Investing: 401Ks and Other Retirement Plans

Hey, associates, continuing on, be explosively successful as a new practice owner. Let's talk about the subject of 401k and other retirement plans. When we say retirement plan, I don't want you to think talking about a projection for when you're going to retire and meeting with a financial planner, all that stuff. No, I'm talking about a practice or a business retirement plan that's going to be a 401k, that's going to be what's called a SEP IRA, a simple IRA, a defined benefit plan. We're going to talk about those, distinguish between them a little bit. Then I'm going to bottom line for you. What I highly recommend is the best approach to setting up and funding your or the type of retirement plan in your practice. But first I want to emphasize how valuable this is. Because in your dental practice, there's things that you can deduct and there's things you can't deduct. You can't be deducting.

You'Re a lawn mower and your pool person at your house. You can't be deducting personal expenses through your corporation. You can deduct your labor lab supply, facility marketing and some mills, some automobile costs that are being used for the practice, the interest on your debt. But you're sort of limited and you get to one point where you just run out of the ability to get further deductions. And if you get too creative and let some people come in and try to give you some ideas on taking certain tax credits and setting up this entity over here, trust me, you're going to run into problems, likely with an audit and avoid the tax shelters. Let's do this straight and get the right tax deductions that you can. Because your goal isn't to eliminate taxes. Your goal is to pay the right amount of tax. We talk about that. But your goal is to not pay any more taxes than you should should be paying, that you really are obligated to be paying as a citizen, using all of the public services and public amenities that are out there. But we don't want you to pay a dollar more than that. Well, one of the most legitimate silver bullet ways to reduce your taxes is to fund an appropriately designed retirement plan for your practice. And I say appropriately designed because these retirement plans can get a little bit complicated. And there's ways to structure and design these retirement plans. And some of those designs are going to be horrible and they're going to come with higher staff costs. You're not going to be able to fund the amount that you want, you're going to fund some and then it's going to get kicked back to you because it didn't follow the rules around these types of retirement plans. So let me go over this for you. Distill it down to something more clear and bottom line it for you. I want to start off by just emphasizing the way this works right now. As you pay money to the irs, you pay that tax rate every, every, every year. Might be 50,000, might be 150,000, might be more, depending on how much you're making. But there's a lot of money going to the irs and the IRS is your biggest friction. Taxes are your biggest friction to becoming financially independent. And so we have to have a specific plan around how you're dealing with your taxes. So hopefully you're meeting with your tax person doing tax planning. If you're working with practice cfo, it's just a part of of the job. We're always doing tax planning as we do your cash flow and global planning. It's that critical. Now what we want to do is figure out a way to reroute money that would be going to the IRS and make that go to you. Now with a 401k, it goes to you, but it goes to the future you. And that's okay because you need to be paying the future you so that when you get there to be that future you, you're thinking, I've done it. I've saved up a pile of assets, a pile of cash, and this is going to now take care of me so I don't always have to be in the operatory doing treatments. So the 401k is going to allow you to divert that money into the 401. It goes to you now when you pull that money out. When you're retired at 55, 60 or 70, when you pull that money out, unless you made what's called a Roth 401k contribution or most of you are going to be paying taxes on the money when you pull it out. So you're thinking, wes, well, I'm going to pay taxes on it, so is it really worth it? Yes. Because number one, wherever you can defer taxes, you start to edge out the irs. You start to beat the irs. We want to defer taxes and the government knows that their Social Security system is going to run into a brick wall here over the next 15, 20, 30 years. They know that. And so they're trying to incentivize you to self fund your retirement. That's why they're allowing these retirement plans now. 401ks. The sweet spot, or the sweet spot as a business structure for 401ks is a standard dental office where you've got maybe seven, eight employees, full time employees, maybe you got a couple part timers in there and then you got the doctor. Why is that a sweet spot? Because you can fund so much. You can have a high ratio of the money going out of your pocket going to you, a smaller amount going to the staff. And it's not that you don't want to fund the staff and help them. That's not it. It's that for it to be viable and to work, we need 70% or more right around there going to you. And as you get older, your cash flows are good. And depending on the amount of staff you have, I've seen that get all the way up to 95% of every dollar going out of your pocket is going to you and maybe your spouse who's on payroll. And that's a great scenario to be in because you're getting tons of tax deductions for paying your future self. It's a great equation. So you get deferred taxes, you get compounded interest on those deferrals over time. And we'll show you in one of our financial planning modules how over time the larger share of your growth comes from compounded growth. And if you're in a taxable account, I don't mind you being in a taxable account, but I prefer you to be in a tax deferred account because all the taxes you would have paid every year are now staying in and they're growing interest and dividends and capital gains on itself. Compound growth is one of the magics of math and 401ks allow you to have more of that. The third thing too is that it will keep you as you fund the 401k, it will both keep you in a lower tax bracket now, because whatever you fund into your 401k is coming off the top. So it moves you into a lower tax bracket on those dollars that would have gone to the irs. Plus, when you're retirement, I can't guarantee this, but when you're in retirement, it's most likely you're going to be on a lower tax bracket because you're not earning $300,000 a year or $400,000 a year. You're earning whatever you pull out of your 401 and your Social Security. And if you have some other assets, great, but you're likely going to be earning less. Now, it's possible at that time that, that the general tax brackets are going to be higher, but I suspect that you'll be in a lower tax bracket. At least that's the theory. And generally that has played itself out over time. So that's another benefit is you're exchanging a higher tax rate now for a lower tax rate.

