Dental Financial Planning: Turning Chaos into Financial Freedom - Part 8

118:Dental Financial Planning: Turning Chaos into Financial Freedom - Part 8

In this episode of The Dental Boardroom Podcast, host Wes Read, CPA, CFP®, explains how your W-2 payroll choice as an S-Corp owner directly impacts taxes and retirement savings. He breaks down strategies for different retirement plan setups, the mechanics of 401(k) and defined benefit contributions, and why aligning payroll with your CPA or CFO is critical. Learn how to use payroll as a lever to reduce taxes and maximize long-term wealth.

If you’re structured as an S-Corp, the way you set your payroll has a direct impact on:

• How much you pay in FICA taxes
  
• How much you can contribute to your 401(k) or defined benefit plan
  
• How effectively you build long-term wealth through tax-advantaged retirement accounts
  

Wes walks through the practical mechanics of W-2 planning and shares clear strategies for different scenarios:

• No retirement plan → Keep payroll low to minimize FICA.
  
• 401(k) without profit share → W-2 in the $100K–$125K range.
  
• 401(k) with profit share or a defined benefit plan → Increase payroll up to the IRS maximum (around $350K for 2025) to maximize deductions and contributions.
  

You’ll also learn:

• The three 401(k) “funding buckets” — elective deferral, safe harbor, and profit share.
  
• How defined benefit plans can supercharge savings (and why compliance is key).
  
• Why tax diversification (Roth vs. pre-tax vs. taxable accounts) matters for long-term flexibility.
  
• The action step every practice owner should take: coordinate with your CPA or CFO to align payroll with your retirement and tax strategy.

Transcript:

Wes Read: [00:00:00] Welcome back. Excited to be with you again. We are carrying on our series on financial planning for dental practice owners, turning financial chaos into financial freedom. I just got done with two episodes on the tax side of phase three, which is doing a business financial plan to support your, what was phase two.

Personal financial plan for independence. So going through the sequence, number one, assemble a great team, have a systematic cadence of meeting with them, find a management system. And my preferred, uh, sort of system of team formation of roster building is to meet on a regular cadence. We use EOS. Over here at Practice CFO in the dental space, there's one called DEO.

I'll give 'em a little shout out. Dental Entrepreneur Organization, which sort of a spinoff of EOS for dentists. Uh, I think they do a, have a, a little bit higher fee, where in e os you could essentially self implement that at no cost other than a few [00:01:00] books. Um, and then, uh, also make sure to meet with these, uh, this team regularly.

Use a system, a software, a, a format of how you run these meetings and the cadence that is phase one or, or, uh, step one is to develop, uh, your team. Number two is the personal financial plan. Number three is the business financial plan for. Supporting the personal financial plan. And then number five is mon implement, monitor and revise.

And, alright, so now we are in that phase three, a business financial plan. We talked about your financial reporting, we talked about your breakevens, we've talked about your tax plan. Now I'm gonna talk about determining your, uh, payroll step forward within this section. Determine your payroll as an S-Corp practice owner.

If you're a sole prop, this doesn't apply. If you are doing more than roughly 800,000 or so in collections, you should probably convert to an S corporation from a sole proprietor. Please don't be a C corporation. If you're a partnership, please own your partnership through a wholly owned S corporation.

That's what's called a partnership of [00:02:00] corporations, and so you'll, as an S-corporation owner, you need to pay yourself a W2. As an employee of your own corporation, how much should you pay yourself? That's the subject of this episode. It's gonna be a shorter one, number one. Number one is if you do not have a retirement plan.

And when I say retirement plan, there's two semantics around retirement plan. One is you met with the financial planner, you forecast it out. When you want to be financially independent, you back into what you need to be savings and what you need to be doing to meet that long-term goal. That is a retirement plan, but in the context of your business, a retirement plan.

