Money Breakthrough Financial Planning

This article was originally published on dentaleconomics.com.

THE NEW YEAR brings with it both good and bad news for dentists as they plan ahead for taxes and retirement.

Each year, the IRS announces cost-of-living adjustments (for everything from tax brackets, to the standard deduction, to personal exemptions), various phaseouts, and retirement plan limits.

There were few changes from 2015 to 2016, but 2017 is another story, with a significant increase in Social Security tax and a modest bump in certain income limits that may affect your retirement planning.

Social Security

The Social Security wage base rose from $118,500 in 2015 and 2016 to $127,200 in 2017.

This is bad news for those who have to pay the higher tax, but good news for those of us who anticipate receiving Social Security benefits in the not-too-distant future.

Social Security tax is 12.4% of wages up to the base, with half paid by employees and half paid by their employers (in other words, 6.2% each).

For employees earning at least $127,200, this means a $539 increase. An equal amount is paid by the employer for a total increase of $1,078.

Independent contractor dentists pay 100% of their Social Security tax. There is no ceiling on wages for Medicare tax, which is 2.9% (1.45% each from the employee and employer).

Retirement Plans

Eligible compensation is the amount used to calculate retirement plan contributions. It increased to $270,000 for 2017, up from $265,000 for 2015 and 2016.

This increase means an additional $1,000 can be contributed to some retirement plans. IRA contribution limits remain unchanged at $5,500, plus an additional $1,000 if you are over 50.

Which retirement plan is best for you?

Like most things, it depends. Let’s look at some common, although not exhaustive, examples.

Dr. White

A Roth IRA, which grows tax free, would be a powerful wealth accumulation tool with so many years left until Dr. White’s retirement. Traditional IRAs grow tax-deferred.

If Dr. White is eligible for a retirement plan at work, she needs to be mindful of income limitations that can affect her IRA contributions.

Dr. Black

Dr. Black has been an associate in a number of practices for the past few years and is very motivated to save. If he is an employee, he has the same IRA choices as Dr. White.

However, Dr. Black is an independent contractor and so has additional options. Dentists in Dr. Black’s position might consider a SEP IRA, into which larger amounts may be contributed.

The calculations are tricky for a sole proprietor, but if Dr. Black earns $200,000, he may put close to $38,000 into his SEP IRA. That contribution will save him about $10,000 in federal tax.

Dr. Brown

Dr. Brown is in exactly the same circumstances as Dr. Black, but selected an individual 401(k) plan instead of a SEP IRA. This enables her to “defer” $18,000 into the 401(k) plus profit sharing using the same math as Dr. Black’s SEP IRA.

Since the maximum contribution allowed to the plan is $54,000, Dr. Brown is limited to a $36,000 profit sharing contribution on top of her $18,000 401(k) deferral.

This is $16,000 more than Dr. Black can put in his SEP IRA and saves Dr. Brown $15,000 in tax.

Dr. Gray

Dr. Gray has a private practice with four full-time employees and three dental hygienists who each work two days per week.

Dr. Gray wants to save as much as possible to achieve his financial goals and, with the help of his advisor, has selected a 401(k) profit sharing plan.

His wife, Mrs. Gray, helps with bookkeeping and social media for the practice and receives a salary of $30,000 per year.

For the sake of simplicity, let’s assume the four full-time employees all earn $45,000 per year and the hygienists all earn $40,000. Dr. Gray, 53, earns $360,000, so he will be able to maximize his contribution at $60,000 ($18,000 401(k) $6,000 catch-up $36,000 profit sharing).

To be eligible to participate in the retirement plan, employees must have one year of service with at least 1,000 hours on the job. The full-time folks have sufficient hours, but what about the hygienists?

Two of them have always worked two days per week and are not eligible. One hygienist worked three days per week for several years before cutting back.

Because once you are in the plan you remain in the plan, she is eligible to receive a profit sharing contribution. Mrs. Gray, also 53, defers $24,000 into the 401(k). Assuming staff contributions equal 8% of their wages, Mrs. Gray receives a profit sharing contribution of $2,400 ($30,000 × 8%).

In all, she and Dr. Gray have a total of $86,400 going into the plan. The contribution for the rest of the employees comes to $17,600.

As long as the tax savings is greater than the staff profit sharing contribution, Dr. and Mrs. Gray are way ahead on an after-tax basis.

This math works out very well for the Grays. They deduct $86,400 for themselves plus $17,600 for the staff for a total of $104,000. Their portion is 83% of the total.

In a 33% federal tax bracket, they save about $34,000 in tax. As long as the tax savings is greater than the staff profit sharing contribution, Dr. and Mrs. Gray are way ahead on an after-tax basis.

Dentists should review their retirement savings options, as well as any potential plan funding obligations, with their CPA/wealth advisors each year to avoid surprises at tax time and so that the best possible result may be achieved.

photo credit: Thomas Hawk Dentistry via photopin (license)