LETTER OF THE LAW

Learn the Ins and Outs of Your Retirement Plan

Here's what you need to know as an employee and participant.

By Joseph W. Gallagher, Esq., LL.M., and Mark E. Kropiewnicki, Esq., LL.M.

Note to Reader: This article deals with retirement plans that are "qualified" under Section 401 of the Internal Revenue Code. Retirement plans are divided into two broad categories known as "defined contribution" and "defined benefit." For the most part, the topics addressed below are applied the same way regardless of the category of the practice's plan. This article is written in the context of the more popular "defined contribution" plan; however, where necessary, any special considerations applicable in the "defined benefit" context are separately noted.

The typical ophthalmologist tends to avoid the details associated with a tax-qualified retirement program (generally a 401[k] profit sharing plan or a pension plan, or some combination thereof offered at his practice). As long as the annual contributions are made and the nest egg continues to grow at an acceptable pace, many professionals are content. But retirement plans have numerous features beyond funding and growth that you should understand.

Once an employee enters a retirement plan and begins to accumulate contributions and investments, numerous collateral issues can potentially arise, including personal financial planning, estate planning and risk management. To maximize the personal beneficial rights of being in a plan, as well as recognize areas of potential tax, penalty or legal exposure, you need to educate yourself about the features of your specific plan and certain legal concepts that have ramifications beyond simply enrolling in and funding the retirement vehicle.

Keep in mind that over the course of only 10 years in practice, the account you maintain in your retirement plan easily can become your single-most valuable asset. So it's important that you know the rules of the plan, how the account can be accessed while you're employed, how to protect your account from adverse parties and what happens to the account if you leave the practice, divorce, become disabled or die.

Enrolling in the Plan

After you've met the eligibility requirements of a plan, you must be notified of your right to participate. Service requirements for retirement plans tend to range from no service up to 2 years of service. Section 401(k) plans (this type of plan is described in more detail later) by law cannot have a service requirement of longer than 1 year. Once the service requirements are met, you should be given an enrollment package for the plan, which typically includes an enrollment form, a beneficiary designation and a summary plan description (SPD). The SPD must contain a list of explanatory and identifying information, including the following: the plan's official name; a description of what type of retirement or benefit plan is involved; a description of how the plan is administered and the process for investing in the plan's assets; and the source or sources of the contributions to the plan and the method used to calculate the amount of contributions.

Opting Out of the Plan

Some plans contain a provision allowing otherwise eligible employees to voluntarily opt out of the plan. In medical practices, the opt-out clause usually will be limited to physicians and other well-compensated workers. The idea is that the practice can give some flexibility to its top paid employees, so they can receive what would have been contributed to the plan as additional taxable compensation.

Perhaps you have an immediate need for the extra cash to pay off education loans or put a down payment on a home.

But be careful when you consider opting out. The plan may require that the decision is irrevocable, in which case you're permanently out of the plan, losing the tax benefits of contributions and investment earnings from current taxable income, forcing you to save for retirement in a different fashion.

Funding Limits

Most ophthalmology practices maintain a defined contribution program that contains a "section 401(k)" arrangement, which refers to the tax code provision allowing an individual to contribute a portion of his salary to the plan.

For 2008, the maximum annual voluntary salary deferral amount is $15,500 for individuals who are under age 50 and $20,500 for those who have reached age 50. In addition to the voluntary limit, the law permits the practice to contribute from employer monies up to $30,500, so that a participant's maximum annual funding amount in a section 401(k) defined contribution plan can be as high as $46,000 ($51,000 if the participant has reached age 50).

If a practice maintains a defined contribution plan or plans with no section 401(k) arrangement, the plan(s) will be funded solely by the employer/practice and again the maximum annual contribution amount for 2008 is $46,000 per participant. Defined benefit plans also have funding limits, but they're expressed in terms of how much the practice is allowed to contribute toward a projected target monthly benefit that would be paid starting at retirement age. Since the contributions are related to the number of years left until retirement, the annual contributions to defined benefit plans for different ophthalmologists will vary widely.

Two Types of Investing

Under law, contributions to a retirement plan are required to be held in a separate legal trust. The trust law states that the handling and investment of plan assets are subject to fiduciary rules, which means the assets must be invested in a prudent manner for the exclusive benefit of participants in the plan.

When it comes to retirement plan investments, the practice can have them handled on a pooled basis or a self-directed basis. Pooled investing means the trustee of the plan invests all contributions for all participants collectively, and each participant's account is allocated its share of total investment gains or losses. Self-directed investing means that each participant's account is segregated from all other accounts, and the participant picks his own investments, so that earnings and losses are applied exclusively to his account. It should be noted that self-directed investing isn't available in defined benefit plans since defined benefit plans don't have individual accounts for each participant.

