How the SECURE retirement act affects physician practice owners and high net worth doctors

Two days ago the president signed the SECURE act, a bipartisan bill reforming some rules regulating retirement plans. Let’s look at how this impacts us solo eye docs both as business owners as well as with retirement planning for high earning physicians. There are probably about 15 of you in our group who are interested in this stuff; for the rest of you, at least read the first two paragraphs and use the rest to put your kids to sleep.

The tax credit for establishing a retirement plan for your business is now $5000, up from $500

For the first three years you establish a 401K you get a tax credit of 50% of the plan costs. Since Vanguard charges $3500 per year, you’d get a tax credit of $1750 and the remaining $1750 would be deductible at ordinary rates. At 35% this is a $612 tax break, which totals $2362 back. The previous $500 credit and 35% tax break on the remaining $3000 would effectively be $1550 back. So over three years this is $2436 back into your pocket! Have your accountant fill out form 8881.

I’m sure the financial services industry will be telling you that you could “get a tax credit for up to $15,000 over three years” but as pointed out above if you use a low cost 401k the savings is much less.

If your business chooses to establish simple IRA the fees to establish the plan are usually much less so this credit is less impactful.

If you don’t have a retirement plan for your practice, or have a SEP IRA that only covers yourself as the owner, guess what you’re in luck. If you already have a simple IRA but want to switch to a 401K, and your employees are essentially the same, my interpretation is you won’t be able to take this break. If most of your employees are different from last year due to staff turnover, my impression is you would be able to take the break.

There is also a $500 tax credit for employers who automatically enroll employees, but this may or may not be to your advantage. Many employees would rather get cash immediately rather than save it in a 401k, and if you choose to enroll them the costs will likely be more than the tax credit. So autoenroll your employees if you think it’s the right thing to do, not just for the tax credit.

Part time workers are now covered under your company’s 401K

If someone works for three years for you at least 500 hours per year, they are now eligible to make employee contributions to your company 401K.

The good news is my understanding is you won’t have to make employer contributions (excluded from nonsicrimination, coverage and top testing) unless they work over 1000 hours per year for you (and meet the vesting requirements).

Safe harbor 401K match for employees

If you use a safe harbor 401K there is more flexibility in the deadline, but the match for non- elective went up from 3 to 4% per year. This would help if your plan used another method to determine matches but failed top heavy tests.

One other safe harbor method was 100% match of the first 3% and 50% of the next 2%, which is 4% anyway. But this would only be if your employees also elected to participate, rather than a non elective match.

Stretch IRAs eliminated for non spouse beneficiaries

This was a terrific asset protection and tax planning tool. When you pass away, and your heirs inherit your IRA, they were allowed to make withdrawals calculated as lasting a lifetime. This allowed your heirs to take small amounts out every year, hopefully preventing them from being bumped into a higher tax bracket. The new law requires that the amounts in the IRA be distributed over 10 years to non- spouse beneficiaries. If you have a low to moderate 401k or IRA balance and were planning on simply leaving it to your spouse this won’t affect you much.

If you passed a roth IRA to your grandkids, they could take distributions over 60 years and the money in the roth would continue to grow free of capital gains taxes. The new law requires that the amounts be taken out in 10 years (unless it’s a child, but not grandchild who’s a minor- then it’s 10 years after they’re 18, or 26 if still in school).

10 years of additional tax free growth is still wonderful, although not as great as stretched over a lifetime. For traditional IRAs, instead of taking out money over a lifetime, it’s 10 years. This could bump your kids or grandkids into a higher tax bracket if the amounts are large or if they’re already in a high tax bracket. Solution: divide it up among multiple family members, or leave most of it to your spouse to delay giving it to your heirs. It might make some sense to give smaller amounts to your heirs depending on their tax brackets so they don’t get it all at once when your spouse passes.

This law is a boon for retirement planners and financial advisors- now that the law is changed, they will be able to charge more for their advice. You should reexamine your beneficiaries and trusts, and take into account your heirs’ tax brackets.