Later. And you can also, and this is really important because of all this, really accelerate the growth in your net worth. It's a lot easier to grow your wealth when you're dealing with with tax advantaged dollars than it is when you're dealing with after tax dollars. That's why real estate can be troublesome. I like real estate, don't get me wrong. A lot of dentists want to build a real estate empire. But just remember, when you take money out of the practice to go buy a rental property, you're paying taxes on that money before you're able to put it in that rental property. So it goes through the tax door and you got 30, 40% tax getting chopped off. And so with a 401k or the right type of retirement plan, you're getting a full tax deduction on that. It's a lot easier to accumulate wealth with pre tax dollars than with post tax dollars. Now there's a few different types of retirement plans and the main ones are a simple IRA, a SEP IRA, a solo 401k, a 401k and profit share plan, and a defined benefit plan. Now there's quite a bit here on this table. You can pause and read through this. But I'm just going to touch on the highlights here is that the simple ira, it doesn't allow you to fund a whole lot. So I'm not a huge fan of that. If all you have is 13,000 bucks to fund, go for it. It's a simple thing to set up. It's low cost. You can put it in some index funds. Great. But usually not my choice because I want my doctors to retire earlier. If Life and funding $13,500, which is your max under age 50, isn't really going to get you there at the speed that I would like you to get there. A SEP IRA lets you fund a lot more. Now these funding limits you see on here are as of 2020, every year they're going to go up just a little bit. But the SEP IRA allows you to do 57,000. There's no catch up, which means after 50 you can do a little bit more for those years. It's $57,000. Well, that's good. That's about this. That's the same as your solo 401k and your regular 401k below that. But guess what, whatever you put in, you have to put that same percentage in for your staff. So it's not a, from a cost standpoint, it's not an efficient one. And therefore you'll see on the very right, I never recommend the SEP ira, even though it is easier to set up and administer than a 401k. You have to put so much in for the staff that it oftentimes just makes it not as feasible. A solo 401k is different in that you can do a solo 401k if you have no employees. If your spouse is on payroll, that's fine. That's the only employee you could have is a spouse on payroll. And this is good for 1099 associates. You can see on the right hand side, 1099 associates with strong income, they have no consumer debt, they're able to really set aside some money. It's very easy to set up a solo 401k and, and they could put $57,000 in there. They can put another $6,000 in there as a catch up contribution as well. So for you solo doctors who may be working as an independent contractor, maybe roving between offices, if that's your scenario, this could be a really good solution for you. The next one is your standard 401k and what's called a profit share plan. And we're typically recommending that those be done together. You, you can do a profit share plan separate from a 401k. But the 401k has this component called the elective deferrals, which is the employee contribution. Then there's the employer contribution. But the employee contribution, you can make dollar for dollar of 100% of your salary up to 20, 20, $19,500. But the total of the employee and the employer contribution, the total is $57,000. Now let me also emphasize going back up a little bit to the SEP IRA and the SEP IRA, you are doing 100% of the contributions. There's no employee putting employees putting any money into a SEP IRA. You're doing 100% of that. Another reason I'm not a big fan of that. But your 401k, your staff can put in out of their own paycheck, which is no skin off your back. That's great. Or you can, and you can match that as well. But the max you could do is $57,000, which is made up of the employee and the employer contribution. When I say employer contribution, I don't mean employer contribution to your staff. I mean employer contribution to you as well as an employee of your own corporation. And then there will be some employer contribution to your staff as well. Defined benefit plans are amazing if you're in the right, if you're in the right circumstance in your career and in your life. These are great for people who are older than 50, 55, they're older by 10 years on average than their staff. They've got plenty of cash flow to the tune of 150 to 250,000 or more dollars per year. And you just want to save taxes. Well, you can save a lot of taxes by setting up a defined benefit plan. These have more rules and they need to be managed carefully. The oversight needs to be very close. We do a number of these. We've never had any problem if they're managed carefully. But they're a great solution for usually the older doctor who's getting closer to retirement and really wants to accelerate that financial independence. The required compensation, this is how much do you have to pay yourself in your corporation? I'm going to assume again that you are an S corporation. If you're a sole proprietor, it's really a function of what your net earnings as a sole proprietor are. Or if you're a partnership, it's a function of what your partnership, your partnership profits are allocated to you. But for your S corp owners, you're taking a W2, a paycheck out of