David Schiller  is a Philadelphia attorney who specializes in taxes and pension planning for physicians.


​Unsuspected errors threaten most doctors’ plans, warns this pension lawyer.  He pinpoints common mistakes and tells how to correct them.

David J. Schiller, J.D.

         Every couple of years, the government can be counted on to sound dire warnings about an onslaught of retirement-plan audits.  Sometimes the flood of audits materializes.  Sometimes it doesn’t.

         Well, they’re at it again, and this time it looks as if the government means business.  With tax rates so low, lawmakers are anxious to squeeze every penny they can out of the current tax system.  Resources are already being reallocated to various agencies’ audit divisions.

         That spells trouble for a lot of doctors.  The sad fact is that most of the retirement plans I’ve seen are rife with problems that an auditor would pounce on.  Sometimes the problem is with the plan itself, but more often it’s with the way the plan is run.  Most doctors commit errors in administering their plans that range from careless mistakes to glaring breaches.

         If you’re audited your retirement plan can be in for a one-two punch.  Both the Internal Revenue Service and the Department of Labor are responsible for overseeing retirement plans, and both conduct audits.  The IRS focuses on compliance with tax law; the Labor Department is more interested in fiduciary responsibility.  But the reality is that if one agency finds any problems with your plan, it’s likely to turn you over to the other for a second audit. 

         An error-filled plan can be an enormously expensive headache.  For one thing, there could be heavy fines—even disqualification of your plan.  For another, the more protracted the audit, the more you’ll fork over to an attorney to represent you.

         The smart move, then, is to take a close look at your retirement plan now and correct any mistakes before you’re called in for an audit.  Here are the most common errors I’ve seen; they’re also the areas an auditor is most likely to zero in on.


         This is one of the simplest retirement-plan requirements to comply with, yet I’d guess that fewer than half of all physicians even know the requirement exists.  It’s simply this:  If your plan covers any employees besides yourself and your spouse, then all plan trustees and anybody else who handles plan money must purchase a fidelity bond for at least 10 percent of the plan’s value.

         This is among the first things you’ll be asked in a Department of Labor audit:  The government wants to ensure that employees are protected against theft of plan funds.  The bonds are dirt cheap:  A $100,000 fidelity bond (for a plan with $1 million in assets) costs only about $100 a year.  After you purchase a bond, make sure it keeps pace with your plan’s growth.  The bond must cover 10 percent of your plan’s value as of the preceding year.  Even doctors who are bonded slip up on this.


         Retirement-plan loans never pass unnoticed by an auditor.  Even if outstanding loans are perfectly legitimate, expect to be asked to produce evidence that all the formalities were adhered to.  Was your plan amended to permit loans in the first place?  Was the loan authorized by plan trustees, and did the borrower sign a note?  Is the rate reasonable?  Is there sufficient collateral?  Can you produce canceled checks showing that repayments are being made according to a fixed schedule?  In short, did the retirement plan benefit from the loan, rather than you?

         The most suspicious loans are those made to outside parties.  For instance, some doctors have arranged to borrow from their associates’ pension plans rather than their own.  That way, they can get around strict loan limits and preserve a tax deduction for part of the interest payments.  Under current tax law, interest you pay on a new loan from your own retirement plan is non-deductible. But if you borrow from someone else’s plan, it ordinarily will be considered a consumer loan, and you can deduct 40 percent of your interest payments this year.  There’s no specific prohibition against lending money to an associate, but auditors don’t like these loans, so you’d better be especially careful to keep them businesslike.

         The auditors are looking for something that is prohibited—a reciprocal loan.  For example, Dr. Johnson and Dr. Smith both need to borrow $100,000.  They’re permitted to borrow only $50,000 from their own plans.  So they strike a deal:  Johnson’s plan will lend Smith $100,000, and, in exchange, Smith’s plan will lend Johnson $100,000.  That’s a clear-cut sham, and if an auditor catches it, Johnson and Smith will be in for whopping penalties from the Labor Department.  When the IRS hears about it, the doctors are likely to owe income tax on the loans, and they may also be in for a premature-distribution penalty.

         An auditor will also scrutinize a loan made to an outside party to make sure it wasn’t made to benefit a family member.  That’s a prohibited transaction.  One doctor I know of made a retirement plan loan to an outside company—perfectly legitimate on the face of it.  But the auditor dug up the fact that the company was owned by the doctor’s wife.  The plan wasn’t disqualified—that time—but the doctor was hit with a 5 percent prohibited-transaction penalty.


         You’d better have an ironclad explanation if any plan investments are bringing in a below-market rate of return.  An auditor may suspect that the investment was made for your personal benefit, rather than for the benefit of the plan.

         A client of mine was recently subjected to an exhaustive grilling by a Department of Labor auditor over bonds he’d purchased that were paying below-market interest rates.  The explanation was perfectly innocent:  The bonds were discount bonds—older bonds bought at a bargain price.  They paid low current rates in exchange for sure appreciation at maturity.  But the auditor kept probing:  Who made the decision to buy the bonds?  Who was the broker?  Did the doctor have a personal relationship with the broker?

         Eventually, the doctor convinced the auditor that he’d bought the bonds for their appreciation, not because he was getting kickbacks from his broker.  But another doctor I know of wouldn’t fare as well in an audit.  He bought farmland that’s bringing in a negligible rental income for his plan.  With such a low rate of return, an auditor would be sure to investigate.  And when he did, he’d find out that the land happens to surround the doctor’s home.  Did the doctor buy the land to insulate his house from development?  That would be an investment with a clear personal benefit.  If an auditor should decide that’s the case, the consequences will be costly.  The doctor may have to reimburse the plan out of his own pocket.  He’ll also be assessed a prohibited-transaction penalty.  His plan could even be disqualified.

