We know that physicians are excellent candidates for cash balance plans. They need all the tax deductions they can get.
But when you have large physicians groups there are often many dynamics at play. It is essential to design a plan that supports the goals of the physician shareholders without sacrificing plan efficiency.
This article will guide you through structuring large physician plans. We will discuss the pros and cons of various design features and show you the step-by-step process. Let’s get started!
Step #1: Understand the Goals of the Partners
Structuring a cash balance plan for a large group can be challenging because the owners rarely have identical goals. One partner may want to maximize contributions, while another prefers a lower annual commitment. As a result, the group often struggles to agree on a design that feels fair, practical, and sustainable.
Age differences within the group can make the plan design even more difficult. Older partners can get higher contributions, while younger ones are usually limited. This can create tension because younger partners may feel they are supporting a structure that primarily benefits others.
A design that satisfies one segment of the group may frustrate another, especially when age-weighted results produce uneven outcomes. For that reason, planning for large practices usually requires careful modeling, multiple design options, and a willingness among the partners to compromise.
Here are some items that should be considered upfront:
- Desired contribution amount for each owner
- Selecting a financial advisor
- Overall tax and retirement goals of the group
- Tolerance for contribution volatility from year to year
- Preferred investment approach and risk level
- Employee demographics and testing impact
- Long-term affordability and permanency of the plan
- Whether fairness or maximum owner contributions is the bigger priority
Step #2: Review Current Plan
Most large groups will start with a 401(k) safe harbor plan. This will give shareholders and employees the ability to make employee deferrals. If desired, the plan will also allow profit-sharing contributions. However, this can be expensive due to testing requirements.
The company will typically have a plan that allows employer contributions based on employee deferrals. But the company can elect to make a 3% non-elective contribution to the plan. If the 3% non-elective is made, the plan will automatically pass gateway testing and result in more favorable overall results. You can find out more about this here.
When the cash balance plan is added to the 401(k) safe harbor, cross-testing is required. This means employees might be required to contribute to profit sharing, allowing shareholders to make larger contributions.
Step #3: Establish Different Groups
Physician compensation can vary across entities. Some physicians are paid the same, while other physician groups pay them by the hour. Lastly, some other groups will pay physicians based on seniority and other responsibilities.
But in either group, you’ll you’lllly find physicians and shareholders making total compensation of $400,000 or more. Of course, age ranges will vary, with physicians in their 30s going up to possibly their 60s. Younger physicians may not want to make large contributions because they’re still paying off student loans.
But other older physicians may be looking to stash away as much as possible as they approach retirement. Structuring a plan to accommodate the diverse backgrounds and personalities can be challenging.
The first step in the plan design is to generate different groups or buckets for them to contribute to. For example, you might have a $300,000 bucket that supports contributions for higher-paid employees. Meanwhile, go down to a $50,000 bucket to accommodate younger employees looking to minimize their contributions. The groups may be structured as follows:
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| Group Label | Pay Credit |
|---|---|
| A | None |
| B | $50,000 |
| C | $100,000 |
| D | $150,000 |
| E | $200,000 |
| F | $250,000 |
| G | $300,000 |
Step #4: Discuss Market vs Fixed Interest Credit
Larger group plans are a situation where market interest crediting rates can work. But there are a few pitfalls to consider. Larger group plans are a situation where market interest crediting rates can work. But there are a few pitfalls to consider.
A market rate adjusts the interest crediting rate to equal the asset’s returns. You can set a maximum and a minimum, with a minimum of zero.
While this type of design can be easy for participants to understand, volatility can still become an issue. Wow, many participants think that a large return like 20% is great. There is a downside.
The actuaries use these rates to discount back for contribution purposes. You’ll find that higher contributions like this or higher investment returns can result in lower individual pay credit contributions. Also, if you have losses, you’ll still have a pay credit of zero, so the account will be in a deficiency, which can require unplanned higher contributions.
Most planned designs will come with a fixed interest crediting rate of 4% or 5%.
