"Am I on track for retirement?", "Am I saving money in the most tax-efficient manner?", "I am maximizing my contributions to my 401(k) plan, I'm sure I'm on track for retirement" are all common phrases heard in a financial planner's office.
Many physicians and dentists endure countless years of training, and therefore their higher earning years often do not start until their mid- or late-30s. This later career start in medicine and dentistry is often in conjunction with soaring student loan debt, new mortgages, childcare, and an increase in symptoms of career burnout. Combining these factors makes understanding and maximizing the benefits of available retirement plans imperative to a successful, stress-free, and potential early retirement.
Retirement plans generally fall into one of two categories: 1) plans for employees and 2) plans for self-employed individuals. We will break down the available plans in each category and describe how you can make the most of their benefits.
A 401(k) plan is a common vehicle for retirement savings because of its numerous benefits. It is a salary-deferral plan, meaning you may elect to have a portion of your salary deferred into your 401(k) plan from your paycheck up to the annual maximum of $20,500 for 2022 ($27,000 if age 50+). In addition, employers have the option to make additional matching and profit-sharing contributions to the 401(k) plan. The maximum amount between employee and employer contributions is $67,500 for 2022. As a "participant-directed" plan, you can choose from a list of provided investment options in which to invest your contributions and account balance.
Contributions to a 401(k) plan can either be made on a Roth or pre-tax basis. If you elect a pre-tax contribution method, the money you put into the plan will grow tax-deferred and will not be taxed at your ordinary income rate until you make a withdrawal from the 401(k). Many high-income earners choose this option as they do not have to pay taxes on the contributions and their account's growth. It is also likely to be in a lower income tax bracket when they are taking withdrawals in retirement.
If you elect a Roth contribution method, you will contribute to the 401(k) with after-tax dollars. Therefore, you will pay ordinary income taxes at the time of your contribution and will not pay taxes upon taking withdrawals. This is a favorable method if you are in a lower income tax bracket at the time of your contribution than you believe you will be when you begin withdrawing from the account. Many retirees favor this method because you avoid paying taxes on this money in retirement and the growth of funds is all tax-free.
The money in a 401(k) plan is unavailable for withdrawal without penalty until you reach age 59½. Once you are age 72, the IRS requires you to begin taking Required Minimum Distributions (RMDs). RMDs are a minimum amount that you must withdraw on an annual basis.
A more cost-effective retirement plan option for employers is a SIMPLE IRA. The rules are just that, simple. Owners and employees can establish a SIMPLE IRA and contribute up to $14,000 for 2022 ($17,000 if age 50+) on a pre-tax basis. The employer is required to match contributions, usually 3% of wages, and that's it! As a company grows, it may choose to switch from a SIMPLE IRA to a 401(k) plan for added flexibility and higher contribution limits.
403(b) retirement plans operate identical to 401(k) plans but are only offered by government and nonprofit healthcare organizations. You may contribute up to the annual maximum of $20,500 for 2022 ($27,000 if age 50+) on a pre-tax or Roth basis, choose what you would like to be invested in from a selected list of options, and must wait until age 59½ to withdraw from the account without penalty, and are subject to RMDs at age 72.
Some hospitals offer a 401(a) plan where the employer determines the contribution rules. Either the employer can make all the deposits in the plan or set a mandatory deposit percentage or specified dollar amount that the employee must contribute. Many hospitals will contribute their matching contribution to this retirement plan. All employer contributions to this account are made on a pre-tax basis, and, like a 403(b) plan, you may choose the investment option, and the funds are not accessible until your age 59½.
If you are already maximizing your 403(b) plan contributions, a 457(b) plan is a great vehicle to build additional savings in a tax-efficient account. You may contribute, usually on a pre-tax basis, up to the annual maximum of $20,500 for 2022 ($27,000 if age 50+) in addition to your 403(b) plan contributions.
The key difference between a 457(b) and 403(b) plan is the protection aspect. The assets in this plan remain the property of the employer and are therefore available to the employer’s general creditors. In case of litigation or bankruptcy, you could lose the entirety of the balance in this account. In certain situations, this type of account cannot be rolled over to an IRA or any other kind of retirement plan. Some employers allow withdrawals from this account after you separate from employment rather than waiting until your age 59½.
