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Educational Financial Planning for Physicians and Medical Profdessionals

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Maximizing your Retirement Contributions

I often get asked about the best way to maximize tax-advantaged retirement contributions. Many are under the belief that the maximum they can contribute is the $17.5k through their 401K or the $5.5k through their IRA for the year 2014 (not including catch-up contributions for those over age 50).

While that is generally true, there is a way to contribute more if you have your own small business. This applies even to those who have a one-person LLC or sole-proprietorship! (Keep in mind, you can’t just open a “shell” company with no earnings, because a lot of the benefits apply only if your company is making some money.)

However, if you do have a legitimate small business, then the way to contribute more to your 401K or IRA is through the Solo/Individual 401K or SEP IRA. Both of them enable you to contribute upto $52k through the addition of employER contributions. In the case of a Solo 401K, you would contribute $17.5k as an employEE for which you would receive your usual pre-tax salary deduction. Then you could contribute the additional $34.5k as an employER for which your “company” would receive a business deduction. Not to mention the overall tax savings of having your employee and employer contributions grow tax-free until retirement, no matter how many stock trades or capital gains you earn.

A SEP IRA works similarly, except for the fact that all $52k would be considered employER contributions. In addition, a SEP IRA has a lower deferral rate so you would have to earn a lot of income to get the maximum $52k deduction whereas with a Solo 401K you could qualify sooner. But if your income is high enough, either the SEP IRA or Solo 401k will enable you to defer the total $52k.

The other way to sneak in more retirement deductions is a rarely used “Defined Benefit Plan”. In this case, amounts of upto $255k could theoretically be deferred based on actuarial calculations. A Defined Benefit Plan defines a “fixed benefit” or monthly amount — similar to a pension — that you will need in retirement. Then, based on assumptions about market performance and the number of years left to retirement, a tax-deferred contribution is made every year to be invested towards that goal. However, unlike a Solo 401K or SEP IRA which are relatively easy to set-up and administer, a Defined Benefit Plan is very expensive and difficult to maintain, and minimum contributions are usually required each year to keep the plan in compliance. Theoretically the plan could be stopped and funds rolled over into a traditional retirement account if needed, but if this route is pursued you want to plan to have all your I’s dotted and T’s crossed so as not to incur any penalties for missteps.

For many of us, the $17.5k contribution to our employer sponsored 401K is enough — even if we could save more, oftentimes bills and those must-have vacations take precedence. But if you do have spare cash and want to take maximum advantage of the tax-deferred benefits of a qualified retirement account, then a Solo 401K, SEP IRA, or Defined Benefit Plan may be something to consider.

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