As a practice at BGA 401k, we have worked with many doctors and other medical groups to help them maximize their retirement savings while taking full advantage of tax benefits. One of the most effective strategies we’ve found is the new comparability profit-sharing plan. Often, medical practices already have a retirement plan with these capabilities in place; it has just not been set up correctly, or their advisor is not aware of the potential benefits.
Let’s explore how this can benefit your practice and secure a successful financial future for you and your employees.
What is New Comparability Profit Sharing?
New comparability profit-sharing plans, also known as cross-tested plans, offer employers the flexibility to allocate contributions more effectively than traditional profit-sharing plans. This flexibility is particularly beneficial for doctor groups where there’s often a significant difference in compensation between doctors and other staff members.
These plans allow for higher contributions to key employees, such as doctors, while still meeting the IRS’s nondiscrimination requirements.
The Benefits
New comparability profit sharing plans offer customizable contributions. Unlike traditional profit-sharing plans that allocate contributions uniformly, these plans enable different contribution rates for different employee groups. This flexibility can help maximize benefits for highly compensated employees, such as doctors, while optimizing tax efficiency.
From a tax perspective, employer contributions are tax-deductible, reducing the taxable income of your practice. For doctors in high tax brackets, this can translate into substantial tax savings. Additionally, by allocating a higher percentage of contributions to doctors, you can significantly increase your retirement savings.
Employee Classification and Contribution Allocation
Employees can be categorized based on job title, salary level, length of service, and employment status. Here’s an example of how contributions can be allocated based on these classifications:
Contribution Allocation
- Class 1 (Doctors): 15% of salary
- Class 2 (Other Employees): 5% of salary
Contribution Calculation
- Doctor A: 15% of $250,000 = $37,500
- Doctor B: 15% of $230,000 = $34,500
- Employee C: 5% of $50,000 = $2,500
- Employee D: 5% of $45,000 = $2,250
Remember, this is in addition to the amount that each employee chooses to defer into their 401(k). In 2024, that limit is $23,000. That means that in this example, Doctor A could contribute $60,500 per year into the plan.
If Doctor A is over age 50, he or she could contribute another $7,500 as a catch-up contribution. This is a total of $68,000 per year in overall plan contributions.
Tax Benefits for Doctor Groups
One of the main advantages of new comparability profit-sharing plans is the substantial tax benefits they offer. For doctors in high state and federal tax brackets, the tax savings can be significant. These benefits can make a significant difference in your financial planning and overall tax strategy.
Employer Tax Deductions
Contributions made by your practice to the retirement plan are tax-deductible, which directly reduces your taxable income. This is particularly beneficial for highly profitable practices. For example, if your practice contributes $100,000 to the retirement plan, that amount is deducted from your practice’s income, potentially saving you thousands in taxes. These savings can then be reinvested back into your practice, enhancing growth and stability.
Deferred Taxes for Employees
For employees, including doctors, contributions to the retirement plan are made on a pre-tax basis. This means that these contributions are not included in their taxable income for the year, which can result in substantial tax savings. The taxes on these contributions are deferred until the funds are withdrawn during retirement. Given that many doctors are in high tax brackets during their working years, this deferral can provide significant tax relief, allowing them to save more efficiently for retirement.
Tax-Deferred Growth
Funds within the retirement plan grow on a tax-deferred basis. This means that any investment gains, dividends, and interest earned within the plan are not taxed until they are withdrawn. This tax-deferred growth allows for compounding returns to accumulate more rapidly than they would in a taxable account, where earnings would be reduced by taxes each year. Over time, this can significantly enhance the growth potential of retirement savings, leading to a more secure financial future.
Maximizing Contributions
To fully leverage the benefits of a new comparability profit-sharing plan, aim to maximize your contributions each year. If you’re aged 50 or older, take advantage of catch-up contributions, which allow you to save more in your retirement accounts. For 2024, the catch-up contribution limit for 401(k) plans is $7,500, in addition to the standard contribution limit of $23,000.
Consider maximizing the profit-sharing contributions to take full advantage of the tax benefits. For 2024, the total contribution limit (employee and employer combined) is $69,000 or 100% of the employee’s compensation, whichever is lower.
Creditor Protection
Under the Employee Retirement Income Security Act (ERISA), assets held in qualified retirement plans, such as 401(k)s and profit-sharing plans, are generally protected from creditors in the event of bankruptcy or lawsuits. This protection extends to current and former employees, offering peace of mind that their accumulated retirement funds are secure. For doctors, particularly those exposed to high liability risks, leveraging these qualified retirement plans not only aids in tax-efficient retirement savings but also acts as a vital shield against frivolous financial claims.
Next Steps
Implementing a new comparability profit-sharing plan can be a game-changer for doctor groups looking to maximize their retirement savings and enjoy significant tax benefits. By tailoring contributions to benefit highly compensated employees, such as doctors, you can create a retirement plan that meets the needs of your practice while ensuring compliance with IRS regulations.
If you’re interested in exploring how a new comparability profit-sharing plan can benefit your practice, feel free to reach out. I’m here to help you design and implement a retirement plan that optimizes your savings and tax benefits.
Together, let’s evaluate the way we approach retirement programs.
Chris Cristallo, CFP®, 401k Advisor at BGA 401k