Should Dentist Start a 401k Plan?

I met with our local Edward Jones Financial consultant thinking it would be wise to start a 401K. After going over my financials, he recommended that I consider a safe harbor 401K versus the traditional 401K.

After digesting all the information and running numbers, I just don’t seem to get it.

I understand you contribute pre-tax dollars to fund your retirement, but you also must take into consideration a match for your employees. If you add profit sharing then everyone gets a piece of the action whether or not your employee chooses to match. If you want to add define benefit plan option to your 401K, then you can channel quite a bit more funding but in the end it still ends up divvied up like profit sharing. That’s a lot of money not including administration costs and management fees. Also your money is locked up with penalties for early withdrawal, not to mention more administration headaches. There is also the fear of the unknown when it’s time to take it out if you make it to the qualifying age!

I keep doing the math but I can’t figure out.

Can you please shed some light for a lost soul?

Can you share examples using hypothetical incomes and comparing one who pays those taxes upfront and invest in same retirement funds versus one who does a 401K but add extra expenditures to forming one?

I spoke to my CPA but seem to be on a similar page at this time.

I’ll try to keep it simple:

Let’s say you can contribute $50,000 and you HAVE to put away $10,000 for your staff AND annual administration costs are $3,000. Let’s also assume you’re currently in one of the highest federal tax brackets, and between federal and state taxes your current tax bracket is 40%. That $63,000 deduction saves $25,000 in taxes. So $38,000 came out of one pocket and $50,000 went into the other pocket. You’re ahead by $12,000. Now let’s also assume the $50,000 doubles to $100,000 by the time you retire. Instead of paying 40% on those earnings over that period of time you’ve deferred the tax on those earnings until you retire.

So now you retire and what’s the “average” tax rate you think you’ll pay on the initial $50,000? I’m betting the “average” tax rate will be 20%.; that’s $10,000 in tax upon withdrawal and when you contributed it you saved $20k (40% of tax). Don’t forget the additional earnings on the $50,000 over the years would have been taxed at 40% and now it’s being taxed at 20%, so you saved $10,000 on those earnings, and a total of $20,000.

So the initial $50,000 COST you $13,000 pre-tax (staff and admin), $8,000 after tax, and over the years you saved $20,000 in total taxes. So you come out ahead by $12,000.

Thanks Tim, I knew I could count on you for clarification.

The E.J. consultant did mention LIRPs in our meeting. He mentioned that variable life might be an additional avenue worth doing when you max out your qualify plans.

Now what about adding a define benefit plan versus a LIRP? E.J. consultant mentioned you can sock away a ton more into retirement adding a define benefit when you get to that point. However when is it to that point?

It seems if you add a profit sharing component to your 401K, you are definitely shelling out some money. Likewise having a define benefit plan.

I guess when is it the best time to do a 401K vs. other retirement vehicles and at what income level should you consider these plans to maximized retirement and tax savings upfront and in the long run ? A loaded question, but I’m sure I’m not the only person in the same boat with the same questions.

Your continued questions require personal and specific analysis and suggestions. You seem to be getting this from EJ and at some point you have to select a financial advisor you trust and take their advice.

With LIRP, it’s just another name for socking a ton of money into a life insurance product with after tax dollars; therefore, those dollars better come back tax-free. Certainly the earnings MAY come out tax free; however, your investments better do pretty well to pay the high costs associated with a life insurance product.

Generally I believe life insurance products used as additional savings vehicles only make sense in certain situations. They’re not for everyone; however, they can work well in certain situations.

Doesn’t this imply there won’t be any major changes in the tax code? Don’t know how safe an assumption will be anymore.

Ok. What changes should one assume?

To NOT make assumptions on specific changes doesn’t really imply anything, other than to imply that I won’t assume what changes MIGHT happen.

I suspect in 20 years the marginal tax rates will be higher across the board. I’d rather pay the tax on it now when I know what the rate will be and not chance it to the future. Didn’t capital gains tax go up quite a bit recently? You have to pay for these social programs somehow, eh?

My CPA said the same thing. This year tax he predicts rates for the top brackets, as well as capital gains taxes will be going up 3-5%. Who could have ever imagined that immense social programs would cost money?

I agree, there will be increases in the tax BRACKETS, but also note the other key word MARGINAL.

As of today I don’t have to predict that the tax rates are going up. As of today, the Bush tax cuts are going to expire at the end of 2010 so we KNOW the tax rates are going up AND we know EXACTLY what those rates will be. Now congress might change that.

Long term capital gains are going from 15% to 20%; however, I don’t believe that’s part of the equation if comparing retirement plans vs. LIRP’s. It certainly does if you’re going to compare to basic after tax investments.