Is these things called 4 0 1 Ks or SEP IRAs or Simple IRAs or Cash Balance Defined Benefit plans there, and there's a few others. These are all under this act called the ERISA Act, the Employee Retirement Income Security Act, which was I think from like this sixties or 70, long time ago. But it put into place this sort of tax advantage advantaged investment vehicle that, uh, [00:03:00] businesses can set up.

Large or small, even if you're alone with no employees, you can set up a solo 401k, which actually a beautiful thing, but you can set these up. You're able to get a tax deduction by funding it and by deferring some of your income that you would pay taxes on today into it and getting a tax deduction. So in other words, it's not tax.

That portion of your income is not, tax is not taxed, which is the same thing as a tax deduction. It's not taxed and or you can do a Roth 401k, which I love. Roth 4 0 1 Ks. You do pay the taxes today, it goes into your 401k or Roth IRA on the outside of. The, your business, but on the inside of your business, it's a 401k, not, not, not a traditional ira.

I don't like SEP IRAs. Never have, you can't fund as much into 'em and you have to fund a lot more for your, for your team. I've never been a fan of simple 4 0 1 Ks 'cause you can't fund much into those things. Never, never, never have I intentionally set up a simple or EP ira. I've set a plenty of solo 4 0 1 [00:04:00] Ks for, uh, doctors who are independent contractors, maybe roaming specialists who don't have employees.

Done a lot of those. Um, and I, uh, uh, and, but our standard is doing a traditional 401k. When you set that up, you as the employee of your own corporation, can do a regular 401k, or you can do a Roth 401k contribution. It is 23,000. If you're under today in 2025, if you're under age 50, you can add on another 7,000.

500 if you are older than age 50 for 30,500 total. That is the employee portion. And then on top of the employee portion you can fund an employee er portion. And there's two buckets there. This is what's called the safe harbor, and the second one's called the profit share. You can fund the, the safe harbor is means that if you safe harbor always means this in the T Code.

If you do a. Then you're allowed to do B In this case. The safe harbor is if you fund a certain amount [00:05:00] to the employees as an employer, contribution as a benefit, not, not them paying outta their own paycheck, but you pay them. If you pay them a certain amount. It allows you to fully fund that. Uh, portion for yourself, the 23,000 I just mentioned, or if you're than 50 to 30,500.

Okay. That the employee portion is called the elective deferral. They're electing to defer some of their income into the four oh K elected deferral eds elected deferral, and. And your employees, they determine, they determine that amount. That's no skin off your back. But in order for you to fund your own elected deferral as the owner or your spouse on there as well, you gotta fund a little bit to your, your team and that's called the safe harbor, contribution.

Safe harbor. If you do this, IE fund a little bit to your team, you can do. IE fund your elective deferrals and you as well as an employee of your incorporation get a little bit of safe harbor. Now the safe harbor allows you two options. You can do a match where you match dollar for dollar, what [00:06:00] they put in, or you can do an automatic 3%.

So if they don't put in anything but they're eligible 'cause they've been there long enough, then they get 3% of their pay no matter what. Now, uh, if you're gonna do that third bucket called the. Profit share. So the three buckets are the elected deferral, the safe harbor, the profit share, the safe harbor, and the profit share is the employer portion.

If you're gonna do that third bucket of profit share, uh, then we usually recommend you actually do the 3% automatic. Option for the safe harbor because that, uh, that plays double duty. That dollar that you put in the safe harbor also covers, uh, your staff in the, uh, profit share portion, which is a bigger portion.

You can, you can throw in usually another roughly 25 to $30,000 a year into the profit share. Um, for yourself, but that's usually gonna come at about 20% of that, uh, will be added to it to cover your team and the safe harbor option of 3%. [00:07:00] Allows you to do more at a lower staff cost collectively across the safe harbor and profit share.

Typically, if you don't do that last layer of a safe harbor, then I would recommend the match, the match option for your safe harbor. If you don't do that last option of the, the, the profit share, sorry, that last option of the profit share, then I probably would just do a match for the safe harbor. Now that was maybe a bit much.

