Episode J - Just For You! (Dentist, two owners, 15 employees)

If you're a business owner and Google "qualified retirement plan", you get over 62million hits - how would you ever be able to figure out which plan is best? 

We'll do it for you! 

We take our 25+ years of experience, and let you know what's out there, the pros and cons of each, and why you may want to choose one plan over another. We also discuss using life insurance within the plan to cover part, or all, of a buy/sell for the owners.

This episode uses a dentists' office as a case study, with two owners and 15 employees. This could also apply to any other office with a similar structure - a few owners, and more than a few employees! 

Interested in seeing a proposal specifically for you and your business? Contact us at  MonarchFinancialAdvisors@gmail.com - proposals are provided at no cost to you,

Transcript

Welcome to Retirement A to Z, I’m Sue Burnett w Monarch Financial Advisors, and this series focuses on qualified retirement plans. There are a lot of moving pieces with these plans, and the rules are complicated and complex, so we’re going to break them into smaller pieces – 26 pieces, to be exact, from A to Z, with maybe a few extras thrown in for good measure. 

This is one of the Episode J’s  – just for you! We’re focusing on what retirement plans are appropriate for a particular business, based on answers to a few simple questions: what industry are you in, how many owners do you have, and how many employees do you have. That’s it! If it’s just you and your spouse, that counts as no employees, by the way – your spouse would be considered an owner, solely because they’re married to you. 

In this episode, we’re going to focus on a dentists’ office. There are two owners, and 15 employees with varying job responsibilities – there’s hygienists, receptionists, billing folks, an office manager – and in total, 15 people are working there. Three of them are there part time, which is less than 1,000 hours, and the others are there full time. 

Quick fun fact about dentists – the first dentist in history was in 2600 BC. The tomb of Hesy-Re, an Egyption scribe, includes the title “the greatest of those who deal with teeth, and of physicians”. Dental hygiene was important even way back then! 

 I’m going to start off by making a few assumptions. First, is that we want to get as much of this contrib as possible to those two owners. This means that if $100,000 is being contributed, we’re aiming to have at least 80%, if not 90%, of that going to them. This is legit, and is more than possible if two things happen – first, the two owners are older than most of the staff, and second, if their pay is higher than most of the staff. Now, the pay comment may sound funny, but if the business is a S Corp, or a LLC taxed as a S Corp, it’s possible that the owners are paying themselves a low W2, and taking the rest in distributions. Well, we can only count W2 for the owners as compensation here, not total income, for our calculations. Sometimes we need to increase the W2 for a few years in order to get the owner’s benefits as high as possible – we can work with the owners, and the CPA, to figure out what makes the most sense.  

If our assumptions are correct, the first thing we would do is exclude the employees that are working less than 1,000 per year. That brings the number of employees down to 12. 

There are then only two options for this office. The first would be to have a profit sharing plan. This plan is a defined contribution plan, where each year, the two owners decide what contribution amount should go in. It can be as low as $0, or as high as 25% of total payroll, or somewhere in the middle - the overall amount is flexible from year to year. If your business wants, or needs, flexibility with how much is contributed, this is a great option. In a profit sharing plan, it’s possible that we can give 25% of pay to the owners, and only 5-7% to the employees – there’s a lot of math involved in this, and the plan will need to have a Third Party Administrator, or TPA make sure the plan passes all of the required tests. Administration costs run in the $1500-$2500 range. I’ve seen plans where 95% or more of the contribution goes to the owners, and remember, that contribution is a business contribution, which is 100% deductible to the company. The contribution needs to be made by the tax filing date with extensions in the next year, but no later than September 15 – so, for 2020, you’d have until you file your taxes in 2021 to make the contribution. 

