Scout said:
I've not heard of the defined benefit plan! Sorry guys I've spent the last 14 years focusing only on medicine so forgive my naivety.
No problem Scout!
Everyone on this forum came here knowing something no one else knew, and sharing that knowledge...whether that made this forum a better place, or it just means it's a ceaseless pit of idle chatter and useless knowledge floating around like atoms swirling around a forming star remains to be seen.
Scout said:
I am an independent contractor. I'm an emergency medicine doc working for a large staffing organization. I get paid a salary only so I have set up my own tax payments, health insurance, disability, etc. The trick is figuring out what all you can write off.
I do max out my SEP at 42,000 and (now that I have my other loans paid off) save an additional 56,000 through my personal accounts yearly. Of course, the additional 56,000 comes after taxes unfortunately!
My wife is also a physician in the same exact situation. We keep our accounts seperate.
1st question - do you have a CPA doing your taxes, or do you do them yourself? If you do them yourself, how much time have you spent researching your various ins and outs of being an independent contractor? If you have a CPA, how did you wind up chosing them over the other hundreds in the phone book?
It sounds good that you're an independent contractor - lots of options here.
For starters, the Defined Benefit Plan is for companies (or independent contractors) that want to start a good old fashioned pension plan for themselves. Why would someone want to do that, when throngs of companies are abandoning them?
They abandon them because they can require great sums of money. However, remember that this money is deducted from your income.
Right now, in 2006, the limit you can stash away in you and your wife's SEP IRA is 44,000 each. However, with a DBP, YOU (and your wife) determine what "annual pension" you want to give to yourself and her. It can be any formula you want - it can be simply:
1) Equal to your last year's salary before you retire
2) Some complex, convoluted equation of (for example) # years of service x 2% x average of 3 highest years of salary equals your annual pension at age 65
3) anything in between of 1) and 2).
one of the few limits is that your annual pension CANNOT be greater than some large number (it increases from time to time. The 2007 limit is a whopping $180,000 as noted in this IRS bulletin:
http://www.irs.gov/newsroom/article/0,,id=163616,00.html )
That means when you and your wife retire whenever, your plan cannot estimate your annual benefit payout to be more than $180,000 for you and $180,000 for your wife.
So why is this a great thing?
The easiest way to analyze pensions and conceptulaize it is to think of it in terms of an annuity (since that what many pensions wind up being). Think of it as your pension plan buying you an annuity when you turn 65 (OR, whatever age you so desire when you set up your DBP). That means, your DBP has to have enough money to purchase an annuity at your magical retirement age for whatever your annual pension will be.
For instance....a man who is 55 years old and wants to "buy" a pension (annuity) that pays out the limit ($180,000 a year) for the rest of his life would have to fork out roughly $2.5 million (source: immediateannuity.com). Granted, if you shop around, you'd get better rates, but this is just a back-of-the-envelope calculation.
So that means the defined benefit plan would need to have $2.5 million in cash when you turn 55 to buy that annuity to pay you $180,000/year for the rest of your life. (you determine the age at which you can start collecting your pension). Working backwards, an actuary would tell you what your pension plan will need to have in annual contributions to reach that $2.5 million stash if you start today and end at your arbitrary retirement age.
Negative notes on the above:
1) I mentioned an actuary. You do need a certified actuary to do the calcs and fill out the IRS form. Not a huge deal, but it will cost perhaps $5,000-$8,000 the first year to set up the plan and fill out the forms, then perhaps cost $5,000/year (perhaps less) to pay the actuary to fill out the annual IRS forms and check the balances and do some more annual calculations. (note: the costs to pay the actuary are TAX DEDUCTIBLE)
2) You will decide how the defined benefit plan assets are managed. You can plunk them into a mutual fund of your selection, or you could pick individual stocks/bonds/etc. POTENTIAL DANGER: If you choose poorly, and your DBP assets drop from what they need to be to reach your retirement age, YOU WILL HAVE TO CONTRIBUTE MORE to bring the balances up to where they need to be, in addition to your annual contributions.
3) If you ever hire anyone else (don't really know if that would be possible, given your independent contractor status), you would have to offer them the same pension calculation you do for yourself. Given that, I would recommend that you focus your pension calculation on annual salary (since it would be unlikely that they would make nearly as much as you).
BENEFITS of the DBP:
1) It's not forever - you are free to stop the plan at any time (although, if you stop it after just 20 days, you will likely arise some suspicion from the IRS). If you decide to cancel your Pension Plan, you simply roll the pension plan assets into an IRA, and treat it like a normal IRA (with RMDs, SEPPs, etc.).
2) Depending on your location, IRA's/retirement accounts sometimes offer better asset protection. So, more of your assets would be locked into your IRA and potentially not have as much lawsuit exposure
3) You can sock away BUKU bucks to meet the funding requirements of your equation - far more than the $44,000 (current) annual SEP contributions. For instance, take the following assumptions:
-You earn 5% of your highest income per year of service, with the max being the $180,000 annual pension allowed by current law
-YOU can set the assumed investment gains in your DBP with a certain range (such as 5% or thereabouts)
-Work 10 years and you have earned 50% of your highest income as an annual payout (5% per year of service). Assuming this would put you at 43 years old, that means that your pension plan, when you turn 43, needs to have enough in investments to continue to grow at 5%/year to buy that annuity paying out $180,000/year when you turn 55. For simple illustration purposes, to have 10 years of contributions (age 33-43) and also having enough at age 43 to be able to buy a $2.5 M annuity at age 55, you'd need to contribute (approximately) $100,000 per year, assuming a 5% annual return. At that rate, you'd be able to sock away roughly $100,000/year to your defined benefit plan and deduct that against your taxes - over twice what the SEP would allow you to put away/deduct.
NOTE: The above are only very rudimentary, rough estimates and calculations. Someone who has defined benefit plan experience will be able to give you more realistic/accurate guesses.
On another note - what kind of health insurance plan do you have? I smell the possibility of an HSA brewing here