Self-directed investing is becoming increasingly popular. Ophthalmology practices tend to seek flexibility for their physicians and, thereby, accommodate the desires and goals of multiple professionals with a potentially wide variety of investment motivations or philosophies. Self-directed investing can take one of two forms: either the practice will decide on a menu of investment options through a single institution (for example, a list of 10 mutual funds through the ABC Investment Company), or the participant will be permitted to pick any investment institution(s) and any available investments that can be made through such institution(s).

Participant Loans

For qualified participants in need of funds, the practice retirement plan can be a source of financing. It's quite common for younger ophthalmologists to be particularly interested in retirement fund loans due to their financial planning and cash flow situations. Financial advisors say one advantage of a self-directed investment plan loan is that the interest paid into the plan benefits the borrowing participant with earnings that would otherwise be paid to a bank or other commercial lender. Loans must bear a reasonable rate of interest and be adequately secured. They must be repaid in 5 years, except loans used to acquire the principal residence of the participant.

A plan participant may borrow up to 50% of his vested plan balance or $50,000, whichever is less. An exception may be made to allow participants to borrow up to $10,000, even if this exceeds the 50% limit. The limits on loan amounts are adjusted in the event the participant has more than one loan outstanding from the plan.

Disability Backup

Disability insurance usually isn't considered in the context of a qualified retirement plan. Regular disability insurance usually protects basic earnings (not deferred retirement plan income). Disability insurance (group or individual) is fine for current wages, but consider what happens to one's ability to fund his or her retirement plan in the event of a serious injury or illness. Many ophthalmologists are accustomed to having the maximum amount (currently $46,000 per year) contributed to a defined contribution retirement plan, but traditional disability insurance doesn't cover this type of income replacement.

Recently, some insurance companies began offering a unique form of coverage to pay retirement equivalent benefits into a trust set up specifically for the insured individual. In effect, this special kind of disability policy substitutes as the employer for purposes of making practice retirement plan contributions, or substitutes as the employee for purposes of voluntary contributions to a 401(k) plan. The policy isn't a pension or profit-sharing plan. Rather, it's a program that provides disability income insurance to ensure retirement plan contributions (generally until age 65).

Beneficiary Designations

What happens to your retirement plan assets if you die? Most plans have provisions to automatically pay survivor benefits to a preordered list of survivors (with spouses being first), if the participant hasn't designated a beneficiary separately. It's wise to complete a beneficiary form for your retirement plan benefits to ensure that your wishes will be followed in the event of your death. Note that the law generally requires that a married participant must name his or her spouse as the sole beneficiary; however, a nonspouse beneficiary is permitted if the spouse consents in writing to the person named.

Divorce

If you're going through a divorce, your retirement plan assets are likely to enter into the property division or settlement agreement discussions. You need to make informed financial decisions regarding the division of the property that you and your spouse have accumulated during your marriage. Retirement savings are one of the largest assets many people own, and, thus, are an important issue in divorce proceedings.

If, as part of the distribution of assets, the parties decide to divide a retirement plan, a Qualified Domestic Relations Order (QDRO) usually is required. A QDRO is a court order that creates or recognizes the existence of another person's right to receive, or assigns to another person the right to receive, all or a portion of the benefits of a divorced participant's interest in the plan.

A court order isn't considered a QDRO unless it's been approved by the retirement plan administrator and the divorce court. Retirement plans often have standard forms that your lawyer can use to draft the wording of the QDRO. Sometimes these are adequate, but if your retirement assets are substantial, you should consider using an attorney who specializes in QDROs to ensure that all of the related issues in your marital settlement agreement are incorporated into the QDRO and that your rights are fully protected in a way that a generic QDRO form may not provide.

Lawsuits and Bankruptcy

Federal law states that if you're sued and a judgment is entered against you, your assets held in the practice retirement plan generally cannot be reached by the judgment creditor while they're held in the plan. Retirement plan assets usually can't be reached by one's creditors in a bankruptcy proceeding, so long as the assets continue to be held by the plan. However, once the assets are paid out, the protection from creditors generally evaporates. Some ophthalmologists elect to keep their assets in the practice plan even after they've left employment with the group. Others arrange for a direct transfer or rollover of the assets to the retirement plan of their subsequent employer. In some states, a rollover IRA may afford similar protections, however, be sure to have your personal attorney research your state's treatment of creditors' rights over IRAs before you authorize such a rollover.

Knowledge is Power

The bottom line is that you need to understand and appreciate the rights, benefits and obligations of being a retirement plan participant. Be proactive in this area. Read your SPD and ask about any special features or clauses, so you can maximize the personal benefits of your retirement plan. nMD