Stacking Up Your Retirement Cake
The Retirement Plans LAYERS
The basic rules of compound interest mean that you should start funding your retirement funding as early as possible. But for young dentist, the reality of dental school debt and practice purchase debt mean that finding the money to fund a retirement account early can be difficult. The alternative of waiting until mid-career, however, means that you miss out on valuable years when those funds could be growing. To help you understand the retirement fund options available to you, here are the layers of retirement funding accounts you have access to and when they are most appropriate for you through your time as a practice owner:
The IRA (Individual Retirement Account). This is the cupcake of retirement funds, as it’s not a part of the retirement fund cake. It will not really get you big results, but is a great place to start. As the name implies, it is owned directly by you as an individual and not related to any workplace retirement account. While there is no age limit to open an IRA, you must have taxable income to contribute to your IRA. The income must exceed the annual IRA contribution limit (for 2024, the IRA contribution limit is $7,000 for those under 50 and $8,000 for those over 50).
Best For: The IRA is best for anyone who is earning money and does not have access to a company retirement plan that includes an employer match. Ideally, this is the plan you start contributing to in your teens and continue with through dental school.
The 401(k) Layer. While other company retirement plans (like the SEP and SIMPLE) exist, the 401(K) is the base layer of a great retirement cake and the first step in building your retirement funds. As a young associate right out of school and in the employ of another, you should be using that practice’s retirement plan to start building your funds. But as soon as the ink dries on your practice purchase, you need to put your big boy/girl pants on and set up a 401(k) plan for your own practice. The 401(k) allows for a much larger annual contribution that an IRA, SEP or SIMPLE plan (for 2024, the 401(k) contribution limit is $23,000 for those under 50 and $30,500 for those over 50). The administrative costs of a 401(k) are easily offset by the practice tax deductions for company matching and the available tax credits.
Best For: As a young practice owner, you should be doing everything possible to maximize your annual contribution, even though it may be painful at the time.
The Profit Share Layer. This is the next layer on the cake and as the practice owner, you can make it as complex and as big as you want (within the IRS limits). A Profit Share plan is added on top of an existing 401(k) plan and is a employer-contribution only plan. That means that you as the practice owner have flexibility in designing the plan and the amount you want to fund on an annual basis. We usually suggest designing a plan that gives the most benefit to you as the practice owner while still rewarding your team. Warning - The allocation of the profit share to team members is based on complex allocation rules so team members might get different amounts based on age and wage limits and not based on their contributions to the success of the practice. The contribution limits for the Profit Share work in conjunction with the 401(k) plan (for 2024, the Profit Share contribution limit is $69,000 so that would mean an additional $46,000 that you could contribute after you maxed out your 401(k)). As the Profit Share contribution is tax deductible, we generally see the tax savings being equal to or exceeding the team cost portion of the Profit Share contribution.
Best For: Therefore, this layer of the retirement cake make total sense for the practice owner that has paid off practice debt and wants to reward the team and themselves with extra retirement funds rather that writing a big check to the IRS.
The Cash Balance Layer. The top layer of the retirement cake is a much more complex and rarely used option referred to as a Cash Balance plan. All the other layers of the retirement cake are Defined Contribution plans, which means the contribution you make is regulated, but the amount you receive in retirement is dependent upon the success of your investing. The Cash Balance plan is a Defined Benefit plan meaning that the benefit you will get in retirement is set like an old fashioned pension. The Cash Balance Maximum Balance for 2024 is $3.5mil but that is funded over multiple years and is not required to reach that limit. The annual contribution limits are based upon age and you must commit to a minimum funding level over the first five years of the plan.
Best For: Due to the complexity of managing a defined benefit plan, the administrative costs and risks are much higher but if you have entered that phase of your practice were you are consistently profiting over $500,000/year and in the top tax bracket, a Cash Balance should be considered as the top of your amazing retirement cake.