28 Jun Monetize Your Practice by Adding a Cash Balance Plan
If you already have a 401(k) plan for your practice, you’ve seen the benefits it can provide in tax-advantaged saving for retirement and helping to retain staff with a comprehensive benefits package.
But if your practice has grown over the years, there’s another plan you should consider adding that will allow highly compensated partners or employees to contribute significantly to retirement savings in a tax-advantageous way, at amounts well above the minimums set for a 401(k) plan.
If you’ve added younger staff along the way, it also incentivizes them while allowing you to stay within the IRS guidelines. It’s called a Cash Balance Plan (CPB).
What is a Cash Balance Plan (CPB)?
A CPB is slightly different from a traditional pension plan or 401(k) plan. In action, it functions as a combination of the two.
401(k) Plan: The employee contributes up to a set limit determined by the IRS every year, the employer can match a specific percentage, and the funds are held in an account in the employee’s name and the employee invests them by selecting from a menu of fund options. Investment returns are a big part of the total amount saved for retirement.
Pension Plan: The employer promises a specified pension payment upon retirement that is predetermined by a formula based on the employee’s earnings history, tenure of service and age. The employee doesn’t have to worry about investing the funds until they receive them upon retirement.
Cash Balance Plan: The employee receives either a lump sum or an annuity on retirement, but it’s held in an individual account structure and is portable if they change jobs. They don’t have responsibility for investing it – the employer sets an annual contribution as a percentage of salary and pays a set interest rate.
An Efficient Vehicle for Medical Professionals
Cash balance plans may be particularly well-suited for medical professionals. They create the opportunity to significantly accelerate retirement savings in a tax-advantageous way. Since the company will be contributing the cash, your business needs to consistently produce a high enough level of revenue to cover the contributions.
What is the Tax Impact?
There are advantages to both the practice and the employee. Contributions result in so-called “above-the-line” deductions, which reduce income dollar-for-dollar. For employees, taxes are deferred until retirement, at which point the tax rate may be lower. Let’s look at some numbers.
A 60-year-old doctor wants to retire from her practice in five years. At that age, the upper limit for a CBP contribution is $261,000. Added to the $63,500 401(k) contribution, the annual total retirement contribution is $324,000.1 At a 37% tax rate, that’s a tax saving of $120,065.2 The lifetime limit for these types of plans is currently $2.9 million,23 so whatever point you are at, they may work for you.
Applicable to All Income Levels
CBPs can be structured so benefit levels can match employee needs, as long as annual non-discrimination requirements are met. For example, a flat dollar contribution could be made to owners while other eligible employees receive a percentage of compensation. This is where pairing with a 401 (k) becomes valuable, as it can help to meet the compliance requirements. In addition, because the existing 401(k) plan does not require an interest credit, it can mitigate some of the investment risks of the CBP.
Time for a Consultation?
Even if you have an existing 401(k), adding a Cash Balance Plan can help you create a flexible solution to provide tax benefits and accelerate retirement savings for owners and partners. There are, of course many more administrative and regulatory details that must be thought through, but if you’d like to know more about how a CBP can work for your business, we’re happy to have a conversation.
1. 2021 Cash Balance Plan Contribution Limits. TRA The Retirement Advantage.
2. Seven Group.
3. Cloud, Scott MBA, CPC and Brown, Kyle CEBS. Frequently Asked Questions About Cash Balance Plans. The Retirement Plan Company. October 28, 2020.
This work is powered by Seven Group under the Terms of Service and may be a derivative of the original. More information can be found here.
The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.
This content has not been reviewed by FINRA.
Sorry, the comment form is closed at this time.