Synthesizing that down, topping it off. One more time. In the 401k, you have three buckets that you can fund. You have the elected deferral out of the pay your employee paycheck in your own paycheck. You have the safe harbor, which you have to do if you wanna do your bucket one for you personally. And then you have the profit share, which is bucket three, which is this additional sort of bonus amount that you can put in to get more tax deductible contributions.

Now, out of all of that, the only one. It's all a hundred percent tax deductible, a hundred percent. Your business deducts a hundred percent of the employer contribution, and from your W2, you get to deduct a hundred percent of your own elective deferral. Same with your spouse. However, of those three buckets, [00:08:00] the only one where you have an after tax Roth option where you don't get a tax deduction for it now, but it grows tax free as opposed to tax deferred, which means it'll grow tax free.

And when you pull the money out, you don't pay taxes on it. On the contribution or the growth. That's why I love Roth so much. We don't know what our tax situation's gonna be like in the future. It's sure is nice to know that we have a portion of our savings that is in a bucket that will never, ever, ever be taxed again.

Now, I don't think that the iris will ever go in and try to get their sticky paws on that tax-free money because you already paid taxes on it. Could that happen if the government is desperate? Who knows? We're in a massive debt situation economically in this country, and they may get desperate, however. I don't think that will ever, ever happen 'cause you already bit the pain, the bullet of paying taxes on that Roth, so the safe harbor and the profit share.

You cannot do a Roth contribution. That will always be tax deductible to the employer. Tax deferred to the employee. Um, and so even [00:09:00] if you, you're in the highest tax bracket, if cash flows allow it, I really like to do that Roth IRA for you. And if your spouse is on there and you're older than 50, that is $61,000 that you could get in there that's gonna grow tax deferred.

So if that turns into three, $400,000 over 15 to 20 years. You're not gonna have to pay a dollar of taxes when you pull that out. And it's a beautiful thing. I call this tax diversification. I like it when you have a tax free bucket of investments, a tax, uh, deferred bucket of investments. And if those two are sort of capped out, then you can even have a taxable bucket bucket of investments through a normal brokerage account as well.

And that's tax diversification. And then. What you invest in each of those accounts should be different. Like in your tax free bucket, I would put the highest risk, highest growth stuff like emerging markets over time. They're very volatile, but they tend to have larger returns over time because of the [00:10:00] related risk.

And therefore, if that grows the most, that's what I want to be tax free. And then in your, in your tax deferred, that has certain types of investments are better suited for that and in the taxable. There are better suited investments in your taxable, like in your taxable, you want high growth stocks. Tech stocks, they don't issue dividends.

They just grow. They appreciate, and you don't pay taxes on appreciation, and so in essence, you're able to defer those taxes until the time that you sell those investments. You don't want high dividend. Producing stocks or mutual funds, you don't want, uh, taxable interest, uh, like corporate bonds in a taxable account.

'cause then you're gonna pay these taxes every year and that sucks. So this is one of the key things we do here at Practice, CFO as an as investment advisors. Managing our doctors' assets is tax allocation across these different buckets, what you put in them. Most people, if you go to like Morgan Stanley, you go to Edward Jones.

Raymond. Raymond, James most. Uh, typical investment [00:11:00] advisors may do a little bit of that, like not putting, they'll put maybe tax-free California muni bonds in your taxable accounts, but beyond that, they're not doing a lot of tax strategy around positioning of your investments across these different buckets of tax-free, tax deferred taxable, and yet that can get you one to 2% extra return over time.

That alone pays our investment fees, in my opinion. That is what I, what I have found. And so this is a really important part of tax planning and good investment Advisors who are a little bit more savvy on the tax side may do this, and we pay good money to a tax software that allows us to configure in the software how.

Or which investments are selected based on the type of of account to optimize over all accounts, the tax minimization on the growth of those investments. Okay. And then you have a defined benefit plan. And defined benefit plan is this additional thing. It's sometimes called a pension plan. Uh, big corporations used to have 'em back in the [00:12:00] eighties where the gover, the company pays a hundred percent.