I’ve mentioned this before so here it goes again. There’s a HUGE difference between your MARGINAL tax brackets TODAY vs. what your AVERAGE tax RATE will be when you retire (that’s assuming we retain our progressive tax system).

Think about it, all those that are converting to ROTHS in 2010 might be doing so at their TOP brackets of 33 or 35% not including STATE tax rates. If you DON’T convert and you take the taxable withdrawals when you retire, you’ll take that income through all the LOWER tax brackets first and you MIGHT hit a higher MARGINAL tax BRACKET of 40% or 45%. HOWEVER, the AVERAGE tax rate you’re likely to pay is more like 20%-25% (federal) AND many states allow an exclusion of pension income for state income tax purposes. For employer qualified retirement plans, don’t forget the payroll taxes you’ll save on PS contributions AND pension withdrawals aren’t subject to payroll taxes either.

So I believe MANY people are going to pay 40%+ upon their ROTH conversions in 2010 when they could potentially pay 25%-30% when they retire. That’s just my opinion based upon my clients who HAVE retired and are able to stay below the 30% MARGINAL brackets and therefore, pay an AVERAGE tax rate of around +-20% (federal).

This theory applies to any deductible retirement plan. If you can save 30%-35% today and have it taxed at 20%-25% in the future, then you’re ahead of the game. The question is how do these savings (or potential savings) compare to the costs associated with these plans? In many cases you can create a retirement plan that helps minimize the staff contributions, not every time, just many times.

Can you elaborate on this Tim?

Sure. There are different types of retirement plans: IRA based plans, defined contribution plans, defined benefit plans and cash balance plans. Within these plans, a pension administrator can usually write the plan to achieve the owner’s goals, as long as the plan passes certain non-discrimination tests.

For example, with a 401k/profit sharing plan, it can be age weighted, integrated with social security, a “non-comparability” plan, paired with a cash balance plan, safe harbored, etc.
The employee census information will have an impact on how much can be done. I was at a seminar yesterday and they gave an example of a typical dental office, owner between 45-50, average age of staff was around 25-30 and with the basic profit sharing plan only the employees were getting 30% of the pot. Add a 401k and it dropped to 20%. Safe harbor it and it dropped to 15%. Add a cash balance plan and it dropped to below 10%.

Will this happen every time? Absolutely not. You have to look at the census info, the earnings of everyone, hire dates, ages, hours worked, turnover experience, etc. A seasoned pension administrative person for a firm will know what to look at and they’ll look outside the box to try and create something that works the best and passes the test.

The brokerage houses that offer pension administrative services will usually offer the straight and narrow plans. Their pension folks are simply hired to do the annual administration, NOT to look outside the box for each and every brokerage client. THEY won’t come to you with ideas whereas a seasoned pension firms will evaluate the employee census data each year and come to you when they see changes that MIGHT warrant improvements to the plan.

GOSH TIM! This is overwhelming information, at least for me to digest in one pass. Again, I’m kind of fresh on a retirement plan. Only thing I’ve got are Roth and Traditional IRAs.

It’s a lot of variables to consider. Then again we are all dentists, and the numbers for overhead and production are fairly consistent across the boards compared to dealing with a broad customer base.

Does your firm offer something to this nature…

No, we’re not pension administrators and I know just about enough to be dangerous.

…or can you possibly suggest any seasoned pension folks you are talking about. I’m in the market for folks that deliver on time and with good customer service.

I’ve had very good success with this national firm:

You can also do a search in your area for a local company or ask around to the doctors that have been open for 10+ years to see who they might use.

My wife is a solo practice lawyer with no employees. Is it wiser for her to start her own, or can I incorporate her into the office 401K? We have put most of our money in real estate, but I’m ready to go past my max in the 401K and our two IRAs each year. My accountant told me I had to consider a pension plan for 2011 or get killed by the IRS.

Look into a solo 401K or single 401K. I know Oppenheimer has them and this might be perfect for her. If you can fund upwards of $100k+ depending on her age you can ask about pairing it with a DB plan or a cash balance plan.

I would NOT throw her onto yours if she can do her own.

100k!!! Holy crap… that’s the ticket!

Yep. I have an Ortho IC client: works in several GP and Pedo practices as an IC, no employees, with a paired DBPS401k plan. He’s averaged around $175k in contributions over the past couple of years. You have to be able to afford that level of contribution though. I wasn’t aware you could have a DB and PS plan until benetech suggested it.

This first appeared on Dentaltown.

Send your questions to Tim Lott, CPA, CVA at

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