Step #5: Understand PBGC & Profit-Sharing Limitations
Often, the issue arises when some physicians want to contribute to the profit-sharing plan but not to the cash balance plan. This is certainly a problem for smaller businesses that the PBGC does not cover.
This is certainly a problem that can be an issue for smaller businesses that the PBGC does not cover. This is certainly a problem for smaller businesses that the PBGC does not cover.
Is a Cash Balance or Defined Benefit Plan Right For You?
By definition, professional services businesses, such as physicians’, are not required to have PBGC coverage until they have 25 participants. When there is no PBGC coverage, profit-sharing is limited to 6% of compensation.
But once the plan hits 25 participants, then that limitation goes away, and contributions can be made up to the IRS limit of 25%. In this example, there are 50 shareholders so the PBGC will cover the plan. As such, full profit-sharing contributions are allowed. But in any case, this can be an issue for smaller corporations.
Step #6: Investment Returns
A cash balance plan uses a single “pooled” account for all contributions. The administrator will allocate the pay credits and interest credits in the participant statements.
Assuming the plan uses a fixed interest crediting rate, their participant statement will reflect this rate and NOT the investment return of the pooled account. If each participant is guaranteed a 5% interest credit, when they leave the partnership, they receive their pay credits plus 5%, which may differ from actual investment returns earned on their allocated contribution.
For example, if your plan has a 5% interest credit rate and the plan assets earn 8%, the extra 3% stays in the investment account and rolls over to the next year. Excess returns stay in the plan and do not go to a departing partner. Losses reduce the balance for the remaining partner.
Step #7: Open Enrollment
Once the plan is designed, each shareholder will select which bucket they want to be in. It’s important to note that the bucket is technically the amount listed or the lower of it and the 415 limit. This prevents clients from thinking they’re getting a higher pay credit than they really are.
It is also helpful for plans that have compensation amounts in sea corporations that must be zeroed out. In fact, they will use the pay credit amount to reduce the W-2.
But what happens if a shareholder wants to change their bucket in a subsequent year? This is a good question that will absolutely come up with a large partnership group like this.
This is treated by having an open enrollment every 2 to 3 years. As you would with health insurance, shareholders would again have the chance to pick the bucket they want.
It is important to note that the open enrollment period. Should occur before an employee becomes eligible for a pay credit in a given year. With typical eligibility being 1000 hours, open enrollment might be June 1 in a given year.
Plan Pitfalls
While these plans offer substantial benefits for large groups, they can also pose a few pitfalls. Here is a list of a few:
- If you have fewer than 25 participants, then the plan will not have PBGC coverage and will be limited to 6% profit-sharing. This could restrict certain professionals who do not want to contribute to the cash balance plan but want to make a full contribution to the profit-sharing plan.
- Managing the investments for larger plans like this can be challenging. Some clients want to manage their own investments. However, with this many participants, there is added complexity and liability for the investment advisor. This plan should earn around 4-5%.
- While we’ve developed a good plan design, communicating this design and getting all participants to fall in line can be a challenge. In large partnerships, there are many disagreements among partners, so establishing a plan can take a long time.
- For plans designed like this, you should contribute the recommended amount. While the IRS allows you higher contribution ranges and higher maximums, you’ll find that it’s tougher to communicate who benefits from these. If these contributions are being made, they are actually not showing up on participant account statements. This cushion funding amount is tax-deductible, but will not be allocated to participant accounts. Shareholders are often confused as to who will ultimately benefit from this cushion.
Bottom Line
Cash balance plans are especially beneficial for physicians because they help highly paid professionals like doctors reduce taxes and build retirement savings securely. These plans provide a reliable, tax-efficient way to enhance retirement security beyond traditional options.
Cash balance plans are a hybrid of defined benefit and defined contribution plans, offering the predictability of a pension while allowing higher contributions and greater flexibility akin to a 401(k) plan.
For older physicians, cash balance plans offer additional benefits, such as the ability to roll out funds and the potential for significant tax savings. Overall, cash balance plans are a valuable retirement strategy for large groups seeking to maximize retirement savings, minimize taxes, and ensure financial security in their later years.
