Retirement Plans: What Every Radiologist Should Consider STAT
If you are a young radiologist, retirement may be the farthest thing from your mind—and possibly decades away. You might think understanding the many different types of retirement plans and investing accounts (and all their intricacies) is something you can deal with down the road. You have plenty of time, after all—right?
Hate to break it to you, but wrong! If this is news to you or you missed my last post on investment accounts (part 1 of this 2 part series), you might want to go back and read it before going on to part 2. Previously, I defined some basic terms, like “retirement accounts” and “taxable” (versus nontaxable) accounts, as well as all the different types of IRA accounts (your IRA-IQ should have jumped at least several points).
In this post (part 2), I will discuss the difference between defined benefit and defined contribution plans and describe numerous types of defined contribution plans available to radiologists. And, saving the best for last, of course—some words of wisdom on choosing investments accounts and a retirement plan comparison chart (yay!). Seriously, who doesn’t like comparison charts and seeing all that information broken down into nice little boxes?
Defined benefit and defined contribution plans
In addition to IRAs, there are what are called defined benefit plans and defined contribution plans, covered by a federal law called ERISA (Employee Retirement Income Security Act) that sets minimum standards for most retirement plans in private industry to provide protection for individuals in these plans. In general, ERISA does not cover plans established or maintained by governmental entities or churches. Therefore, ERISA and its provisions do not apply to public pension plans, such as a state teacher’s pension plan, which many academic radiologists are eligible for.
A defined benefit plan (aka, pension) promises a specified monthly benefit at retirement. The plan may state this promised benefit as an exact dollar amount, such as $100 per month at retirement. Or, more commonly, it may calculate a benefit through a plan formula that considers such factors as salary and service. Both private and public sector employers can offer defined benefit plans. However, they are becoming less common in the private sector as they are replaced by defined contribution plans.
The Pension Benefit Guaranty Corporation (PBGC) insures most private-sector pension plans. It does NOT insure federal, state, and local/municipal government pensions, military pensions, pensions associated with religious institutions (including hospitals and schools with religious affiliation), pensions for small professional practices (a doctor, lawyer, or other professional with fewer than 25 employees), 401(k) plans, IRAs, profit-sharing plans, health benefits, employee stock ownership plans (ESOPs), thrift savings plans, or money purchase plans.
A defined contribution plan does not promise a specific amount of benefits at retirement. In these plans, the employee or the employer (or both) contribute to the employee’s individual account under the plan, sometimes at a set rate, such as 4 percent of earnings annually. These contributions generally are invested on the employee’s behalf. The employee will ultimately receive the balance in their account, which is based on contributions plus or minus investment gains or losses. The value of the account will fluctuate due to the changes in the value of the investments. Examples include 401(k), 403(b), employee stock ownership, and profit-sharing plans. These plans are not protected by PBGC.
Non-IRA defined contribution retirement plans
401(k) (of which there are several types) and 401(a) plans are defined contribution retirement savings plans offered by employers that allow for employee and employer contributions. They take their names from Section 401 of the IRS, which defines them. The biggest distinction between the two is that 401(a) plans are generally offered by government and nonprofit employers (and available to most academic radiologists), while 401(k) plans are more common in the private sector (and available to most private practice radiologists). 401(a) plans are customizable and many of the terms and conditions are dictated by the sponsoring employer rather than being specifically outlined by the IRS. For example, the employer determines if employee contributions are voluntary or mandatory, the amount each employee must contribute, the degree to which that contribution is matched by employer funds, whether contributions can be made with pretax or after-tax funds, and the types of investment options available.
A 403(b) plan (also called a tax-sheltered annuity or TSA plan) resembles a 401(k) but serves employees of public schools and tax-exempt organizations rather than private-sector workers. When the 403(b) was invented in 1958, it was known as a tax-sheltered annuity. While times have changed, and 403(b) plans can now offer mutual funds, many still emphasize annuities. Academic radiologists can often contribute to both 401(a) and 403(b) plans.
The features and advantages of a 403(b) plan are largely similar to those found in a 401(k) plan. Both have the same basic employee contribution limits—$19,500 in 2020. The combination of employee and employer contributions are limited to the lesser of $57,000 in 2020 or 100% of the employee’s most recent yearly salary. Both also offer Roth options and require participants to reach age 59½ to withdraw funds without incurring a penalty (with exceptions). Both offer $6,500 catch-up contributions for those aged 50 and older. Employees aged 50 or older with at least 15 years of service may be eligible to make additional contributions to a 403(b) plan in addition to the regular catch-up.