         Some other prohibited transactions I run across frequently:

  •  Foreign Investments.  A client of mine, originally from India, wanted to buy some real estate back home for his plan.  He knew the market and felt certain he could get a 15 percent return.  I managed to talk him out of it.  Although foreign real estate might provide a high-yielding investment, it’s absolutely forbidden to take plan funds out of the country.  The government needs to be certain it can get hold of your retirement-plan assets if it needs to.  It’s okay to buy foreign investments through a U.S. intermediary such as a mutual fund or a bank, but you’re never allowed to buy directly.

  • Collectibles.  Before 1982, a retirement plan that was managed by a doctor participant was allowed to invest in collectibles—art, coins, stamps, antiques, gems, or the like—but only if the doctor manager didn’t take possession of the items.  The reasoning:  If you could enjoy the collectible, you’d be deriving a personal benefit from the investment.  Yet many pension planners tell of doctors who exhibit in their offices art objects that belong to their pension plans.  If you’re the trustee of a retirement plan that purchased collectibles before 1982, you should keep them locked away with a third party, so that there’ll be no question of your deriving current benefits from them.  Since 1982, of course, doctor-managed plans have been prohibited from buying collectibles under any circumstances.

  • If your retirement plan is managed by an outside trustee, collectibles are acceptable investments under existing rules.  But you still have to be careful to keep the items out of sight.  One doctor invested pension money in stamps and coins.  The investment was perfectly legitimate—until the doctor decided he wanted to own some of the coins in his plan himself.  He gave his accountant money to buy the coins from the plan and had the accountant turn the coins over to him.  During a routine audit, the auditor deemed the sale a premature distribution.  The doctor had to pay both income and excise taxes.

  • Practice Real Estate.  Too many doctors have gotten their medical offices mixed up in their retirement plans.  Typically, the plan owns all or part of the building, which it leases back to the practice.  That’s a blunder.  The law expressly forbids any transactions (including leases) between your retirement plan and your practice.  Because a medical office building probably takes up the lion’s share of your plan assets, there’s a very real risk that an auditor will close down your plan.

  • If you’re caught in this trap, you could ask the Labor Department for a retroactive exemption from the prohibited transaction rules.  But it’s a lengthy, costly process, and the outcome could go against you.  The best move is to get your office building out of your plan as soon as possible.


         Most practices take an informal approach to an employee’s retirement.  That informality can cause them to flunk an audit.  When an employee leaves, the law mandates that you follow a clearly defined procedure set down in writing, and an auditor will want to see evidence that your practice conforms to the law.

         When an employee announces his retirement, he should be provided with a written explanation of your practice’s retirement procedures.  Among other things, it should describe employees’ retirement-plan options:  annuities, lump-sum distributions and rollovers into an Individual Retirement Account.  The law requires that all retirement plan payouts be in the form of joint-and-survivor annuities unless retirees formally elect otherwise.  So if an employee elects a lump-sum payout, he and his spouse must sign a special wavier.  The law also requires your practice to withhold income taxes on any lump-sum distribution unless the employee makes a written election not to have tax withheld.

         Typically, in practices I’ve come across, an employee announces he’s leaving, and the accountant is instructed to make out a check.  That’s the sum total of the formalities.  Ignoring the paperwork that the government demands can get you in a heap of trouble.

         If your practice doesn’t require employees to formally opt out of income tax withholding, an auditor might assess fines.  But fines could be the least of your problems.  The real headaches occur if an employee reneges on his tax liability and leaves your practice holding the bag.  In one recent case, a retiring partner took a lump-sum distribution without making a written election opting out of withholding.  Then he skipped town without paying the tax.  Because he hadn’t signed the election form, the remaining partners were held liable for his taxes.

         Failing to require an employee to waive a joint-and-survivor annuity can be equally costly.  The annuity requirement was intended to protect spouses’ rights to their share of a retirement plan.  The courts recently have seen more and more cases brought by wives whose husbands divorced them shortly after taking a lump-sum payout from a retirement plan.  The courts’ decision in most cases:  If both spouses didn’t sign the waiver, the retirement plan is held responsible.  That would require your plan to hand over more money to a former employee’s ex-spouse.


         No doubt about it, all those tax law changes—six since 1980—have imposed an enormous paperwork burden on doctors.  If you’ve fallen behind, now’s the time to do something about it.  Expect an auditor to comb through your retirement plan documents to make sure your plan has been formally amended to conform to every new law change, that the amendments have been signed, and that new summary plan descriptions have been distributed to all plan participants.

         This might seem like so much nitpicking, but failure to keep up-to-date can create real problems for your plan.  For instance, failing to produce an up-to-date summary plan statement when an employee requests it can result in a large fine.

         A more serious problem could occur if your employees’ plan statements haven’t been updated to reflect changes in your plan.  Say you’ve changed your plan to cut back on contributions, but your employees’ summary plan statements reflect the old, higher contribution level.  If an employee decided to sue, a court could decide to hold you to those higher payments.

         Whether the government follows through on its threat to step up audits remains to be seen.  But it’s just plain foolhardy to play Russian roulette.  Take the time now to conduct a thorough review of your retirement plan’s transactions and procedures.  Don’t let an auditor wreak havoc with your most valuable investment.