By Laurie E. Ingwersen
When planning for retirement, you are likely familiar with IRAs, 401(k)s and pension plans as the traditional path to retirement savings. But for many doctors and medical practice owners, these options may prove inadequate.
Fortunately, there is another lesser known qualified savings plan option available to you: cash balance pension plans. A cash balance pension plan is considered a defined benefit plan, but with some elements of a defined contribution plan, and allows doctors to save more than the 401(k)/profit sharing maximum. Cash balance pension plans are gaining popularity as a way to provide doctors and medical practice owners with an opportunity to increase their annual retirement savings by as much as four times, while reducing their taxable income. Working with your financial, tax and retirement advisors, you can determine if these plans are the right fit for you.
Below we examine some of the more common questions about these plans, so you can decide if they are right for you:
What is a cash balance pension plan?
Cash balance pension plans, also known as hybrid retirement plans, are defined benefit plans that can be combined with a 401k and profit sharing plan to reduce your taxes and maximize your retirement savings. First introduced in 1985, cash balance pension plans did not get much attention until the Pension Protection Act of 2006, which removed uncertainty about their status. In 2010, the IRS provided greater clarity and expanded options for interest-crediting rates, and consequently, the number of active cash balance pension plans have risen exponentially since then.
Contributions to the plan are made by the employer and are a determined by a formula detailed in the plan document. The amount is determined either by a dollar amount or a percentage of salary, this is an important decision when developing the cash balance plan.
Who is the ideal cash balance pension plan candidate?
Cash balance pension plans may be most suitable for older professionals or established business owners who are interested in deferring taxable income and would like to accelerate their retirement saving. Professional practices, such as dental and medical, currently account for the majority of cash balance plans, because these professionals often earn above average annual salaries and tend to get a later start in accumulating personal retirement savings. For example, doctors often are not able to contribute to retirement savings during the early years of practice because of student loan debt, or because they are reinvesting in their practice. In these cases, cash balance pension plans may be desirable to help them “catch up” on retirement savings later in their career.
What are the major benefits of cash balance pension plans?
Because cash balance pension plan contributions reduce adjusted gross income, participants can also benefit from reduced tax liability in several areas through contributing to a cash balance pension plan. For example, long-term capital gains tax rates and applicability of the new investment income tax are both dependent upon a taxpayer’s income level.
Cash balance pension plans are also more portable than traditional pension plans. Participants are generally entitled to take the balance they have accumulated in a cash balance pension plan with them when they leave the company, whether to retire or to start new employment.
What are the advantages for medical practices?
Cash balance pension plans are ideal for the doctor with a large amount of income who may be 10 years or so from retirement and who wants to deduct more than $54,000 per year. The plan allows for up to $200,000 per year annual contributions, and can favor the medical practice owners or partners, as long as the plan meets the 401(k) and profit sharing requirements for the other participants.
Cash balance pension plans allow considerable flexibility. For example, a medical practice may credit either a percentage of salary or a fixed dollar amount each year to an owner-employee’s account. While larger corporations often set the amount credited at 5% of an employee’s salary, it is easier for medical practice owners/partners to make personalized decisions to meet the retirement savings needs of a plan participant who is closer to retirement.
For example: Tom, age 50, is a doctor with a very successful practice and has a high-income level. While the high income is good, it has become painful paying taxes — last year alone was over $200,000. Tom has a typical 401k/profit sharing retirement plan that he was able to max out with a $60,000 contribution. By adding a Cash Balance Plan, Tom could be able to defer up to $217,000 of income by contributing to the combination of a 401k/profit sharing and Cash Balance Plan. Assuming a 45% tax rate, that could amount to a $97,650 tax savings for Tom.