The Power of Employer Sponsored Qualified Retirement Plans

Many dental practice owners offer some type of employer sponsored qualified retirement plan for the dental practice staff and himself or herself. They range from the popular 401k profit sharing plan to the more sophisticated cash balance or defined benefit plan.

Depending on the dental CPA employed by the dental practice and his or her knowledge and experience with these types of plans, a good acceptable legally discriminatory plan can be adopted where most of the benefits are allocated to the owner and the participants that he or she want to have the most benefits. Discrimination is not allowed so a real expert in the design and implementation of these plans is the critical point.

There may be thousands of dollars at stake for the owner with a sophisticated plan design that is legally discriminatory in favor of the owner. Over the number of years that the dental practice is operating, this type of plan design may be one of the smartest financial decisions that the dentist can make. Spending some time with the dental practice CPA—if that person understands what these types of plans can accomplish—may change the dentist’s life at retirement. It may be the difference between a high standard of living at retirement and an amount that is much less and may cause some struggling at retirement.

The following paragraphs will describe the current and long term benefits of these employer sponsored qualified retirement plans in a detailed format so that some new ideas about their use may be learned.

The current benefits for the owners of the dental practice when adopting an employer sponsored qualified retirement plan for the dental practice:

When thinking of the short term benefits afforded to the owners of the dental practice, the first thing that should come to mind are the instant tax benefits that will be accrued. In today’s dollars, the owners of the dental practice will see tax deferrals in the thousands of dollars. There will be an accumulation of assets in the retirement plan of untold amounts of investment dollars allocated in such a way as to create diversity along with good short term and long term investments. These funds will grow on a tax deferred basis faster than the same investments that were made outside of the protective shell of the retirement plan.

An example is a personal investment yielding 4% in one’s own name. If a federal and state tax rate combined was 35% and using $100,000 as an example, what would the net return be when added to the $100,000? At 4% a $100,000 investment would return $4,000. Subtract 35% for federal and state taxes, and the individual investor is left with ($4,000 x 65%= $2,600. (tax is 35%).

Using an employer sponsored qualified retirement plan as a comparison, the same $100,000 investment at 4% would offer $4,000 as a return but it would be tax deferred. At the end of the year, there would be $104,000 in the account using a simple interest format. At the end of year two, 4% earned on the money in the retirement account would be ($104,000 x 4%) = $108,160. On an individual investment at the end of year two, the $102,600 [this figure comes from the first year’s earnings of $4,000 x 65% (net of 35% tax)= $2,600 plus the $100,000]plus an additional $4,000 at 4% net of the 35% tax would be equal to $104,290. It is easy to see in this example comparing the same data that the investment in the retirement account is worth $108,160, or $3,870 more after 2 years, than the $104,290 Think about how the difference progresses over the years. As the funds are withdrawn from the retirement plan, a tax is due. The main point is that the tax will be paid from funds coming from the earnings that would not be available on an individual basis.

An analysis of the earnings but not the tax deferrals from expensing those funds as a deduction to the dental practice every year.

Since an analysis was just completed on the earnings comparison within the retirement plan compared to what an individual would have (above), let’s look at the tax deferral to the owner and the dental practice. If the dental tax deduction was the $100,000 that we used to illustrate the funds available in the retirement plan for investment purposes, what does that mean to the dental practice and owner? Assuming a 35% tax rate for the owner and dental practice, which is probably on the low side, that would equate to another $35,000 for the owner to be able to understand where some of the funds would be coming from to make the $100,000 retirement contribution. The higher the tax rate, the more money would be available from the write-off. If the retirement plan contribution were not made, a great deal of those funds would be used to pay taxes so it would not be in the owner’s pocket anyway. We’ve just looked at the tax deductions and deferred taxes for the owner and the dental practice.

Another option for the dental practice owner for his or her use in the adoption of an employer sponsored qualified retirement plan within the dental practice.

There comes a time when the owner feels it is time to move on from dentistry or at least from his or her own practice. Working full time may not be an optimum choice for dentists at this stage of their careers. Many dental practice CPAs understand the power that retirement plans offer to dentists while practicing as a clinician as well as when heading towards retirement. Just as the prior paragraphs gave some insight as to the short term benefits and if continued, how the same approach becomes a long term benefit, a similar understanding can offer an unconventional method to sell the dental practice with a minimal amount of tax being incurred by the buyer and the seller.

The dental CPA should be the first person to speak with regarding how the retirement plan can assist in creating an exit strategy for the dentist that is a win-win situation for the buyer and the seller. This method will provide an abundance of buyers if the advisors to the dentists understand its significance.