Financial Wellness co-columnist Jason Castner is the managing shareholder at Lacher McDonald & Co., CPAs & Consultants. He leads the company’s veterinary consulting segment and assists clients on tax and financial planning and other issues. Learn more at triunefp.comRead Articles Written by Jason Castner
Financial Wellness co-columnist Fritz Wood is a veterinary industry veteran with a special interest in finance. He works with Triune Financial Partners to connect veterinarians with experienced, independent financial planners. He is the former personal finance editor of Veterinary Economics and was a treasurer and board member at the American Veterinary Medical Foundation. He holds bachelor degrees in accounting and business administration from the University of Kansas.
CFP, ChFC, CLU, CKA
Financial Wellness co-columnist Geoff Huber leads Triune Financial Partners’ retirement plan department. He’s been in the financial planning industry for three decades, focused solely on retirement plans for over 20 years. He and his team partner with credentialed third-party administrators to serve clients. Together, they work with small- to mid-sized business.Read Articles Written by Geoff Huber
We hear from veterinarians across America — both small and large animal — that recruiting sharp, young clinicians to their practices is difficult. To attract, retain and reward employees, practice owners must offer competitive compensation and an engaging culture as well as a properly designed retirement plan. Further, in an environment where taxes could rise, an effective retirement funding tool coupled with the opportunity for tax savings becomes increasingly important.
Often, the progression in retirement plans as a veterinary practice matures and grows more profitable includes:
- Simplified Employee Pension (SEP-IRA) or Solo 401(k) plan: Best when you are the only employee.
- SIMPLE IRA plan: An ideal starter retirement plan once you add employees.
- Regular 401(k) plan: Comes with increased contribution limits and allows for Roth deposits.
- Safe Harbor 401(k) plan: A practice owner and any other highly compensated employees can contribute the IRS-prescribed maximum salary deferral of $19,500, or $26,000 if they are at least 50 years old, without regard to how much an employee is contributing.
- Safe Harbor 401(k) plan with profit-sharing: A practice owner and other highly compensated employees can contribute up to $58,000, or $64,500 if age 50 or more, when adding in employer contributions like matching contributions and profit-sharing.
- Cash balance plan: A form of defined benefit pension plan, this one can be tacked on to the Safe Harbor 401(k) plan with profit-sharing and enable the practice owner and other highly compensated employees to increase total contributions to as high as $150,000 to $200,000 apiece.
Always consider the size of your practice, its profitability, your need for retirement fund accumulation and income tax savings, and demographics, specifically the ages and incomes of you and your team members. Frankly, the greater disparity between the ages and incomes of the practice owners and employees, the more efficient your retirement plan contributions become. Be sure to work with qualified advisers, like your CPA and a certified financial planner. Often, they will hire a retirement plan administration firm called a TPA (third-party administrator).
Let’s consider two scenarios.
1. Many practices offer a SIMPLE IRA, allowing employees and their employers to contribute to traditional IRAs through payroll deduction. Long a favorite of CPAs and small-business advisers, a SIMPLE IRA is ideally suited as a start-up retirement savings plan for small employers that don’t sponsor a 401(k) or profit-sharing plan.
The annual salary-deferral limits are $13,500 for anyone age 49 and under, and $16,500 for anyone 50 or over. In addition, the employer is obligated to contribute to each employee’s account (and their own) an amount equal to either 2% of a person’s wages or a matching contribution of up to 3%.
- Inexpensive to set up.
- Easy to operate.
- No discrimination test.
- Employees share responsibility for their retirement funding.
- Much lower contribution limits than other types of retirement plans.
- Employees can empty their accounts at any time (subject to taxes and a 10% IRS-imposed penalty if the person is under 59½).
- No Roth provision.
- No profit-sharing component.
- No ability to customize the plan to benefit key employees or classes of employees.
- Cannot include a vesting schedule for employer contributions.
Is a SIMPLE IRA the right retirement plan for your veterinary practice? Consider this case study:
A practice has two equal partners, both in their mid-50s, who plan to hit it hard for 10 more years. They employ two other veterinarians and a staff of 20. Their practice is profitable, and they own the real estate. The partners believe they are underfunded and ill-prepared for retirement. Over the past 15-plus years, they funded a SIMPLE IRA plan to the maximum.
As advisers, we take an employee census and run projections. Turns out this practice would benefit from a 401(k) plan.
Under a Safe Harbor 401(k) plan that includes a cross-tested profit-sharing provision, the partners could nearly triple the amount they contribute annually, from $20,000 to $60,000. This means their retirement account balances will grow three times as fast.
The upfront cost to implement a custom 401(k) plan is less than $5,000. The sum of the required profit-sharing contribution for employees plus the annual administration and tax filing fees is less than the annual income tax deduction the partners will receive for funding the plan.
2. Your 401(k) plan is through a bank, payroll company, insurance agent or stockbroker. Chances are it’s not customized, so the profit-sharing component is not tailored to your situation and therefore inefficient.
Here’s what we mean: Often, practice owners set up a 401(k) because they’ve outgrown the SIMPLE IRA by bumping up against contribution limits. The problem is, 401(k) plans from a bank, payroll company or insurance provider often do not contain customized provisions. Think of it as a 401(k) in a box. Thus, most practice owners will never make a profit-sharing contribution because it’s not efficient.
Many 401(k) plan documents are drafted with a generic profit-sharing formula. This often means that any tax-deductible profit-sharing contribution by the practice will merely be shared by all employees, including the owners, in a calculation based on compensation. So, if the owners’ compensation is 20% of total wages, the owners receive 20% of the profit-sharing deposit. We would deem this inefficient, and most CPAs would counsel their client against doing it.
With a customized 401(k) plan document, you can have a profit-sharing formula that benefits the owners and other highly compensated employees. This is where the services of a certified financial planner and third-party administrator become essential. A custom formula using provisions set forth by the IRS could facilitate a much larger percentage of the overall profit-sharing going to the owners and key employees.
Comparing the Pair
Consider these two plans for a two-owner practice client:
401(k) IN A BOX FROM A PAYROLL COMPANY
After three requests to the payroll company to see a profit-sharing allocation, the practice owners learn that a $75,300 contribution is required, of which the two owners will receive $37,450. Less than 50% goes to the owners.
Email from the payroll company states: “Here is your profit-sharing calculation.” The response from the practice owners and their CPA: “Not worth it.”
401(k) WITH CUSTOMIZED PROFIT-SHARING LANGUAGE
Unprompted, the third-party administrator provides the practice owners with a projection showing that a profit-sharing contribution of $42,695 is permissible, of which the two owners will receive $37,450. Nearly 88% goes to the owners.
Email from the administrator and certified financial planner: “This is incredible. 88% goes to the two owners. Wow!”
Response from the CPA and owners: “Let’s do it.”