They want to make significant tax-deductible contributions for their own benefit, which will reduce their current income tax bill and serve as a nest egg for their future. At the same time, they are not interested in maintaining a plan if the staff costs are too great. This goal of making significant contributions for owners and other key employees, while keeping staff costs under control, is not easily achieved under the Internal Revenue Code.
The Code generally requires that a tax-qualified retirement plan not discriminate in favor of highly compensated employees. This article discusses how the dental practice owner’s goal can often be achieved, in whole or in part, through the creative use of a “new comparability” profit-sharing plan that satisfies the Code’s requirements.
Traditional profit-sharing plans and Simplified Employee Pension Plans (SEPs) require that a level percentage of compensation be contributed on behalf of all plan participants. As a result, in a traditional arrangement, if the owners of dental practices want to increase contributions on their own behalf, they need to also increase the contributions for their staff.
In a new comparability plan, actuaries use certain IRS-blessed “cross-testing” rules, and demonstrate compliance with the non-discrimination requirements by converting the contributions that are made under the plan to their equivalent benefits under a defined benefit pension plan. All of this is done “behind the scenes” so that the plan is easily understandable by dentists and their employees. Although these tests are sensitive to demographics and do not always yield favorable results, in many situations-particularly, if the group that the owner wants to favor is predominantly older than the rest of the employees-they allow higher contribution rates for the owner and other key employees than for the rank and file staff. In addition, new comparability often provides a plan with flexibility and allows different groups of owners and highly compensated employees to have different contribution rates.
All of this is done “behind the scenes” so that the plan is easily understandable by dentists and their employees
To demonstrate this, assume that there are two dental practice owners and four employees for a total of six plan participants. One of the employees is the wife of one of the owners. The compensation and contributions under a new comparability plan are set forth on the following chart:
The owner who is 46 is older than each of his employees by six years or more. That “age spread” is one of the key components to successfully maximizing the contributions for the owners while minimizing staff contributions.
In our example, a new comparability formula has been devised that gives the owners the maximum allowable contribution under the Code. For 2009, that means a contribution per owner of $49,000. Under the facts in the example, the contribution rate for the owners is 20% of compensation. Applying actuarial cross-testing, contributions for the other employees are set at 5% of compensation. This results in the owners and the wife receiving 94% of the total contribution that is made to the plan and the staff employees receiving only 6% of the total contribution.
Compare this to a traditional profit-sharing or SEP: In order for the owners to receive $49,000, each staff member would have to receive a contribution of 20% of compensation. The staff cost for a traditional plan utilizing the demographics in the case study would be approximately $25,500 versus approximately $6,300 in the new comparability plan. In this example, the new comparability plan design results in a staff cost savings of over $19,000 per year!
Thus, an owner of a successful dental practice who does not yet have a qualified plan should consider establishing one, utilizing a new comparability design. In addition, owners of dental practices who already have a plan should review their existing retirement plan arrangement to see if they are really maximizing their own benefits.
If you do not yet have a profit-sharing plan, or if you have a profit-sharing plan or SEP that uses a formula other than new comparability and you would like to see what new comparability can do for you, kindly contact Andrew E. Roth, Esq. at (914) 948-1556 or at email@example.com.
Andrew E. Roth, Esq. is a partner at the White Plains, New York firm of Danziger & Markhoff LLP.