Big corporate pension plans may be just what the doctor ordered.

These days, even self-employed physicians with no employees, or practice owners with fewer than five employees may want to consider defined-benefit pension plans to maximize the amount of money they save for retirement, and at the same time provide an important benefit to their employees.

Save $100,000 or more per year

Defined benefit plans can help eliminate one of the major hurdles of traditional small business retirement plans–an annual contribution limit that often is below what many physicians need to put aside for their own retirement.

Some of the most commonly utilized retirement plans for physicians and other small businesses, such as SEP and Profit Sharing plans, are defined contribution plans, which by law limit annual contributions to $42,000 (in 2005) per participant annually.

Defined benefit plans allow tax-deductible contributions that can be as much as $100,000 or more each year–often more in line with what many physicians will want to save for their retirement. Defined benefit plans can therefore allow physicians and business owners to build up retirement assets faster than they would under most other plans.

Choose the annual benefit

With a defined benefit plan, the physician or business owner chooses the annual benefit (i.e. annual income) that will be provided at retirement. The plan’s benefit formula is set when the plan is established. The practice or business is then required to make the annual contribution needed to ensure that the goal is met for each eligible employee.

For example, let’s assume a self-employed physician, age 52, is earning $210,000 annually and intends to retire at age 62. Because of his age, income and intended retirement age, he is permitted by the tax code to contribute enough money to pay a benefit at retirement of up to $170,000 per year (this annual limit is adjusted periodically by the IRS). If he has employees, he will also need to fund their retirement benefits as well. If the employees are younger and earn less, the contributions made on their behalf can be significantly lower.*

An actuary, an individual retained by the plan provider to perform defined benefit calculations, determines the amount that needs to be contributed each year in order to fund all the retirement benefits, which are deducted from income as business expenses.

Physicians and practice owners will want to consult their tax advisor about the amount they can comfortably contribute each year, and determine their plan’s benefit formula accordingly.

Understand the Plan’s Requirements

A physician or practice establishing a defined benefit plan is making a commitment to fund the retirement benefit, therefore, annual contributions to the plan are mandatory, regardless of the performance of the practice. A defined benefit plan should only be considered by practice owners who expect to be able to maintain the plan until the practice owner’s retirement. The practice owner should have steady and substantial income and be comfortable committing to the required annual contributions. The required annual contribution could decline if investment returns exceed the actuary’s assumptions, but can also increase if the actuary’s assumptions are not met.

If the business circumstances change after a number of years (generally no sooner than three to five years), the practice owner can consider changing the benefit formula or terminating the plan, but the plan will be subject to IRS rules on plan excesses and shortfalls.

Contributions to a defined benefit plan are deducted from income as a business expense, which could potentially lower the practice’s tax liability. Distributions from the plan are eventually taxed to the recipient, usually at ordinary income tax rates. However, the plan can provide that if terminated, participants can roll over the assets attributable to their benefits to an IRA, which can allow for continued tax-deferred growth on the assets.

When is a Defined Benefit Plan Appropriate for a Practice?

Practice owners should consult with their financial and tax advisors to evaluate whether a defined benefit plan may be appropriate for their practice. A defined benefit plan may be suitable for self-employed physicians or small practice owners who are in their late 40’s, 50’s or 60’s and interested in contributing more than the $42,000 per year, for themselves and their employees, if applicable, that SEP and profit sharing plans permit.

If a practice has employees that meet the plan’s eligibility requirement, actuarial assumptions will be used to determine to determine the total contribution to the plan on behalf of all employees, and how much of the contribution will be allocated to each of the employees.

This article intended to provide a general discussion of defined benefit plans for small business owners. Neither UBS Financial Services Inc. nor any of its employees provide tax or legal advice. You must consult with your legal and/or tax advisors regarding your specific financial situation.