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Hi there! I'm a financial planner for therapists!

Why Retirement Plans are SO CONFUSING šŸ«¤

Published almost 2 years agoĀ ā€¢Ā 4 min read

Hello Reader!

If you've ever attempted to set up a retirement plan through your private practice, I'm guessing it was a pretty frustrating experience. They are complex and confusing things.

I believe a big part of the challenge with retirement plans - and so many other aspects of the financial world - is that it's like diving into a 500-level course when you've never been given the opportunity to attend the 101.

Well - no more! (For retirement plans at least).

This email kicks off a multi-email series about retirement plans. And where do we begin? With Retirement Plans 101 of course!

Now, I'll admit. This material is a little bit... dry. It's not the most exciting. But that's actually a good thing. When it's dry and boring - it's also low anxiety. And that's the best time to learn.

So if you've been meaning to set up a retirement plan for yourself, but haven't been able to figure out where to begin - be sure and read this email (and watch for upcoming emails in the series)!

The fun begins below my signature!

And of course, if anything is unclear - or you're not sure how it might apply to you, HIT REPLY and let me know what's on your mind.

Best,
Dave

Retirement Plans 101: Foundational Concepts

Retirement plans and retirement accounts are confusing and detailed things. Here Iā€™ll outline a few of the basics. A lot of this might feel like arcane details. But understanding these basics is essential to make informed decisions (not to mention avoid money anxiety and overwhelm!)

Three topics Iā€™ll cover here:

  1. Sponsored Retirement Plans versus Individual Retirement Accounts
  2. Employer contributions versus Employee contributions
  3. Discrimination provisions

Sponsored Retirement Plans versus Individual Retirement Accounts

I make a distinction between retirement PLANS and retirement ACCOUNTS.

Retirement plans must be ā€œsponsoredā€ by an employer. Your private practice is an employer eligible to sponsor a retirement plan. These retirement plans typically allow higher annual contributions than individual retirement accounts (which are NOT sponsored by an employer).

There are many different types of retirement plans and all use some type of retirement account for each individual participant of the plan. Each account within the plan is governed by the rules of the written plan - because itā€™s just that: a PLAN for how the whole thing operates.

In contrast to retirement plans, retirement accounts that are not attached to any employer-sponsored plan are simply Individual Retirement Arrangements (IRAā€™s). They are literally an individual arrangement instead of an employer plan.This ā€œordinaryā€ IRA is not sponsored by an employer - itā€™s opened and maintained by an individual.

Pretty much anyone with earnings from employment can open and fund an IRA. Again, it doesnā€™t need to be linked to (e.g. sponsored by) an employer. In fact, IRAs were created for just this purpose: to offer employees whose employers donā€™t offer a retirement plan a way to save for retirement.

Although most IRAs are unattached to an employer retirement plan, that isnā€™t always the case. For example, SEP-IRAā€™s and SIMPLE IRAā€™s are both employer sponsored plans which just happen to use the IRA as the individual employee account. When IRAā€™s are attached to an employer plan (like a SEP or SIMPLE), the plan rules (rather than the ordinary IRA regulations) dictate everything about the IRA, including how much can be contributed into the account each year. No wonder folks find this stuff confusing - because it is!!

Employer contributions versus Employee contributions

For retirement plans which are sponsored by an employer, there are two different sources from which contributions can be made. The employER may make contributions on behalf of the employees. And employEEs can choose to take a portion of their compensation (e.g. their payroll or salary) and contribute it to their retirement account. This employee contribution is sometimes called an ā€œemployee deferral.ā€

When youā€™re the business owner (e.g. itā€™s your private practice), you are both the employer and an employee. That means you have complete control over both employer and employee contributions.

Whether itā€™s an employER or employEE contribution, itā€™s all your money of course. But the distinction between employER and employEE contribution is important to remember, because the rules are different. Again, I know, this stuff is confusingā€¦

Discrimination Provisions of Retirement Plans

When an employer sponsors a retirement plan, both the Department of Labor and the IRS want to make sure that the employer isnā€™t using the retirement plan in a discriminatory way. This discrimination has nothing to do with race or ethnicity - rather, it refers to discrimination on the basis of income (or business ownership). Here, Iā€™ll collectively refer to the Department of Labor and IRS as ā€œthe government.ā€

The government wants to make sure that business owners donā€™t set up retirement plans to benefit themselves, and then leave their employees out in the cold. This is why the moment you hire a W-2 employee, you need to be exceptionally careful about how you operate any employer-sponsored retirement plan. There are very substantial penalties that add up insanely quickly if your business operates a discriminatory retirement plan. This is one area you really donā€™t want to run afoul of the rules.

Note that 1099 independent contractors are not employees and donā€™t get factored into retirement plan discrimination provisions. But this is another reason to be very, very careful that you treat 1099s as independent contractors and not like employees - otherwise there can be huge penalties from both state and Federal levels of government.

Discrimination provisions and the associated calculations are insanely complex. If youā€™re a solo practitioner, itā€™s enough to simply know these discrimination rules exist (and you may have to worry about them in the future). If you have employees, I highly suggest working with a professional to administer the details of the retirement plan on your behalf.

If you have no employees in your practice other than yourself, a sponsored retirement plan is reasonably simple and something you probably can DIY with the help of a financial institution like Vanguard. Note your business (e.g. practice) can employ your legally married spouse without having to worry about discrimination provisions. For better or worse, the government doesnā€™t consider your legally married spouse to be an outside employee.

Hi there! I'm a financial planner for therapists!

David W. Frank

I help therapists navigate every element of their financial lives: from understanding your practice P&L and building a personal budget to managing student loan debt and investing for retirement... and everything in between. But don't let my love of the tax code and spreadsheets scare you off! You're just as likely to find me with my nose buried in one of Pema Chodron's books as reading up on the latest financial planning techniques.

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