Professionals (doctors, dentists, lawyers, etc.) may have very high wages, but the earnings come after years of school, training, buying into a practice, and paying down student debt. Because of these factors, professionals often are unable to make meaningful retirement contributions until the middle or later parts of their careers.
Professionals, who are owners in a practice, can make up for lost time by utilizing a Cash Balance plan to save for retirement and defer tax on income well in excess of the limits of a traditional 401(k) with profit sharing plan. For example, a 44-year-old could place approximately $102,000 of compensation into a Cash Balance plan in addition to $54,000 into a 401(k) with profit sharing plan (using 2017 contribution limits). The plan allows a professional to make considerable retirement contributions in a compressed period of time.
Cash Balance plans also provide meaningful tax savings. The tax on the compensation placed in a Cash Balance plan is deferred until the participant’s retirement. If the 44-year-old in the example above paid 45% of their income in federal and state tax, their tax savings could be $70,200 that year.
These kinds of contributions are possible because Cash Balance plans are considered “defined benefit” plans, similar to a traditional pension plan. Because of this classification, contributions are not capped in the manner that they are in a 401(k) plan. Instead, the contributions are limited in terms of a maximum annual payout that the participant may receive at retirement. For this reason, the older a participant is when starting a cash balance plan, the larger their annual contribution may be.
Each participant has either a percentage of their pay or a flat dollar amount credited to their account annually. Additionally, each participant’s account must grow by a stated “interest credit” each year. At retirement, the accumulated balance can be paid out in a lump sum or in annual payments for life in the form of an annuity. Unlike a traditional pension plan, the accumulated account balance is calculated annually and a statement is given to each participant. This account balance can be rolled into another retirement plan if the participant leaves prior to retirement.
There are several factors to consider when determining if a Cash Balance plan would be a good fit for your practice:
Consistently high salary of the owners. Cash Balance plans require working with an actuary, which can make administering a Cash Balance plan more expensive than other retirement plans. Because of this expense, the owners of a practice would want to ensure that they can regularly afford to fund their plan with contributions greater than the annual limits of a 401(k)-profit sharing plan.
Practice should have steady cash flow. Cash Balance plans must be funded every year. The practice should have steady and predictable cash flows to ensure that the plan can meet the funding requirements every year.
Age of practice owners compared to employees. Older plan participants have much higher contribution limits than younger participants. The most efficient plans practice owners that are older than the employees who would also participate in the plan.