Generally, contributions to 401(k), 401(a), and 403(b) plans are not subject to federal income tax withholding at the time of deferral, and they are not reported as taxable income on the employee’s individual income tax return. When withdrawn, income taxes are paid on the amount withdrawn at one’s ordinary income tax rate, according to prevailing tax brackets. Roth versions work in reverse. Contributions are reported as taxable income, but are never taxed again.
457 plans (aka “deferred compensation” plans, described in IRC section 457) can be either eligible plans (457(b) or ineligible plans (457(f). The organization must be a state or local government or a tax-exempt organization under IRC 501(c) to offer eligible 457(b) plans, allowing employees of sponsoring organizations to defer income taxation on retirement savings into future years. Ineligible plans may trigger different tax treatment under IRC 457(f).
457 plans are technically owned by your employer because by definition they are a form of “deferred compensation.” Governmental plans, such as the ones most academic radiologists have access to, are probably worth contributing to. There may be more risk associated with a non-governmental 457 plan if the company sponsoring the plan is not very stable and/or if the distribution and investment options are suboptimal.
|Academic radiologists are often able to contribute to a 457(b) plan, in addition to 401(a) and 403(b) plans.|
Academic radiologists are often able to contribute to a 457(b) plan, in addition to 401(a) and 403(b) plans. The 2020 contribution limit ($19,500 plus $6,500 catch-up for those aged 50 and older) is the same in all three plans, and the contributions and earnings are tax-deferred in all three. In addition, as with 401(a) and 403(b) plans, a governmental 457(b) plan may be amended to allow designated Roth contributions that are not tax-deferred.
An individual 401(k) (also referred to as i401(k), one-participant 401(k), solo-k, uni-k, and one-participant k) isn’t a new type of 401(k) plan. It’s a traditional 401(k) plan covering a business owner with no employees, or that person and his or her spouse. It has the same rules and requirements as any other 401(k) plan.
The business owner wears two hats in an i401(k) plan: employee and employer, and contributions can be made to the plan in both capacities. The owner can contribute both:
- Elective deferrals up to 100% of compensation (“earned income” in the case of a self-employed individual) up to the annual contribution limit ($19,500 in 2020, or $26,000 in 2020 if aged 50 or older), plus
- Employer nonelective contributions up to 25% of compensation as defined by the plan
Total contributions to an i401(k), (not counting catch-up contributions for those aged 50 and older), cannot exceed $57,000 in 2020. You must make a special computation to figure the maximum amount of elective deferrals and nonelective contributions you can make for yourself. When figuring the contribution, compensation is your “earned income,” which is defined as net earnings from self-employment after deducting both 1) one-half of your self-employment tax, and 2) contributions for yourself.
An i401(k) can be set up, at no cost, at one of several brokerage accounts that offer a wide range of investment options. The employee contributions can be invested in a Roth i401(k), but the employer contributions must be invested in a non-Roth 401(k). The employee Roth contributions are not tax deductible, just as with other types of Roth accounts, but the employer non-Roth contributions are tax deductible.
i401(k) plans are not subject to the pro-rata rule as are the IRA plans for self-employed individuals (e.g., SEP IRA and SIMPLE IRA), and are therefore ideal supplementary plans for radiologists who also want to contribute to a backdoor Roth IRA. Also, a Roth i401(k) can be converted to a Roth IRA prior to age 72, eliminating the need for required minimum distributions since there is no RMD requirement for Roth IRAs.
Why wouldn’t a radiologist want to withdraw money from their Roth IRA at age 72? Radiologists at age 72 who have saved a lot in taxable and non-Roth retirement accounts may not need to use money from their Roth IRA. They may prefer to let the money remain in the account and continue to grow tax free. At some point, however, a decision has to be made as to what all that money will be used for. You can’t take it with you, so they say. But if you don’t want to spend it on yourself, you might want to let the money grow for your heirs.
Cash balance plans
If you are a partner in a radiology group, you may have access to an IRS qualified cash balance plan. Whereas a 401(k) is strictly a defined contribution plan, a cash balance plan is a hybrid between a defined benefit plan and a defined contribution plan, and it can be opened in addition to an existing 401(k).
