Earlier this summer, Mr. Stewart wrote an excellent article for Birmingham Medical News addressing almost every issue that may need to be considered when a physician leaves a practice group. This article will address the one area that was overlooked: corporate retirement plans.
For many physicians, the practice retirement plan can result in providing one of their most significant assets to be used after retirement. These plans are called qualified retirement plans because they fall under requirements of IRS Internal Revenue Code and are eligible to receive certain tax benefits, unlike non-qualified plans. These plans are governed by the Employee Retirement Income Security Act (ERISA). (Keep in mind: employment contracts don’t override the rules of retirement plans). The most common qualified plans are 401(k), Profit Sharing, Traditional Defined Benefit, and Cash Balance Plans.
Every year a contribution in the retirement plan(s) is critical for accumulating wealth in the plan(s). While every plan is unique, most plans have certain requirements that must be met each year to receive a contribution or accrue a benefit. For example, needing to work 500 hours or be employed on the last day of the plan year or working 1,000 hours and being employed on the last day of the plan year are common contribution requirements. It is even common for plan sponsors to choose a specific individual and not allocate a contribution on their behalf regardless of employment status (as long as nondiscrimination requirements are met). It can be the case that there will be little or no employer contributions for a physician for the year in which a physician leaves a practice.
It is often ideal for physician groups to pair a Cash Balance Plan with a 401(k) Profit Sharing Plan. Cash Balance Plans, which are defined benefit plans, are popular with physician groups because they allow owners to have substantially greater contributions to accumulate retirement plan wealth and also greater tax deduction benefits than when only having a 401(k) Profit Sharing Plan. The theorical approach of a Cash Balance Plan is relatively simple. The plan sponsor provides “credits” to the participant accounts each year. The first is a pay credit that is either a fixed percentage of compensation or a specified dollar value. The second is an interest credit, which is generally a fixed rate of return for the account. For those who love accounting, think of these credits as entries on a ledger. The plan sponsor contributes money to the plan trust to support the total amount of the calculated credits for all participants in the plan.
There are specific provisions regarding when a terminated participant may receive a distribution in any type of qualified plan. Back in the old days, it wasn’t uncommon for a 401(k) Plan to require the participant to reach age 65 to be eligible for a distribution. While that’s almost never the case today, it’s very possible for a plan to require a wait until after the end of the plan year before a distribution from the plan will be made. If a Cash Balance Plan hasn’t been well “funded” under IRS regulations, a highly compensated employee (HCE), such as a physician, is restricted from taking a lump sum distribution. This doesn’t ultimately impact their benefits, but can cause a timing impact of the payout of said benefits. (In order for any HCE to be paid out, the Cash Balance Plan must be funded 110 percent of the liability amount the plan has for all participants).
Example of Why Planning Is Needed:
Owner A is one of three equivalent physician owners in their current practice. The three physicians add a 401(k) Plan and a Cash Balance Plan to maximize contributions and take advantage of tax deductions. The practice is doing well and generating good revenue, but as usual, Medicare reimbursements and health insurance, are being discussed in political circles, so the owners decide to “prefund” the Cash Balance Plan, while things are good. Thus, they make contributions that are deductible on the corporate tax return, but are in excess of the total benefits for the applicable plan year. They continue to do this for a few years. After time, the Cash Balance Plan has $150,000 more in the plan than is needed to cover the current accrued benefits. Owner A decides to leave the practice. Since the Cash Balance Plan is ‘over funded’, there is likely not any distribution restriction (as discussed in the paragraph above).
However, there may be a different problem. The Cash Balance Plan requires that Owner A gets paid out the “lump sum equivalent” of his benefit. What this means is Owner A doesn’t have any claim on the $150,000 of excess funding even though he helped contribute approximately $50,000 of the $150,000 excess into the plan. Owner A didn’t fully understand this as they were making excess contributions and, while they all enjoyed the tax deduction benefits, Owner A feels like he’s owed one-third of the excess assets that they contributed. If the situation was reversed and the plan was underfunded by $150,000, Owner A would be unable to simply withdraw his benefit and disregard that the plan was underfunded by $150,000. These are real and common issues, which is why planning is essential.
A qualified retirement plan or plans can provide one of the best methods for physician practices to maximize retirement benefits. Differing plan designs with various eligibility and payout requirements can prove very useful to practices, which is why it is wise for the physician group to consult with a retirement plan design expert to ensure they have a plan (or plans) designs that make the most sense for their practice. As you can see from the illustration above, planning is key and the best time to plan is at the design stage and again prior to when physician exits are anticipated.
William C. Presson, ERPA is a Senior Manager at Pinnacle Plan Design. During his career, Presson has started and sold his own Third Party Administrator (TPA) practice, served as COO for a national trust company and led the TPA operations for a large regional CPA firm.
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