the corporation. Taking draws on the side. But I'm only talking about the W2, what you run through payroll. And for a simple IRA, you can contribute dollar for dollar up to that 13,500. For a SEP IRA, you can only contribute 25% of your income. So if you make $100,000 paycheck through W2, you can only contribute $25,000 into your SEP IRA. A Solo 401K allows you to do dollar for dollar up to 19,500 and then after that it ends up being 25% of your compensation. So it's really around 152,000 plus or minus, where if you pay yourself that much, you can fully fund up to $57,000, your solo 401k and your 401k profit share plan. If you have employees and can't cannot do a solo 401k for a defined benefit plan, we really always want to hit you at $285,000 of W2 now for your 401k and profit share just above that. If you're trying to max your 401k and get the full $57,000 or $63,000 if you're older than age 50, then you're going to also want to try to get your W2 all the way up to 285,000 because how much you have to contribute to the to your staff in part a function by the spread between your W2 and the staff's average W2. The other thing I want to mention here about the staff is that they're only eligible if they meet certain criteria and you can set that criteria as of as of today. It's typically a thousand hours during the year is the most strict sort of eligibility guidelines that you can that you can set. And they have to be older than 21 and a couple other basic eligibility requirements. They can have a waiting period for up to a year with enrollment dates on twice a year. We typically do January and July. Let's go on to staff requirements. What do you have to fund for the staff? Well, for a SIMP IRA it's matching 3% or automatic 2%. For the SEP IRA you've got to do the same percent as you do to yourself solo 401k. You don't have employees so there are no match requirements. If you have a 401k and a profit share, you have two choices. You can do what's called a match which typically ends up being around 4% of you matching them whatever they put in. So they don't put anything in. Great. You don't have to match that or an automatic 3% whether they put anything in or not. You do 3% of their salary. And if you're doing a profit share, that's often the better approach do which I won't go into why here. But that's typically the better approach. And so you'll typically if you have a staff of eight eligible people, you might end up having to put in 15 or 20,000 in order for you to get your somewhere around 60,000. If you put your spouse on payroll and fund it, you might get up closer to $80,000 or so, plus or minus. And that's a great ratio considering it's all tax deductible and defined benefit plan. You do have to put some money for the staff but that's really based on their age and their compensation and some statistical analysis Actuary is typically involved when you have a defined benefit plan. So there's a little bit higher administrative costs on that. So that one's going to be very tailored to whatever the staff situation is. Now, a third party administrator is the one who makes sure that these are compliant with the Department of Labor and IRS laws. And you need this only for the 401k and profit share and the defined benefit plan. You don't need to pay every year a TPA for simple IRA, SEP IRA or a solo 401k. Those are simple and they're easy to administer. You can set the number at Schwab, Vanguard, Fidelity and fund those as well. You do need that third party administrator to do the year end testing for the 401k and the profit share plan as well as the defined benefit plan. If you're with us, we do all that work with the tpa. You don't need to do anything and we sort of come back to you and report what's happening and what we're recommending. There's a few notes there on the side. I sort of explained what some of those are.

And a few more details. So when you get to that point where you've got some surplus cash flow in your practice, now's the time to start thinking about a retirement plan. Financial I bottom line it for you. I typically will say fund your personal IRAs. Don't fund a simple IRA or SEP IRA. Then once you have the cash flow, let's move into a 401k with what's called a safe harbor provision. And then when you have more cash flow, add on the profit share on top of the 401k. So you got both of those things going at the same time. Then when you're really cranking it a little bit older, move into the defined benefit plan. Now I also want to state that this is you got to do this in sequence of events with relative to other things. I generally don't recommend that you paid off your student loans yet until you start funding your retirement plan. Because paying off your student loans gives you zero tax benefit, funding your retirement plan gives you a big tax benefit. So you need to play that tax game. That's usually the order of events is once you bought your practice in your house and are funding your 401k, now might be the time to refinance your federally your federal direct student loans into a private loan and start paying that off. But I typically wouldn't start accelerating payment of your student loans until you're funding your retirement plan. Especially because you perhaps could have some of those student loans forgiven after a period of time based on the rules today. So a lot of context here. A lot of details on these retirement plans. They are a critical part of the path toward financial independence. Hopefully you got some good information out of this one.