Understanding IRA Options for Physicians
The essentials physicians need to know about different types of individual retirement account options
It has been more than 35 years since Congress enacted legislation that established the Individual Retirement Account (IRA) as an incentive for individuals to take responsibility for their own retirement security. Since then, billions of dollars have flowed into IRAs held by millions of Americans. Then Congress provided another boost to retirement savings by introducing a cousin version to the IRA known as the Roth IRA. Since then, the challenge for many physicians saving for retirement has been to compare the traditional IRA versus the Roth to determine which is most suited to their needs.
Traditional IRA Essentials
Individuals who are eligible to establish an IRA can do so at just about any financial institution. Although the tax code allows for almost any type of investment to be made within an IRA, most of the billions that have been contributed have flowed into mutual funds. Bank CDs, individual stocks and bonds, and, more recently exchange-traded funds, have received a fair portion of IRA contributions.
Anyone with earned income can contribute to an IRA as long as their income level doesn’t exceed prescribed amounts. Contributions are fully tax-deductible, and the earnings inside the account are allowed to accumulate without being currently taxed. Income eligibility and contributions limits are adjusted frequently.
Distributions made from an IRA are counted as ordinary income and taxed as such. Although distributions can, technically, be made at any time, they may be subject to a 10% IRS penalty if the distribution is made prior to age 59 1/2. There are some exceptions for early withdrawals, among which are the need for a deposit on a first time home purchase or possibly some college expenses. It is also possible to take distributions, free of penalties, if they are made equally over your life expectancy.
Roth IRA Essentials
The major distinction between a traditional IRA and a Roth IRA is in the tax treatment of the contributions and the withdrawals. In a Roth IRA, the contributions are not tax-deductible; however, they are allowed to accumulate tax-deferred. And, the withdrawals from a Roth are tax-exempt. So, essentially, the tax benefits of a traditional IRA and a Roth are reversed.
There are other aspects of a Roth IRA that differentiate it. The eligibility rules for a Roth are a bit more liberal in that participation in an employer-based plan doesn’t preclude a person from establishing a Roth. There are, however, limits to the amount of contributions that can be made based on income levels.
Withdrawal penalties are also relaxed for early Roth IRA withdrawals. Because withdrawals are considered to be, first, a return of principal, they are neither taxed nor penalized. There is, however, a time restriction for when withdrawals can be made which is no earlier than 5 years after the initial contribution is made.
Additionally, unlike a traditional IRA which requires that distributions begin no later than age 70 ½, there is no such requirement with a Roth.
Which IRA is Right for You?
Many financial planners tend to lean toward the Roth, as much for its increased flexibility as for its reverse tax benefits. If you are able to qulaify for a Roth and anticipate that your tax bracket will be as high in retirement as it is now, or you expect tax rates to increase, you may be better off with the tax-free income from a Roth. Often physicians will exceed the Roth income qualification limits once they leave training. The right decision can only made after a thorough assessment of your financial situation. Only then can you properly compare the two.
For Independent Practitioners
Simplified Employee Pension (SEP) IRA
A SEP IRA allows you to make contributions to your retirement plan as well as your employees’ based on your business’ annual profits. The maximum contribution limit is 25 percent of net profit up to the contribution cap of $52,000 in 2014 ($53,000 in 2015). While you can set any percent of profit as a contribution, you must contribute an equal percent to all eligible employees. If you have no profits or they are to be allocated to other purposes, you need not make any contributions. Alternatively, you can establish a flat contribution amount paid equally to each employee. SEP IRAs require more administration and additional compliance with ERISA, so these additional costs need to be considered.
If you employ more than twelve people, a SIMPLE IRA could be your best choice. It’s relatively easy to establish and manage, and it can be the least costly. Employees can have their contribution deducted from their earnings on a pre-tax basis. Employees may contribute up to 100 percent of their salary up to the contribution limit which is $12,000 in 2014 or $12,500 in 2015. Employers must provide a matching contribution of 3 percent or a non-elective contribution of 2 percent. Each employee manages their own IRA account.
Download The Physicians Tax Reference Guide for current contribution limits and tax deductibility rules.
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The information presented here is meant to be educational and should not be construed as advice to invest in a specific product or as tax advice. Please consult a financial or tax professional to discuss your specific situations. Our advising team can discuss financial planning options with you further. Request a consultation today and get the answers you need.
These resources from the IRS offer additional information.