Here’s the big difference between a 401(k) and a cash balance plan: With a 401(k), the money that the employee will have in retirement is not “defined.” Instead, the employee’s retirement benefits depend on the performance of the market and of the funds that hold the 401(k) contributions. The employee bears the risk that a market downturn will wipe out her 401(k).
With a cash balance plan, on the other hand, the amount of money an employee can expect in retirement is “defined.” That’s what makes it a defined benefit plan. The employer, not the employee, bears the risk of market fluctuations.
The main advantage of a cash balance plan is higher contribution limits than you’d get with a 401(k). The contribution limits for cash balance plans are based on age and top $200,000 for radiologists aged 60 and over. And these contributions are tax deferred. A cash balance plan can help boost your tax-deferred savings if you plan to retire in 10 years or less and you would like to catch up quickly.
Why doesn’t every radiology practice offer a cash balance plan? They are more costly to maintain (annual actuarial certification is required) and require more administrative oversight than more traditional plans. There are a lot of nuances associated with cash balance plans that go beyond the scope of this post, but if you are in a group or contemplating joining a group with such a plan, you should familiarize yourself with how the plan will work for you.
Sounds cool, but what is it? The “stealth IRA” is a term used to describe a Health Savings Account (HSA) that is available to anyone who has a qualified high-deductible health insurance plan (HDHP) and not enrolled in Medicare. In 2020, a qualified plan is defined as having a deductible of $1,400 or more for individual coverage or $2,800 or more for family coverage. To participate in an HSA, your out-of-pocket maximum can’t exceed a certain threshold, which in 2020 is $6,900 for individuals and $13,800 for families. Although technically not a “retirement” account, many people use it as such.
An HSA is a tax-exempt account that is used to pay for or reimburse certain medical expenses. No permission or authorization from the IRS is necessary to establish an HSA. For 2020, if you have an HDHP, you can contribute up to $3,550 for self-only coverage and up to $7,100 for family coverage into an HSA. There is also a $1,000 catch-up contribution limit for those aged 55 and older.
|Because neither the contributions, nor earnings, nor qualified distributions are taxed, an HSA is called a “triple-tax free” account.|
You set up an HSA with a bank, an insurance company, or anyone already approved by the IRS to be a trustee of IRAs. The HSA can usually be established through a trustee that is different from your health plan provider, although there are exceptions. There are numerous things to consider when choosing a trustee, including fees (account fees, trading fees, etc.), investment options, requirements to keep part of the funds in a cash account, convenience (e.g., having other accounts with the same company), and customer service. When using an HSA as a retirement savings vehicle, you want to be able to invest in a brokerage account with low or no fees. Not all accounts offer this feature. Because neither the contributions, nor earnings, nor qualified distributions are taxed, it is called a “triple-tax-free” account.
HSA dollars can be spent on anything, but if you spend them on non-healthcare expenses prior to age 65, you will not only pay taxes at your marginal tax rate on the entire withdrawal, but you will also pay a 10% penalty. After age 65, that penalty goes away, but you will still have to pay taxes on the withdrawal. Because of these taxes and penalties, it is best to spend HSA dollars on healthcare, but if you must spend it on something else, do so after age 65.
There are numerous benefits of an HSA:
- You can claim a tax deduction for contributions you, or someone other than your employer, make to your HSA even if you don’t itemize your deductions on your income taxes
- Contributions to your HSA made by your employer may be excluded from your gross income
- The contributions remain in your account until you use them
- The interest or other earnings on the assets in the account are not taxed
- Distributions are tax free if used to pay for qualified medical expenses
- An HSA is “portable”; it stays with you if you change employers or leave the workforce
- There is no rule requiring that the money must be withdrawn from the HSA in the same year the qualified medical expense incurred; you can keep your receipts for qualified unreimbursed medical expenses and take the money out of the HSA to cover those costs at any time in the future
Final words on choosing investment accounts
If you are wondering whether to invest in one or more retirement accounts, there are a couple things you should consider. Since there is a maximum amount you are allowed to contribute to any retirement account each year, any year you don’t contribute is a year of investing that can’t be made up. You can’t contribute twice as much to a retirement account next year because you didn’t contribute anything this year. And all the money in retirement accounts grows tax free. You can compensate for not saving now in a taxable account by saving more later in a taxable account (since a taxable account has no contribution limit) but investments in a taxable account do not grow tax free.
