For many physicians, the decision to move into an executive role is driven by a desire to improve the health care system. Their unique knowledge of the health care system, combined with practical experience, often translates well into a role as a health care steward. However, although the personal rewards are obvious, one important consideration is the potential impact on retirement plans.
KEY WORDS: retirement plan, leadership role Supplemental retirement plans
In my practice as a financial consultant, I work exclusively with physician clients, some of whom have decided to transition into an executive role. For many physicians at the higher end of the pay scale, a common question is how to set up a supplemental retirement plan to compensate for the fact that they have maximized their registered retirement savings plan (RRSP) contributions.
A hospital or health care facility may offer a supplemental retirement plan, such as a retirement compensation arrangement (RCA) as an additional incentive to enhance retirement income benefits. These structures help physician executives retain more money in registered savings than they could in a regular RRSP. In turn, the hospital can avoid the administrative burden and risks associated with operating a retirement pension plan for such a relatively small pool of senior employees.
Many hospitals will supplement their executive compensation packages with long-term incentive payouts. Unfortunately, when these payouts are received by the executive they will be treated as income and taxed at the top marginal rate, which could amount to more than half of the incentive compensation. In some cases, restructuring an RCA agreement can reduce the tax impact on these payouts and improve the client’s longer-term retirement outlook. Top
Fraser Lang, senior vice-president at Gordon B. Lang & Associates Inc., specializes in retirement, health and welfare, and taxation solutions. He and his team have done extensive work with MD Management over the years, and he believes that supplemental retirement plans may become increasingly valuable to physicians, particularly given the federal tax changes to certain complex corporate and partnership structures. The new rules may affect some physicians’ eligibility for the small business tax deduction.
“Because the options for corporate savings strategies are continually changing, it’s essential for executive physicians to focus on registered plans to help them defer taxes as they accumulate assets,” says Fraser. “For many hospital executives, the RCA is one of the few tax-efficient vehicles available that does not place undue burden on the hospital’s finances.”
A closer look at retirement plan options
Here’s how these supplemental retirement plans work.
An individual pension plan (IPP) is a defined plan funded by an employer on behalf of an employee. Like an RRSP, assets accumulate in an investment account over time as retirement benefits. Top
However, an IPP allows up to 65% more in asset accumulation than an RRSP and sets your monthly income at retirement. Your locked-in pension savings benefit from tax-deferred growth and are paid out and adjusted for inflation on retirement. Contributions are tax deductible for the company.
A retirement compensation arrangement (RCA) allows an employer to make tax-deductible retirement contributions on behalf of an employee, to the maximum amount allowable. An RCA is flexible (especially during retirement), creditor proof, and allows access to funds (not locked-in).
On retirement, you may draw from the assets of the RCA without any restrictions on maximum or minimums, potentially at a lower tax rate. Ultimately, an RCA allows a hospital to specifically tailor the funding that they and the physician executive have agreed on. Top
What about incorporation?
In most cases, if an incorporated physician is transitioning into a fully salaried role, the corporation would drop the “Medicine Professional Corporation” portion of its name (by filing Articles of Amendment) unless a continuing stream of earnings from medical services remains. If the accumulated funds in the corporation are not significant, it might make sense to wind up the corporation rather than continue to incur professional fees. In all other cases, the corporation would continue with corporate funds paid out to shareholders, as appropriate, or conserved and used as supplementary retirement income.
There are also situations in which a physician accepts a salaried role but continues to have an opportunity to earn income from medical services. In these cases, the salaried position is often less than full-time and the remuneration is usually less than $200 000 a year. Directing clinical income to a corporation could allow a physician to shelter it from the additional 4% increase in the top federal tax rate applicable to incomes over $200 000 (introduced in the March 2016 federal budget). A physician might also have the opportunity to split the corporate income with a spouse, adult children, or even parents. Alternatively, the physician could pay the corporate income to him- or herself at a later time, when personal income from other sources is lower. Top
Part-time executive appointments
Part-time appointments are similar to hybrid situations in that compensation is usually in the form of salary and benefits. However, in the absence of other income, there may be implications for projected savings, taxation on retirement income, and a physician’s ability to achieve retirement/estate plan goals.