Required minimum distributions won’t be required until age 72

If you have a traditional 401K or IRA, you are required to start taking distributions at age 70.5. The legislation increases this to age 72. This allows more time to do partial Roth conversions if you are high net worth, or simply let your 401K grow a bit more.

One excellent tax strategy, particularly if you retire early, is to “fill up” your 0, 10 and 15% brackets with roth conversions of your IRA or 401K. There’s nothing better than avoiding taxes at 35% or higher and then only paying taxes at 0 or 10 or even 15%. As a practice owner, a defined benefit plan can add $2.5 million in pretax, asset protected savings. This law gives you an additional1.5 years to do Roth conversions, or simply let your money grow.

Annuities are available in 401Ks

It will make it easier for 401K sponsors to offer annuities by removing fiduciary and legal risks. Annuities are instruments that guarantee you an income stream for the rest of your life in exchange for your 401K balance. The older you are, the higher the stream will be. It is a bet for longevity and long lifespan- if you have good genes and live a long time, this might be good for you. But if you pass away three years after you purchase the annuity, you are only being paid out for a few years and the company that sold you the annuity will keep the rest of the balance. Annuities might be good for those who fear the market will drop or want to simply guarantee what their income stream will be.

But annuities come at a higher cost than mutual fund expense ratios. My opinion is that if you can keep five years’ expenses in conservative investments you will be able to get past any bear market, which outweighs the costs of the annuities. But for those of you who think you’ll live long or can’t stomach seeing your 401K balance drop when you aren’t earning anything, annuities might be a good idea.

As solo eye docs we aren’t required to make annuities available in the 401K plans we sponsor. And if you want an annuity you could’ve got one anyway before the legislation, albeit potentially with higher fees. So this probably won’t impact us too much, but this law was a gift from the gods to annuity sponsors who lobbied hard and stand to make a lot of money off this.

MEPs- multiple employer 401k plans

The idea behind this is to have related businesses band together to form a group 401K to reduce costs and administrative duties. In my opinon this isn’t the game changer that it is made out to be, since Vanugard’s annual 401K has low expense ratio funds and a fee of $3700 or so which isn’t unreasonable, especially since this is tax deductible and subject to the credits listed above. Some articles I read even indicate that a MEP might be more expensive than a low cost option like Vanguard. The law builds in protections in case if one company in the MEP doesn’t comply it won’t “poison” the other companies, but I have also read that when you close the 401K you might have more options if your company has its own plan rather than participating in a MEP.

The age 70.5 limit for IRAs is lifted

Again this is of minimal value for most of us because you could’ve still contributed to a Roth IRA over age 70.5 and most of us will earn under the roth limits after 70.5. But if you’re in the unusual situation where your IRA distributions or passive plus active income is over the Roth limit, and you want to do a traditional or backdoor Roth, now you can. Given your age, there will be minimal years of compounding in your lifetime, but this could be very beneficial for your heirs.

If you didn’t save enough for retirement, this could be a very nice tax arbitrage if you avoid paying taxes on $6000 at 35% and take withdraws a few years later at 0 or 10% that’s a $1500 to $2100 tax arbitage, but this tax break won’t make you independently wealthy.

Using a 529 plan to pay back student loans

If you have any leftover money for your 529 plan beneficiary (a 529 plan works similar to a Roth IRA- post tax money is contributed and the money grows free of capital gains taxes on investment earnings), up to $10,000 lifetime can be used to pay back student loans. Not a game changer to me because the 529 could’ve been used to pay off tuition in the first place. I suppose if you oversaved in your kids 529 plan, you could transfer funds to nieces and nephews, and the new law gives you flexibility if they’ve already graduated to help pay off their loans.

This might be helpful if you frontloaded your kid’s 529 with $75,000 or five years of contributions when they were born, one of my favorite tax tricks.

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