Another potential opportunity that is “forever lost” when you don’t invest in a retirement account is losing an employer match. Many employers match a percentage of what you contribute to a retirement account, up to a certain limit. By not collecting this match, you are leaving money on the table. It’s like taking a pay cut. If you don’t have enough money to contribute the maximum amount to a retirement account, at least contribute enough to receive the maximum match.
As a prior academic radiology department chair, I knew many radiologists, especially junior faculty, who thought that because the department was contributing a large amount to their 401(a) each year, they didn’t need to contribute to a 403(b), 457(b), or Roth IRA. After making monthly student loan, mortgage, car loan, and other payments, some didn’t have enough money left over to fully fund all available retirement accounts. Others just didn’t realize the value of contributing maximally to retirement accounts. Most are not thinking about the possibility of not being able to practice as a radiologist and make a radiologist’s salary as long as they want to. Radiologists can lose their jobs, get hit with high costs of divorce, or suffer burnout and not be able to keep working as they have been. These unfortunate events can happen early in a radiologist’s career. Those that have been feeding retirement and taxable accounts from day one will be in a better position to survive such events.
Not all radiologists will have access to all types of retirement plans. I urge you to speak with the human resources person, business manager, or whoever else manages the plans at your workplace, and learn about how you can participate to maximum advantage. Don’t wait until you’ve been on the job for a while. Do it day one. You’ll be glad you did.
“I really wish I hadn’t contributed money to those retirement accounts when I started working.”
—Said no one ever
Congratulations if you’ve managed to read through all that information on investment accounts, parts 1 and 2. For your reward, I’ve provided you with a handy table that compares the features of all the accounts discussed, as promised.
Now that you’re familiar with the “baskets,” in my next post, we’ll move on to the “groceries.” This will include a discussion of the different types of investments (e.g., CDs, stocks, mutual funds, etc.) that you can put into your baskets. Until then, enjoy the following chart and bullet points, and give yourself a pat on the brain!
Comparison of Common Retirement Plans
|Account||2020 Contribution Limit||Tax Treatment|
|Traditional IRA||Smaller of: $6,000 ($7,000 age 50 or older) OR Taxable earnings||Pre-tax contribution (deductible type), post-tax contribution (non-deductible type); withdrawals from non-deductible type taxed on earnings only|
|Roth IRA||Same as traditional IRA||Post-tax contribution; tax-free withdrawals|
|Non-Roth 401(k), *401(a), 403(b)||Employee limit: $19,500 ($26,000 over age 50); Combo employee and employer limited to lesser of $57,000 ($63,500 age 50 or older) or annual compensation||Pre-tax contribution|
|Roth 401(k), **403(b)||Employee limit: $19,500 ($26,000 age 50 or older); Combo employee and employer limited to lesser of $57,000 ($63,500 age 50 or older) or annual compensation||Employee: post-tax contribution; tax-free withdrawals
Employer: Pre-tax contribution
|457(b)||$19,500 ($26,000 – $39,000 age 50 or older); in addition, a governmental 457(b) plan may be amended to allow designated Roth contributions that are not tax-deferred||Pre-tax contributions (unless Roth contributions)|
|***Health Savings Account||$3,550 for self-only coverage and $7,100 for family ($1,000 catch-up contribution limit for those age 55 or older)||Pre-tax contributions; tax-free withdrawals for qualified healthcare expenses|
|SEP IRA||lesser of 25% of compensation, or $57,000||Pre-tax contribution|
|SIMPLE IRA||$13,500 ($16,500 age 50 or older)||Pre-tax contribution|
- All except HSA require earned income (interest, dividends, pensions don’t count)
- All except HSA have required minimum distributions (RMD) at age 72 (if born on or after July 1, 1949) or age 70 ½ (if born before July 1, 1949) except the Roth IRA
- All except HSA have penalties on early withdrawal (10% if under 59.5 years, with some exceptions; there is also no penalty on early withdrawal of Roth contributions)
- All except HSA have no age limit for contributions (Note: contributions to an HSA are allowed up to age 65)
- All grow tax-free
- *Contributions to a 401(a) are either mandatory or voluntary. In addition, the employer decides whether those contributions are made before or after tax. In most academic settings, it is pre-tax.
- **Employer contributions are tax-deferred and exempt from FICA taxes; employee elective contributions to 403(b) plans that are considered employer contributions pursuant to a salary reduction agreement are deferred from income tax, but taxable for FICA
- ***An HSA is technically not a “retirement” plan, but many use it as such given its advantageous tax treatment