Retirement Planning For Dentists: Securing Your Golden Years

Retirement planning is a critical aspect of financial well-being, and dentists, like any other professionals, need to carefully consider their retirement goals and craft a solid plan to achieve them. There are various retirement plans available to dentists, including 401(k) plans, IRAs, and SEP IRAs. Dentists should also consider diversifying their investment portfolios and staying updated with retirement planning strategies, tax laws, and investment options. Consulting with a financial advisor who specializes in working with dentists can be beneficial in navigating the different options available.

401(k) plans

Understanding 401(k) Plans

Advantages of 401(k) Plans for Dentists

One of the biggest advantages of 401(k) plans for dentists is the potential for higher contribution limits. The regular 401(k) contribution limit for 2020 was $19,500, with an additional $6,500 allowed for those over 50. Solo 401(k) plans, designed for self-employed individuals with no employees, offer even higher contribution limits, allowing dentists who own their practices to maximize their retirement savings.

Another advantage of 401(k) plans is the Roth 401(k) component. This option is particularly attractive to dentists who have a high personal income, as it does not have the income limits associated with a Roth IRA. By contributing after-tax income, dentists can enjoy tax-free withdrawals in retirement, potentially reducing future tax burdens.

Safe Harbor 401(k) plans are also worth considering. These plans combine the benefits of a traditional 401(k) with the simplicity of a SIMPLE IRA, making them ideal for small businesses. Safe Harbor plans allow employers to avoid large administrative expenses while still offering high contribution limits. Employers typically match contributions dollar-for-dollar up to 3% of an employee's income.

Implementing a 401(k) Plan for Your Dental Practice

When implementing a 401(k) plan for your dental practice, it's important to seek guidance from experts. Human Interest, for example, specializes in helping small businesses, including dental practices, set up and manage their employees' retirement plans. They offer automated plan administration, in-house record-keeping, and help with IRS testing and government filings.

Additionally, consider the design of your 401(k) plan. You have several options, including safe harbor provisions, employer matching, profit-sharing, and traditional or Roth deferral types. Each of these options has different contribution limits, eligibility requirements, and compliance testing requirements. It's essential to understand these nuances to make the most of your 401(k) plan.

IRA and Roth IRA

Individual Retirement Accounts (IRAs) are a common vehicle for retirement savings. IRAs can be traditional or Roth. Both types of IRAs have their own pros and cons, and it is important to understand the differences between the two before making a decision.

Traditional IRA

For 2024, the annual contribution limit for traditional IRAs is $7,000 (or $8,000 if you are aged 50 or older). Contributions to a traditional IRA may be tax-deductible, and no taxes are due while the money stays in the account. However, when you take money out of a traditional IRA, all the growth will be subject to income tax—and possibly the principal, too—at whatever tax rate you happen to be in at the time. Traditional IRAs do not have an income limit, so you can contribute to one regardless of your income and earnings.

Roth IRA

The annual contribution limit for Roth IRAs is the same as that of traditional IRAs. However, in a Roth IRA, you make contributions with after-tax dollars and receive tax-free growth. Therefore, it is a good option if you would rather pay taxes on this money in the current year to avoid paying taxes in retirement.

Roth IRAs do have an income limit. Most physicians and dentists earn too much to be eligible to contribute directly to Roth IRAs. For 2020, single taxpayers who make less than $124,000 can contribute the full amount to a Roth IRA, while those making over $75,000 do not get a deduction, and if they make more than $139,000, they cannot make a Roth contribution. For married couples filing jointly, the income limit is $196,000 for making a full Roth contribution, and if they make more than $206,000, they cannot.

Backdoor Roth IRA

The "backdoor Roth IRA" is an option for high-income earners who are ineligible to make direct contributions to a Roth IRA. In a backdoor Roth IRA contribution, you make a non-deductible contribution to a traditional IRA, and then convert the contribution to a Roth IRA. This allows high-income earners to still take advantage of the benefits of a Roth account, such as tax-free withdrawals during retirement.

Solo 401(k) plans

As a self-employed individual, you can contribute to a Solo 401(k) plan in two ways. First, as an employee, you can make salary deferral contributions of up to $23,000 or 100% of your compensation, whichever is lower. If you're 50 or older, you can also make catch-up contributions of up to $7,500 per year. Second, as the employer, you can contribute up to 25% of your compensation or 20% of your net self-employment income. The total contributions to your account, including catch-up contributions, cannot exceed $76,500 if you're 50 or older, and $69,000 if you're under 50.

When setting up a Solo 401(k) plan, you will need to obtain an Employer Identification Number (EIN) or use your Social Security Number (SSN) if you are a sole proprietor. It is important to keep detailed records and be aware of any applicable fees associated with the plan. Additionally, if your plan's year-end balance exceeds $250,000, you terminate the plan, or an employee becomes eligible, you may be required to file IRS Form 5500 for tax reporting purposes.

SEP IRAs

A Simplified Employee Pension (SEP) IRA is a traditional IRA for self-employed people and small-business owners, including dentists with their own practices. It is one of the most popular retirement plans for small business owners.

You are not required to contribute every year, which provides flexibility. However, it is important to note that there is no catch-up contribution for savers 50 or older. Additionally, there is no Roth version of a SEP IRA, which means you cannot opt to pay taxes on contributions now and take tax-free distributions in retirement.

Like traditional IRAs and 401(k)s, SEP IRAs require minimum distributions. Beginning in 2023, these must start at age 73. Distributions before age 59½ are taxed as income and subject to a 10% penalty, unless the reason for the early withdrawal satisfies one of the exceptions.

To open a SEP IRA, you can follow the three steps outlined by the IRS:

• Create a formal written agreement using IRS Form 5305-SEP or through your account provider.
• Give eligible employees information about the SEP IRA. You can provide them with a copy of IRS Form 5305-SEP or similar information from your account provider.
• Set up separate SEP IRAs for each eligible employee with the account provider.

Defined benefit plans

Defined benefit and cash balance retirement plans, including Solo Cash Balance plans, allow self-employed dentists to make the largest IRS-approved tax-deductible contributions each year, often exceeding $150,000. All contributions to these plans are tax-deductible in the year they are paid. This means that dentists can reduce their tax liability while saving for retirement.

For example, a physician earning $345,000 annually from the age of 52 can accumulate $3.4 million in 10 years. When the physician retires and terminates the plan, they can roll the assets into an IRA, where they continue to grow tax-deferred until withdrawn.

Traditional defined benefit plans are ideal for solo practitioners or doctors with spouse or family practices. When a medical practice includes common-law employees, a combination of a Cash Balance plan with a Safe Harbor 401(k)/Profit Sharing plan is recommended.

Frequently asked questions