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Good news on the retirement plan front

By Jeffrey B. Sansweet, Esq.

Malpractice insurance is skyrocketing. Third-party reimbursements are still low. Health insurance costs keep rising. The stock market still has a lot of recovering to do. Costly retirement plan amendments are required in 2001 or 2002. But all is not gloom and doom economically-speaking, as the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) provides for many favorable changes in the retirement plan arena beginning in 2002.

The two most significant changes are an increase in the annual contribution limit and the annual compensation limit. From 1983 through 2000, the annual limit on contributions to defined contribution plans has been $30,000. For plan years ending in 2001, cost-of-living adjustments increased the limit to $35,000. EGTRRA has increased the annual limit to $40,000 for plan years beginning in 2002. The $40,000 limit will be increased in $1,000 increments tied to cost-of-living adjustments. EGTRRA has also increased the annual compensation limit from $170,000 to $200,000 for plan years beginning in 2002. Cost-of-living adjustments will result in $5,000 incremental increases in future years.

For many practices, the combination of these two increases can result in a higher contribution for the physicians, while at the same time saving some money on contributions for the staff. The following example will illustrate this concept.

Let’s assume a practice is owned by two physicians and has four staff members eligible for the retirement plan. The practice is on a calendar year fiscal year and has a money purchase pension plan and profit sharing plan. The physicians each have a salary in excess of $200,000 and the four eligible staff participants have a combined salary of $100,000.

The formula for the mandatory pension plan contribution is 10% of compensation up to the taxable wage base ($80,400 in 2001 and a projected $85,000 in 2002) and 15.7% (the maximum allowable percentage spread is 5.7%) of compensation between the taxable wage base and the annual compensation limit ($170,000 in 2001 and $200,000 in 2002).

The physicians wish to maximize their contributions each year, so the profit sharing contribution for the staff is calculated as a straight percentage of compensation tied to the percentage of the physicians’ contributions. For example, in 2002, if the Pension formula results in a contribution of $26,555 for each of the physicians, the profit sharing contribution will be the maximum desired $40,000 total contribution less $26,555, or $13,445. When $13,445 is divided by the salary limit of $200,000, the percentage is 6.7%. Thus, the staff profit sharing contributions are 6.7% of compensation.

Based upon the above assumptions, in 2001, each of the physicians would have received a contribution of $35,000, and the total staff contribution would have been $17,600. In 2002, each of the physicians will receive a contribution of $40,000, and the total staff contribution will be $16,714.

Note that the percentage of the total practice contributions that is allocated to the physicians goes from 79.9% in 2001 to 82.7% in 2002. As compared to 2001, the practice is able to contribute an additional $5,000 for each of the two physicians, while contributing $886 less for the staff. The reason for this savings is the additional $30,000 in eligible compensation which brings down the necessary profit sharing contributions.

Practices that currently have both a money purchase pension plan and profit sharing plan may consider terminating the pension plan or merging it into the profit sharing plan in 2002 due to another favorable EGTRRA change. The new law has increased the deduction limit for profit sharing contributions from 15% of compensation to 25% of compensation. This change will allow a practice to contribute the maximum $40,000 for a physician through just the profit sharing plan.

If the pension plan is no longer in existence, the practice can reduce administrative fees associated with having two plans. However, the decision by a practice to eliminate a pension plan should be thoroughly discussed with its plan advisors. If the pension plan is terminated, the participants would become 100% vested and there would be administrative costs for the plan distributions. A merger would avoid the 100% vesting and distribution options, but other plan amendment issues would arise. In addition, employees may not like the elimination of the pension plan, as a profit sharing plan leaves the contribution amount completely up to the owners in each year; whereas, the pension plan has a mandatory contribution formula. Finally, the 2001 tax law is due to expire in 2011, so the practice may find itself wanting to put a pension plan back into existence.

For those practices with 401(k) plans, EGTRRA has increased the $10,500 annual elective deferral limit to $11,000 in 2002, $12,000 in 2003, $13,000 in 2004, $14,000 in 2005 and $15,000 in 2006. Any increases after 2006 will be based upon cost-of-living adjustments. In addition, a participant who has reached age 50 by the end of the plan year is permitted to make additional annual “catch-up” elective deferrals of up to $1,000 in 2002, $2,000 in 2003, $3,000 in 2004, $4,000 in 2005, and $5,000 in 2006, with any increases thereafter based upon cost-of-living adjustments. The Plan can also allow for contributions up to 100% of compensation. EGTRRA also eased some of the restrictive top-heavy rules and non-discrimination tests.

If your practice entity is anything other than a C Corporation (i.e., a partnership, S Corporation, sole proprietorship or limited liability company), you may now allow for Plan loans to the owners under EGTRRA. Prior to EGTRRA, only C Corporations could allow for Plan loans to its owners without creating a “prohibited transaction”.

EGTRRA has also provided incentives for practices with no greater than 100 employees to implement a retirement plan. Beginning in 2002, for the first three years of a new plan, the employer will receive an annual tax credit of 50% of the first $1,000 of plan administration costs. The IRS user fee (typically $125) charged for approving the new plan would also be waived.

Finally, Plan documents need not be amended to reflect these EGTRRA changes prior to 2005. However, in order to take advantage of some of the changes, minor interim amendments may be required.

In conclusion, EGTRRA has made numerous favorable changes to the retirement plan laws that provide significant opportunities for physicians. It is a good time to contact your plan advisors to make sure you are taking full advantage of the opportunities.

Jeffrey B. Sansweet, Esq., is a Shareholder of the Wayne, Pennsylvania health care law firm of Kalogredis, Sansweet, Dearden and Burke, Ltd.

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