I often speak with physicians who are looking to improve their retirement situation and save on taxes. As a result, cash balance plans for physicians and doctors can make a lot of sense.
Most of my clients can quickly understand the mechanics of a 401(k) plan. But a cash balance is entirely different. Let’s take a closer look at a couple real-life examples.
In this article, we will show you how these plans are structured and examine a couple examples. Let’s get started!
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When it comes to retirement planning, there are many different solutions. If a physician has few or no employees, then there are a couple of ideal situations. It usually revolves around a 401k with a profit-sharing component along with a cash balance plan.
This example involves a 52-year-old Anesthesiologist. But in reality, it doesn’t matter what type of physician you are because the plan works for anyone (radiologist, oncologist, podiatrist, internal medicine, etc.).
He is married and has two children. He had saved approx $550,000 in retirement already, which was not enough based on his age and income. Like many physicians, he has lived a comfortable lifestyle and realizes now is the time to try to maximize his retirement.
This physician operated as an independent contractor. This works out well because he had no employees (other than himself). He had an S corporation structure and paid himself a wage of $220,000. He already had a solo 401k in place, and that is where he had all his retirement to date.
Cash Balance Plan Example
There was no reason to change his solo 401k. This allows him to contribute up to $24,000 (including the $6,000 catch-up provision). Also, he had a profit-sharing component that will enable him to contribute another 6% of his W-2 wage into the solo 401k. Just leave this alone.
The 401k provision also allows for a Roth 401k. I would not usually recommend this for someone with such a high income. But it is still a nice option to have.
But the key then is to add a cash balance plan into the mix. Yes, you can have both a cash balance plan and a 401k profit sharing plan. In fact, the vast majority of cash balance plans also have a 401k plan attached. There are, however, a few considerations when you have both plans in place. Let’s take a look.
Cash Balance Plans For Doctors: Combined Plans
A cash balance plan is a variation on a traditional defined benefit plan. It actually acts similar to a defined contribution plan (like a 401k) and a traditional pension. That is why it is often called a hybrid plan.
A cash balance plan creates an individual account for each participant and defines a specified lump sum balance. As a business owner, the cash balance plan allows for significantly higher contribution limits than you’d ever get with a 401k.
This can be a tremendous benefit to someone (like many physicians) who wants get get sizable amounts into retirement. The contribution limits for cash balance plans are based on age and income and can top $250,000 for some participants.
Cash Balance Plans For Doctors: The Results?
So back to the client. We were able to put $24,000 into the 401k employee deferral and an additional $12,000 into the profit sharing plan. The profit sharing plan was limited to a 6% contribution as a result of testing limitations.
But the good part was that we were able to contribute $188,000 into the cash balance plan. The combined total was $224,000. Assuming a combined federal and state tax rate of 45%, this resulted in a cash balance plan tax deduction of $101,000. Not too bad for physicians looking to supercharge retirement.
Physician #2: A 35 year old Cardiologist
Dr. Fox has an S corporation where he works alone as an independent contractor. After deducting all business expenses, he has a business profit of $305,000 and he takes a $200,000 salary. He is left with $105,000 business profit and wants to lower it by maximizing tax-deductible contributions towards a retirement plan. Since he is structured as an S-corporation, his profits pass through to his personal return.
The first option for him is to combine a 401k profit sharing plan with a cash balance plan. He, therefore, can make the following contributions:
$18,000 – 401k (Contributed from W-2 salary hence tax deductible on personal tax return)
$12,000 – Profit Sharing (Tax deductible as a business expense)
$48,000 – Fully Insured Defined Benefit Plan (Tax deductible as a business expense)
$78,000 – Total Contributions
The second option for Dr. Fox was to contribute to a SEP IRA, where he could only contribute $50,000 or an individual 401k, where for his $200,000 of W-2 salary, he could contribute only $54,000.
With the first option, Dr. Fox would make $28,000 tax-deductible contribution as compared to the second option.
The first option also had the following advantages to Dr. Fox:
- Increased savings towards retirement.
- Increased tax deductions which is usually the most important concern for physicians. Using a 33% marginal tax bracket on the $78,430 tax deductions made, Dr. Fox saved $25,881 on federal taxes.
- By the age of 65, minimum guaranteed policy value for an annuity as Dr. Fox retires will be $2,494,272. This is based on the annual defined benefit plan contribution of $48,000.
- Ability to combine 401k, profit sharing, and a defined benefit plan.
Also, make sure that you consider a Mega Backdoor Roth IRA.
|Advantages ⏩||Disadvantages ⏩|
|Contributions as High as $300k||Higher Fee Schedule|
|Custom Plan Document||Permanent Plan Design|
|Funding Range: Min/Max/Target||Requires Discrimination Testing|
|Large Tax Deductions||Complex IRS Rules|
Not only do cash balance plans for doctors offer exceptional retirement savings, but they also provide significant tax benefits. This is true for both the contribution amounts and the earnings on those contributions. If you are looking to get started take a look at setting up a cash balance plan.
Now, these are just a couple cash balance plan examples. Each physician’s situation is different. But the goal is to make sure that you listen carefully to your client and craft a retirement plan design that suits their needs.
As you can see, medical professionals can aim to increase their retirement savings in addition to generating tax deductions. That’s why they should consider this excellent retirement strategy!