Pension Protection Act Creates Tax Savings

Many aspects of the Pension Protection Act of 2006 (PPA) have gotten notice in the press. One measure that has gone largely ignored is the relaxation of the dual plan deduction limits. Now, it is possible for physicians to offer their staff two retirement options by sponsoring a defined-benefit plan and a defined-contribution plan, allowing larger tax-deductible contributions and potentially larger plan values at retirement.

Defined-contribution plans are retirement plans where the amount of the contribution is known and the amount you will have at retirement is unknown. 401(k)s, profit sharing plans, and simplified employee pension (SEP) IRAs are types of defined-contribution plans. Contributions to these plans are flexible and the limits are lower than those on defined-benefit plans. The limits for 2007 are as follows:

• 401(k): up to 25% of compensation plus a salary deferral of $15,500 (under age 50) and $20,500 (over age 50). Limited to a total maximum contribution of $45,000 (under age 50) and $50,000 (over age 50).
• Profit sharing plans: up to 25% of compensation limited to a maximum contribution of $45,000.
• SEP IRA: up to 25% of compensation limited to a maximum contribution of $45,000.

Defined-benefit plans start with the end in mind. With a defined-benefit plan you calculate the amount of money you want in retirement and then work backwards to what level of contribution you will need. At ages over 45 these plans can allow for much larger tax-deductible contributions than the defined-contribution plans.

Prior to the PPA a physician had to choose between a defined-benefit plan or a defined-contribution plan. A physician could have both, but they would be limited to a total deductible contribution of 25% of payroll. Therefore, if a defined-benefit plan contribution exceeded 25% of payroll, then contributions to a defined-contribution plan would not be allowed.

Under the PPA a physician who sponsors a defined-benefit plan can also have a defined-contribution plan and contribute up to 6% of eligible payroll and salary deferrals if they sponsor a 401(k) plan. The following is an example of a physician who is 50 years old and makes $225,000 yearly: defined-benefit plan contribution, $150,000; 401(k) salary deferral, $20,500 (including $5000 catch-up contribution for those aged 50 and older); and 6% of payroll contribution, $13,500. The total tax-deductible contribution would then equal an impressive $184,000.

Matthew Tuttle, CFP®, MBA, is president of Tuttle Wealth Management, LLC in Stamford, Connecticut, and the author of Financial Secrets of My Wealthy Grandparents (iUniverse; 2006). He welcomes questions and comments at 203-564-1956 or matthew@matthewtuttle.com.