The employee doesn't contribute to this. The company pays a hundred percent and you're defining the benefit when you retire. How much are you gonna pay out per the design of this benefit that you're offering to your employees? How much are you gonna pay out when they retire and you pay for the rest of your life, their life?

Now in reality, when you sell your practice and you close down the benefit plan plan, everyone rolls it out into their own ira. That's what happens every time. So you're not actually gonna be paying your employees benefit from the time they retire to the end of their life. No, you're gonna, you're gonna close it down, package it up in a lump sum, drop into their Roth ira, and you'll do the same for your own defined benefit plan.

Now, what I love about defined benefit plans is the vast majority of it goes to you. In a 401k, you might have only 75 to 80% going to you, the owner and and spouse. But in a defined benefit plan, you're getting like 90% to you. But they're more expensive. They require an actuary, they're very delicate. You can't do it wrong otherwise, trust me, you're gonna regret it with tax letters and penalties and excise [00:13:00] taxes and all this stuff.

This requires careful, uh, curating every, in the beginning and every year. Inside the ecosystem of all of your global cash flows. This is, I just can't emphasize that enough. I would never do a defined benefit plan if you don't at least have a modest amount of business and personal financial planning and tax planning in place as the foundation to do that.

Right. Okay, so, uh, if you do not have a 401k defined benefit plan or any sort of retirement plan in your practice, you wanna keep your W2 as low as possible because you're paying 15.3% FICA taxes on your W2. Now, again, as an S corporation owner, you take out income in two ways. Your W2 and your K one, your K one being the net profit.

If your W2 to yourself goes up, that's an expense to the corporation and therefore your profits go down. So your K one goes down. If you pay yourself a lower W2, your profits go up, means your K one goes up and therefore your, um, yeah, your K one is [00:14:00] higher, but the sum of your K one and w your personal W2 are always gonna be the same.

W2 plus K one equals X. That X isn't gonna change no matter how you shift your W2 and K one 'cause they're directly inversely related to each other. And so if you don't have a retirement plan, like a 401k defined benefit plan, let's try to get your FICA taxes down as much as possible by paying you a low W2.

Now I emphasize that Teeter taught our analogy because what your W2 is has very little effect on your taxable income when you don't have a 401k plan. It doesn't. If you lower your W2, your K one goes up, because the sum is the same, you're gonna have the same amount of income, uh, that that is, that is taxable income to the IRS and the state income tax agency.

What's different on those two ends of the teeter totter is that only social security and Medicare. Which is called fica, which is 15.3% combined up to $176,000. That is only, that is only applied on your [00:15:00] W2. And so if I can take you down from $150,000 W2. To $50,000 W2, I'm gonna save you about $78,000 in FICA taxes.

And who doesn't want seven or $8,000? And I think at a hundred thousand dollars, even if you have a really good big practice and you have a pretty big K one, let's say, let's say your K one is four or 500,000. If you're W2 is a hundred thousand six figures, you're probably not gonna be audit. You're probably just fine.

It's when you're paying yourself like $25,000 W2 and your K one is $400,000. The Iris is gonna say, Uhuh, no, you should have paid yourself a higher W2, and that's therefore more in FICA taxes. So there, there's a limit there. I, I usually don't go under a hundred thousand unless your practice is running a loss.

Maybe you're a startup. Um. Or maybe you're an independent contractor and you and your total revenues, IE revenue, which is your production pay, is maybe 200,000. I may justify going [00:16:00] down to $75,000 or so, but I almost never go down below 75 ever. Ever. Now, that's if you don't have a retirement plan, and that's us trying to save in FICA taxes.

Again, income taxes, doesn't matter. Let's go to the four without a profit share the four without a profit share or, uh. If you have a 401k, but you're not doing that, that other bucket of profit share, getting that additional 25, 30,000, you're just doing the elected deferral and the safe harbor bucket. Then same thing.