Let’s look at an example. Dr. G a full-time physician, transitions into a part-time executive arrangement and experiences a significant decrease in compensation. She does not adjust her lifestyle expenses accordingly, resulting in a reduction in annual non-registered savings toward her projected retirement income goals. Dr. G also has several estate objectives she has not yet acted on, including leaving a bequest to a specific charity using permanent life insurance. However, her new cash flow budget is making it more challenging to afford the annual premiums associated with this type of policy. This is especially the case if a policy is owned personally rather than by a medical professional corporation, where the premiums would be more affordable on an after-tax basis.
Here’s another example. Dr. J has accumulated substantial registered savings and, as a result, will have to draw on these funds in retirement as regular income — potentially at a high average tax rate. Depending on Dr. J’s projected tax rate in retirement, it may make sense to forego sheltering his part-time salary in an RRSP and, instead, pay tax on these funds now, as long as his current average tax rate is lower by comparison. Before making a final decision, Dr. J will also need to consider the tax deferral advantage that the RRSP provides over the period leading up to retirement. Top
Finally, a part-time physician should understand the employer’s benefits package and how it may change leading up to and during retirement. Often, a physician may have to make changes to his or her current personal benefits coverage as a result.
Unfortunately, not all situations with split income streams lend themselves to the benefits of incorporation. Each situation must be evaluated based on the specific circumstances.
I recently worked with a client who is the director of a large Canadian hospital and whose compensation was equally divided between salary and self-employed income. His retirement plan had to account for both types of income, and we had to consider whether it made sense for him to incorporate his self-employed earnings. After carefully considering opportunities for tax deferral and income splitting, the benefits did not merit the cost and complexity of introducing a professional corporation into the plan. Top
A comprehensive financial plan is the first step
If you’re considering moving into an executive role, it’s crucial to plan ahead to ensure that your retirement plan is on track. The process should begin by meeting with a financial consultant who understands physicians and their unique needs, to develop a complete financial plan with special focus on your current retirement scenario.
Most people don’t realize the importance of having a thorough and integrated financial plan. Without one, a consultant will not have a complete picture of a client’s situation and might overlook key factors that will help improve the quality of the retirement plan.
For example, a simple cash flow statement can help the consultant understand the various components that make up a client’s lifestyle expenses and project how they may change leading up to and during retirement over a 5-, 10-, or 20-year period. An accurate net worth statement can also help the consultant assess the client’s capacity versus appetite for risk. Depending on the risk profile of each asset, various growth rates might be assumed, which can significantly alter a client’s projected long-term aggregated net worth.
Your compensation structure will help to shape your retirement plan
Once you have transitioned into your new role, it’s important that both you and your financial consultant understand the impact of your new compensation structure on your retirement plan. Some questions to consider:
Does the hospital plan to compensate you with salary or will you be self-employed or both?
What form of pension will you receive, if any?
If you are incorporated, what role should the corporation play leading into retirement and beyond?
Working with an integrated team of qualified financial planning professionals can help you find the answers to these questions and create a solid retirement plan that provides guidance, clarity, and peace of mind.
Vince Tarantino is a senior financial consultant with MD Management Ltd in Toronto. To learn more, please visit mdm.ca
MD Management Limited – Member – Canadian Investor Protection Fund
The information contained in this document is not intended to offer foreign or domestic taxation, legal, accounting or similar professional advice, nor is it intended to replace the advice of independent tax, accounting or legal professionals. Incorporation guidance is limited to asset allocation and integrating corporate entities into financial plans and wealth strategies. Any tax-related information is applicable to Canadian residents only and is in accordance with current Canadian tax law including judicial and administrative interpretation. The information and strategies presented here may not be suitable for U.S. persons (citizens, residents or green card holders) or non-residents of Canada, or for situations involving such individuals. Employees of the MD Group of Companies are not authorized to make any determination of a client’s U.S. status or tax filing obligations, whether foreign or domestic. MD Financial Management provides financial products and services, the MD Family of Funds and investment counselling services through the MD Group of Companies. MD Financial Management Inc. is owned by the Canadian Medical Association.