A Self-Employed Pension (SEP) plan may be opened at any institution and invested in any funds by a self-employed individual. A SEP IRA is a pre-tax retirement plan that you can contribute up to the lesser of 25% of your compensation or $61,000 in 2022. Like pre-tax 401(k) plans, the money in the account grows tax-deferred and is only taxable when distributed. You may roll over this plan into other qualified plans.
A Solo-K plan is an available retirement plan option for a practice with only one owner or a practice employing an owner and spouse. You can contribute to this plan as both the employer and employee. As the employee, you can make pre-tax or Roth contributions up to the annual maximum of $20,500 for 2022 ($27,000 if age 50+). As the employer, you can also contribute up to 25% of compensation or a total annual contribution to the account of $61,000 for 2022.
This plan allows individuals to make pre-tax contributions up to $6,000 per year ($7,000 if age 50+). You may deduct your IRA contributions if you are ineligible for a retirement plan through work. The account balance grows tax-deferred and is taxed at your ordinary income rate when withdrawn from the account. Withdrawals cannot be taken before age 59½ without penalty.
Contributions limits to a Roth IRA are the same as Traditional IRA limits. However, in a Roth IRA, you make contributions with after-tax dollars and receive tax-free growth. Therefore, it is a good option if you would rather pay taxes on this money in the current year to avoid paying taxes in retirement.
Most physicians and dentists earn above the adjusted gross income (AGI) limitations of $144,000 per year for single filers and $214,000 for those married filing jointly, making them ineligible to make direct contributions to a Roth IRA. In this case, you may consider the option of completing a "backdoor Roth IRA" contribution. In a backdoor Roth IRA contribution, you make a non-deductible contribution to a Traditional IRA and convert the contribution to a Roth IRA.
Important note: Please reach out to your financial advisor and CPA if you are interested in completing a backdoor Roth contribution, as this requires a careful strategy to avoid taxation.
A common savings vehicle for physicians and dentists that have maximized their employer retirement plans and any eligible IRA accounts is the non-qualified investment account. This may also be referred to as a joint account, individual account, or after-tax investment account to name a few. Ultimately, this account structure has no limitations. Contributions made to the account are made on an after-tax basis, the growth of the funds is subject to capital gains and dividends as they are paid, and any distributions could also subject the account owner(s) to capital gains tax. Despite the taxation of this account, it offers the most flexibility. There are no withdrawal penalties or requirements.
Cash Balance Pension Plans may be provided by employers and are also available for self-employed individuals. It is a defined benefit plan with a maximum contribution limit that varies by age. All contributions are pre-tax, and the employer (you if self-employed) provides a guaranteed interest rate on the account. This plan provides security and additional savings and can be an excellent addition to a portfolio if available to you.
While not a retirement account, a Health Savings Account (HSA) is a savings vehicle that offers pre-tax contributions, tax-deferred growth, and tax-free distributions for qualified healthcare expenses. It is the only account that provides all three tax savings options! In addition, employees covered by a High Deductible Health Plan are eligible to contribute up to $7,300 for families or $3,650 for individuals to an HSA. Keep in mind that if your employer makes any matching contributions to your account, the matching contributions will count towards the annual limits.
Saving for retirement can be challenging when faced with the reality of financial responsibilities, like a mortgage or rent, student loan debt, and childcare and schooling expenses, to name a few. There is not a one-size-fits-all retirement plan. Since every situation is unique, it is vital to understand your retirement options and what best aligns with your employment situation and future goals and dreams.
As you care for your patients, we can help care for you. As you look ahead to retirement, Spaugh Dameron Tenny can help you create a sound strategy for a lifetime income. Connect with our dedicated team of financial advisors to get started today!
Rachel Adams is a research and planning analyst on our team, where she analyzes financial plan data, prepares client annual review meetings, and conducts financial research. In addition, Rachel holds the Series 7 and 63 registrations.
As a second-generation legacy graduate of Appalachian State University, Rachel enjoys returning to Boone for football season and the mountain weather.
For over 50 years, Spaugh Dameron Tenny has provided comprehensive financial planning for physicians and dentists across the U.S. In addition to providing personalized advice, we walk our clients through their options to help maximize finances and maintain financial security.
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