If you’re a self-employed physician, saving for retirement isn’t as straightforward as opting into an employer’s plan. Your plan must align with your long-term goals while also giving you as many tax benefits as possible.
But there’s no one answer to the type of vehicle you should be contributing to. The retirement strategy that’s right for you will vary based on whether you have employees, how much you can contribute to your plan each year, and other factors.
Key factors when selecting a plan
In general, here are the essential things to consider when you’re preparing for retirement and looking at plans:
- The maximum allowable annual contribution
- The annual contribution flexibility amount
- If incidental benefits are allowed
- If loans are allowed
- If employee discrimination testing is required
- If employee vesting is allowed
- The date when a plan must be established
- The deadline for contributions
- The tax treatment of contributions
- Payroll taxes owned relative to contributions
- If integration with other plans is allowed
- If plan assets protected from creditors
- The tax treatment of distributions
- The cost to establish and maintain
- The ability to self-direct investments
Each plan should be evaluated through the lens of these factors, though some will be more important than others, depending on your situation and priorities.
Tax-efficient wealth creation
Let’s start with an important note about tax diversification during retirement. Make sure you are strategically allocating the types of retirement plans so that all your income isn’t in a tax-deferred account that pushes you into the highest tax bracket.
Instead, don’t solely focus on tax deferment. Create an investment portfolio that will allow you, when you sell part of that portfolio, to receive a more favorable capital tax gains rate. Balance your plan with tax-free income from sources like Roth IRAs and 401(k)s, tax-deferred income from IRAs and 401(k)s, and taxable income like investment and bank accounts.
Types of retirement plans for self-employed doctors
Let’s walk through plans to choose from if your contribution budget is under $100,000 per year. First, if you’re putting $25,000 or less into retirement, your options are:
- Traditional and Roth Individual retirement accounts (IRA)
- Health savings account (HSA)
- Simple IRA
If you have under $100,000:
- Simplified employee pension plan (SEP)
- Restricted property trust
Plans for individuals
Here’s a quick snapshot of retirement plan contributions limits for individuals if you’re working with $25,000 or less:
Traditional and Roth IRAs
- $6,000 if under age 50
- $7,000 if over age 49
- $3,550 if single
- $7,100 if married
- Age 55 and older – Additional $1,000
- $13,500 if under age 50
- $16,500 if over age 49
- $19,500 if under age 50
- $26,000 if over age 49
Note that traditional IRA deduction limits may make a Roth IRA more desirable. However, if you make too much income for a Roth IRA, the solution is a “back door” Roth IRA. This involves you funding a traditional IRA but converting that over to a Roth IRA. It’s basically a non-deductible traditional IRA contribution that you’re making and then converting.
However, when you do this, there is a pro-rata allocation. If you have money in a traditional IRA, the allocation may cause the conversion to be partially or entirely taxable. Ensure you’re aware of that possibility and work with a financial advisor to make the proper calculation for Roth IRA conversions.
Health savings account benefits and eligibility
The benefits of an HSA include:
- Contributions are tax-deductible
- Growth is tax-free
- Distributions for qualified medical expenses are tax-free
- Investments can be self-directed (i.e., if you want to own real estate, you can use your HSA to do that)
- An employer-provided account is portable, so you can take it with you
Eligibility for HSAs:
- You must have a high-deductible health plan (one that fits within the minimum annual deductible and maximum yearly deductible, which changes each year)
- You can’t have other health coverage, like a flexible spending arrangement or health reimbursement arrangement
- You can’t be enrolled in Medicare
- You can’t be claimed as a dependent
Now, let’s look at the types of retirement plans for businesses:
Plans for Businesses
Here are retirement plan options based on a contribution budget of under $25,000 per year.
The simple IRA is a good option for those with a limited budget. Some notes about these retirement accounts:
- They are for businesses with fewer than 100 employees
- They give you flexibility in investments
- No tax filings are required
- They have limited contribution flexibility
- They are a low-cost retirement plan
- They’re simple to set up and easy to administer
- You must sign up by 10/31 in the current year
In a SEP-IRA, the maximum annual contribution is calculated based on a percentage of your self-employment income. In 2020, the limit is the lesser of 25% of your compensation or $57,000. Additional notes about the SEP-IRA:
- Flexibility with contributions
- No tax filings required
- Investment flexibility
- Easy administration
- Low cost to set up
- Tax-deductible to the employer and tax-deferred for the employee
- Can be set up any time prior to tax return filing
However, these plans result in very little net marginal tax savings, so these are not always recommended.
401(k) (non-safe harbor)
Non-safe-harbor 401(k)s are good for businesses with lots of employees. Employees can defer a portion of their wages, and Roth contributions are allowed for high-income taxpayers. There is also contribution flexibility in these plans.
But if your other employees don’t contribute to their 401(k), the amount you can defer is limited by how much they, on average, defer. This is only a risk if you have employees, mind you. But if you do, you may not have control over how much you can defer since it’s based on how many employees actually participate.
401(k) safe harbor
This plan has a matching requirement, so you generally match 3% of employees’ compensation. To maximize your plan, you may weigh the costs of having a safe harbor 401(k) and calculate how much of that matching contribution you’ll be required to make—and see if that makes sense for your goals.
Other notes about these:
- 100% of contributions are immediately vested with the employee, but you can set up additional contributions on a vesting schedule
- You must set it up before the end of the year
- Not overly expensive, but more costly than the simple plans listed above
Retirement plans if you have under $100,000 for retirement per year
This account is ideal for a one-person business. Roth contributions are allowed for high-income taxpayers, and plan assets are fully protected from creditors. Other terms:
- You must be the only employee
- 100% immediate vesting
- Must be set up before the end of the year
- The maximum annual contribution is 20% of Schedule C income or K-1 income, or 25% of W-2 income
Mega “back door” Roth 401(k)
These are the same as solo 401(k)s except that the plan allows you to take in-service distributions on the contributions that are above the 401(k) portion.
So, if you want all $57,000 to ultimately go into a Roth account, the first $19,500 is basically a traditional Roth 401(k). The other $37,500 goes initially into a tax-deductible profit-sharing plan. Then, immediately after you contribute, you are rolling it into a Roth IRA. The net effect is that $57,000 is going into the Roth IRA.
These are usually attached to a 401(k) plan, but that isn’t a requirement. They look a lot like SEP plans, including the downside that if you don’t attach it to a 401(k), it’s a challenge to max out contributions.
- Lots of flexibility
- You can contribute to it or not each year
- You’re not locked into anything long-term
This article covered options for both individual physicians and businesses contributing under $100,000 for retirement. Part II of this series will discuss types of retirement accounts for those who can contribute more than $100,000 per year.
If you have questions about the right retirement tax strategy for you or your practice, get in touch with us to walk through your options.
Physician Tax Solutions supports busy medical practitioners with proactive strategies and full-service tax preparation services that dramatically reduce tax bills. Contact us online or by calling 1-855-693-7829 to start saving today.