The 411 on 401(k) Plans

Publish Date: October 30, 2012

By: Matthew Wallace

Young physicians just starting out in their career will need to make a variety of choices that will have major, lasting impact on their financial position in the near and long term. It’s tempting to forego savings in favor of a bigger paycheck now, but ask any experienced physician and their advice will be to invest in the employer’s 401(k) plan right away. Physicians working in a large practice or hospital may have this retirement plan available, but studies show that a whopping 87 percent of medical practitioners operating alone do not have a 401(k) plan in place, and as such may not be saving adequately for retirement.

A 401(k) plan is a type of tax-advantaged retirement savings vehicle that takes its name from the section of the Internal Revenue Code that describes it. Contributions to the plan (via payroll deduction) are made on a tax-deferred basis, meaning they are not taxed until they are withdrawn (presumably at retirement, when one’s tax rate may be less). When it comes to physicians specifically, a 401(k) plan can be set up with a profit-sharing element to allow principal physicians to maximize their contributions and tax deductions, while at the same time limit the contributions to employees that are classified as nonessential.

How the plan works

Currently, one can contribute up to $17,000 annually to his or her 401(k) plan. Some employers offer to match employee contributions up to a certain dollar amount or percentage, resulting in even greater returns on the investment. Over time, account owners earn interest not only on the amount they contribute to the plan but on the interest that has accumulated, resulting in an opportunity for even small investments to grow substantially over time.

Penalties for making an early withdrawal—that is, before age 59 ½—from one’s 401(k) are significant. Not only are withdrawals taxed at the person’s current tax rate, a 10 percent federal tax penalty will also apply. Thus, early withdrawals from a 401(k) should be taken only as a matter of last resort—in instances of true emergency rather than, say, to pay for a vacation or a boat purchase.

Minimum monetary distributions from one’s 401(k) are required to begin by April 1 in the calendar year in which the account owner turns age 70 ½ or April 1 of the calendar year after the account owner retires, whichever comes later. The minimum amount to be distributed is based on one’s life expectancy. Refer to a tax professional for complete information about a 401(k) plan and how to include it in a comprehensive retirement program.

Complete planning goes beyond retirement

Establishing a 401(k) helps plan for retirement; to plan for the unexpected (such as a long-term disability, which will affect one of every three physicians before age 65), it’s wise to purchase physicians disability insurance. The coverage offers protection for a young physician’s greatest asset—the ability to earn an income—and fortunately, premium amounts can be tailored in keeping with a young physician’s limited income during his or her early years in practice. Contact a professional insurance agent to learn more about physicians disability coverage.