carefully review all available options. Don't be swayed by sales pitches, glossy brochures or professional association endorsements. Demand to see how different plans would work in your practice. You may consider retaining a qualified, independent benefits specialist to evaluate your alternatives.
Re-evaluate your current plans to ensure they are still appropriate, considering the new opportunities. You should make these decisions now, as the new provisions take effect in January 2002, and a plan cannot begin to accept salary deferrals until it is officially adopted.
Here are the major developments in the new law:
1. The individual contribution dollar limit has been increased to $40,000.
2. The percentage limit on individual contributions has been eliminated.
3. Employee salary deferral limits (and personal IRA limits) have been significantly increased.
4. The percentage limit on profit sharing plans has been increased to 25 percent of total compensation, and salary deferrals will not count towards this percentage limit.
5. "Catch up" provisions in salary deferrals (and personal IRA contributions) are allowed for those age 50 and over.
6. Salary deferrals in 2006 and beyond may be treated as Roth IRA-type contributions.
7. Dollar limits will be indexed.
The vast majority of practices now only have two options, the Simple-IRA or a profit-sharing plan (perhaps with a "safe harbor" 401k option). In both options, the participant contributes much of the annual contribution through salary deferrals. Money purchase plans have effectively been rendered obsolete with the increased limits on profit-sharing plans.
When choosing the right plan for your practice, consider these factors:
1. How much can the business afford to commit (in before-tax income) to the plan, including plan administrative expenses? Don't choose a complex plan that cannot be fully funded.
2. How much do you want to contribute for employees? Often sacrificing a little efficiency to truly reward valuable employees can be a savvy business tactic.
3. Is your spouse a practice employee? If so, your spouse's salary deferral may almost double your family contribution.
4. What is the business form of the practice? Subchapter S corporations sponsoring Simple-IRAs may offer opportunities for huge payroll tax savings.
5. How efficient is the plan? What percentage of each dollar committed to the plan goes into your account? of the plan. Generally, a plan should be more than 70 percent efficient.
6. What are all the fees associated with the plan, including plan start-up and annual administrative fees, advisor fees, and mutual fund annual expenses?
7. What investment products are available to plan participants? The plan should offer a wide variety of outstanding investment products.
8. What is your fiduciary liability (if your are the trustee)?
The Simple-IRA, the simplest of the three, has no administrative fees, very little fiduciary liability and is the best plan for most practices. It allows every participant to defer $7,000 annually in 2002 (increasing to $10,000 in 2005), and the employer normally contributes a matching contribution of up to 3 percent of each participant's wages.
For instance, if you, and other eligible employees, earn $80,000, whose spouse is employed by the practice for $7,600, you will be able to contribute $16,500 (increasing to $22,500 by 2005) to your plan accounts, contribute $6,000 (increasing to $10,000 in 2008) to their personal IRAs, and have a maximum liability of $2,400 for the other employees. Participants over the age of 50 can contribute significantly more. The ability to treat contributions as Roth types after 2005 will effectively mean far more pre-tax income can be committed to the plan. The assets can be invested with any custodian that accepts Simple-IRAs. Discount brokerages such as Charles Schwab or TD Waterhouse are excellent choices, as they offer the widest variety of low-expense, no-load products.
Pros and Cons of Profit Sharing
Profit-sharing plans, which are complex, expensive and have significant fiduciary liability, may allow far higher owner contributions, but are only appropriate for those practices that yield very high owner compensation or that want to contribute far more than 3 percent for nonowner employees. They can have several design characteristics that allow—within limits—higher percentages to be contributed for owners than nonowners. Additionally, they can feature a "safe harbor" 401k provision, similar to a Simple-IRA (except the deferral limit is $11,000 in 2002, increasing to $15,000 in 2006, and the match is 4 percent). A practice should never consider a 401k plan without this "safe harbor" provision.
Considering a profit-sharing plan is a very complex decision. The correct way to approach this process is to first determine the efficiency of a Simple-IRA, and then determine the efficiency of the extra dollars contributed if a profit-sharing plan was used instead of the Simple-IRA. Don't make the mistake of maximizing your contribution solely to save on annual taxes. If those extra dollars are too inefficient, you would be far better off to contribute to a Simple-IRA and, with the remaining savings, simply invest them in a taxable account using the newly available tax-managed mutual funds.
401k plans, which, unfortunately, have been vastly oversold to veterinarians, present an especially challenging problem. The participants should each have their own account. To offer individual participant-directed accounts, the plan will either incur very high fixed initial administrative costs or pay a percentage of assets to a financial firm. The financial firm will offer only investments. sold through that firm and may provide little or no advice on plan design. Those investments could be very poor performers. Additionally, that percentage fee may become exorbitant as the plan assets increase.
Difficult decision? Yes, but the right plan for your practice is available, and doing nothing is undoubtedly the worst choice. Shop wisely, consider all options, don't be afraid to ask for help, and realize that this is one of the most important financial decisions you will ever make.
Robert M. Frey, MS, VMD, CFP, offers general financial planning services in the areas of retirement planning, educational planning, investments, tax planning, insurance, charitable gifting, estate planning and appraisal services to veterinary practices. He formerly owned and operated the Wignall Animal Hospital, which served more than 15,000 clients from two locations in the Lowell, Mass., area. He currently offers his services through Professional Financial Management, Inc., in Bozeman, Mont.
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