These plans are great for their flexibility, and a 401(k) for the employees can be added if the owners want the employees to be able to contribute. There are a few disadvantages – first, there is an administration cost – but this cost is also deductible, so it’s generally worth it, in order to maximize the owner benefits and minimize the contributions to the employees. Next if you want to contribute more than 25% of your pay, or more than $57,000 in a year for each owner, you can’t do that. Finally, there’s no guarantee as to what this balance will be at retirement, because you could put in a lot in one year or nothing the next.  So if those last two are an issue for you, we need to move onto option 2 – a cash balance plan, layered on top of a profit sharing plan. 

A cash balance plan is a defined benefit plan, where there’s a guaranteed benefit at retirement, based on a formula in the plan document. Contributions can be upwards of $250,000 per year for each owner, if their ages and pays allow for that. These really help accelerate their retirement savings, and will help provide a known level of income when the owners decide to retire. This plan is combined with a profit sharing plan for all of our testing, to be sure the plan doesn’t discriminate too much in favor of the owner – it’s usually called a combo plan. Most of the benefits for the owner are in this cash balance plan, where we have the nice high contribution amounts, and most of the benefits for the ees’ over in the profit sharing side. The amounts for the employees may increase a little bit, but the amounts for the owners can increase substantially, because that cash bal plan has a much higher contribution – and much higher deductions. If the business is looking for larger contributions and deductions, this plan would be the way to go. So what’s the down side? The owners  have to make a contribution every year, and there will be higher administration costs because two filings and additional testing need to be done. We would set the overall contribution to be in a range that the owners and their CPAs are comfortable with, and we can always put more into the profit sharing side or into the 401(k) account if there’s a good year and the owners want additional deductions. 

Here’s another piece of trivia about dentists – in 2019, there were 200,419 dentists working in dentistry in the US alone. There are almost 704,000 across the globe! 

Note that I didn’t say anything about a SEP here. SEPs are great if there aren’t any employees, but a SEP doesn’t really work for a business like this for a few reasons – first, a SEP requires that the same percent of pay is contributed for each person, including owners, so there’s no skewing the benefits to the owners. A PS plan allows different contributions by participant, so we can give more to the owners – a lot more – as long as it passes testing. Next, a SEP doesn’t allow employee contributions, so if youre looking to add a 401k piece, that can’t happen. SEPs are immediately vested, which means that if an employee has only worked there a year, gets a contribution, and quits, they can take the whole amount with them. PS, and CBs, allow vesting, which means employees need to work for at least 3 years (if not more) to get their entire contribution. And finally, if a business has a SEP, they can’t have any other QP – so, no CB would be allowed for those add’l contribs and deductions. If you’re looking to maximize retirement savings and deductions, a SEP falls short. 

One addl point I’d like to make is that with 2 owners, generally a business would have what we call a buy-sell, which could be funded with insurance on each of the owners. If an owner passes away, the other owner uses the insurance money to buy the business shares back from the spouse. Generally, buy sells are paid for after-tax – so, no deductions are allowed. With a CB or a profit sharing plan, insurance can be used as an investment – which means that part, or all of the buy sell can be funded with in the plan, and the business would get a deduction for the life insurance premiums. If the owners don’t have a buy sell, and are looking for more deductions, this is a great way to pay premiums pre-tax, and have a majority of the death benefit also be paid to the business without being taxed. There’s more about this in Episode B for businessplanning, and Episode L, for life ins in a plan. 

Wrapping it up – there are really 2 choices for an office with a few owners and employees when it comes to qualified retirement plans – a profit sharing plan with or without a 401k piece, which is easy and flexible, or a Cash balance plan plus a profit sharing plan to give the owners higher contributions, higher deductions, accelerated retirement savings, and possibly deductible life ins premiums for a buysell. Which is best for you? Depends on your cash flow, and how much you’re looking to contribute. Give us a call and we can run some proposals for you to see how things shake out – there’s no charge for them, and it’ll give you a sense of what’s possible. 

Wanna learn more? Tune into the other a to z podcasts where we continue to break down these wonderful and complex plans into bite size pieces. Remember, how do you eat an elephant? 1 bite at a time. Have any questions? Shoot me an email at MonarchFinAdvis@gmail.com. Thx for listeining in and have a great rest of your day!