I wouldn't go above maybe a hundred thousand, 125,000. It's when you want to fund that profit share bucket. That last layer in the 401k um bundle, that last layer. And or that defined benefit plan. And I never do a defined benefit plan without the 401k. It's called a combo plan. You first, these are like stairs.

You first do the elected deferral, save harbor. I would never set up a 401k if I, if I as the doctor, I'm not doing at least the elected deferral and the safe harbor. That's the first step. The second [00:17:00] step is the profit share, and the third step is the defined benefit plan. I always go in that order.

Depending on how much surplus money you have in your practice that you can allocate to these things, the more you can allocate. The more, uh, um, I tend to move into that next stair and eventually, if you have a lot where you above the, the 401k profit share above that, if you have another a hundred, $200,000 to invest and you don't have many staff, or you're a bit older than your staff, then I'm starting to look hard at a defined benefit plan.

Because of the massive amounts of money these things can save, and sometimes a doctor will complain and say, Wes, I'm having to pay $5,000, $6,000 a year to fund my defined benefit plan. I'm like, yeah, that's true because there's an actuary in place and they're more regulatory intensive and so they require more work and you're gonna pay the TPA more money for that.

That said, you're funding $250,000 in that thing. Do you know what that thing is? Saving you in taxes. A hundred thousand dollars in taxes and you're gonna get, uh, you're gonna need this massive amount of money, [00:18:00] 250,000 that's gonna grow tax deferred for a long time and end up being a million dollars in your retirement account in 15 to 20 years.

I don't mind you paying $6,000 every year to do the administrative compliance and actuarial work on this defined benefit plan. So you can't, you've gotta see the forest through the trees that yes, there's a cost with these things, but the forest is massive tax savings and massive, uh, a massive propulsion toward financial independence.

Okay, so tier one, no retirement plan at all. Pay yourself as low W2 as you can, never below 75 or a hundred thousand 401k without a profit share. Same thing. Alright, now you get into the profit share. And the defined benefit plan layered on. Now, you want to go, you wanna jack your payroll way up all the way for 2025.

That's 350,000 every year. That's going up about 10,000. But you, you wanna find out what it is for that year, that max W2 limit in order to optimize your, uh, profit share and defined benefit plan, which simply allows you to get more in. [00:19:00] And at a lower employee cost. And I'm not trying to be scrooge. It's not that you don't wanna provide the benefit to your staff.

Trust me, if you have a defined benefit plan, they're getting way more contribution than they would at any other practice. Trust me, even at the minimum amount. Now, it still is a huge benefit to you, way more than the staff. This is about you. But they will get some defined benefit plan contribution, and some safe harbor contribution.

But when all is said, done, if you can get above 75 to 80% out of pocket. Is going to you. It is an absolute win. Now, when you layer on a defined benefit plan and you're funding 2, 3, 300 50,000 of this thing a year, you're getting somewhere close to like 92 to 95% is going to you and it's all a hundred percent tax deductible.

So it's a, it's a beautiful thing actually. It is a it beautiful thing to do that. Alright, so those, those are the primary drivers for me of what your W2 target should be for the year. So the action plan is have your CPA recommend a payroll structure consistent with your tax [00:20:00] plan and 401k or defined benefit plan.

I have a resource called the 10 Questions to Ask your CPA each year that I'll include in the show notes. That can help drive that conversation. Ideally, your CPA can sort of do this more finance perspective analysis and not just be a historian or you can look at more of a CFO model. There's a few of us out there as, uh, what is just built in from the ground up.

It's like some softwares now are built in from the ground up with ai and they're probably gonna do a lot better than the old legacy systems that are trying to sort of embed AI in there as well. For us, AI is embedded from the ground up, meaning that. Business planning, personal financial planning, tax planning.

It's all embedded from the ground up in our model since we are a finance wealth management firm, first and a CPA firm. Second with the CPA firm driving the data engine and x-rays to be great business and personal financial planners. Thanks everybody for joining another episode of the Dental Boardroom podcast.