We often talk to clients who are searching for retirement structuring. But more often than not, they are interested first in reducing their tax liability. The first option we usually select is a defined benefit cash balance plan.
Retirement advice can be challenging because all clients have unique tax and financial situations.
Retirement planning is not a one size fits all approach. If a doctor is simply an independent contractor or has just a few employees, then there are a couple of perfect structures. It will usually employ a 401k (with profit sharing) in addition to a defined benefit plan.
The majority of our doctor clients will quickly understand how 401k plans work. But a defined benefit plan is a different animal. Let’s take a look at how they work.
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Retirement Advice
Defined benefit plans (as well as other types of hybrid defined benefit plans like cash balance plans) are beginning to receive increased attention. Available literature indicates that transition appears to be largely aimed at making employers more attractive to workers who do not plan to remain with the same employer for their entire career.
A defined benefit cash balance plan promises these workers a larger benefit than they would receive under a traditional defined benefit pension plan, as well as a benefit accrual pattern that may be better understood.
Cash balance and other hybrid plans contain features of both defined benefit (DB) and defined contribution (DC) plans. This allows the plan sponsor and participants to take advantage of features of both types of plans (see our dummies post).
One key reason for the growth of cash balance plans was the improved ease of understanding of a participant’s retirement benefit. Another reason was the movement to retirement income based on lump sum values, similar to 401(k) savings plans, and the availability of lump sum payment options.
More recently, small employers have adopted cash balance plans since defined benefit plans may provide higher retirement income than defined contribution plans. A cash balance pension plan is a defined benefit pension plan. Cash balance plans are career average plans in which benefits are accrued incrementally year by year.
Defined Benefit Cash Balance Plan Formula
The benefit is defined by a formula containing a specified pay credit (or allocation) which is placed into a hypothetical account for each participant. A cash balance plan mimics a money purchase pension plan formula; the employer contributes to each participant a percentage of their plan year compensation (as opposed to average annual compensation).
This allocation is called a “Hypothetical Allocation”. To determine a participant’s accrued benefit at any particular time, the hypothetical account balance is projected, with interest, to normal retirement age. This projected lump sum amount is then converted to an annuity by dividing the amount by the an annuity purchase rate specified under the plan.
Let’s examine some of the advantages of a defined benefit plan:
- In general, they allow for significantly higher employer contributions than other types of plans. This allows you to take a large tax deduction and funnel substantial funds into the plan. We can assist in the calculation.
- Significant benefits possible in a relatively short period of time.
- Can be combined with other retirement plans including a 401k.
- Can be a business of any size in any industry including solo practitioners.
- Vesting can be immediate or spread out over a seven-year period.
- Plan can be used to promote certain business strategies by offering subsidized early retirement benefits.
- Participant loans are allowed.
- No set contribution limits. The deduction limit is calculated by an actuary and is any amount up to the plan’s unfunded current liability.
- Benefits are not dependent on asset returns.
Quality retirement advice for doctors should encompass many factors. But the most important is considering a defined benefit plan. This is often the best strategy of all.
Are you looking to stash more money into retirement? A pension plan may be a great option for you. I will show you how setting up a pension plan might not be as tough as you might think.
While a majority of the business world has moved to defined contribution plans, such as 401Ks, the pension plan or defined benefit plan has many benefits that you may want to consider.
Plan Strategies
How do you set up a pension plan? It’s not as hard as it seems. Check out our simple how-to guide below.
There are a lot of requirements that go along with setting up a pension plan. Let a seasoned financial advisor help you navigate the rules and regulations. The advisor needs information about your employees, their ages, and salaries to calculate the amount you must contribute to the plan based on your chosen percentage and the IRS rules.
Your pension plan document is the governing document that includes all the rules and regulations of the plan. This includes details such as the amount of the contributions (percentages) and interest rates. The plan document must follow all IRS rules but can incorporate its own rules and regulations as well, as long as they are within the law.
Illustrate what the plan looks like to you as this helps keep you accountable. Make sure you have provisions in place should your company face issues and be unable to make contributions.
Your plan or illustration should include plans to amend and freeze the plan, if necessary. It should also include the options and circumstances under which you can terminate the plan and how you’d distribute the assets to participants.
Choose a Third-Party Administrator
Rather than taking on the administrative components of a pension plan, hire a third-party administrator to handle it for you. TPAs work alongside you to help you remain compliant and accurate in your record-keeping and plan contributions/distributions.
A TPA can help you create the plan documents, prepare statements, perform annual reviews, prepare necessary reports for the IRS, calculate contributions, and manage audits.
Make the required contributions
You must make all necessary contributions by the due date of your tax returns, whether you are on a calendar year filing or tax year filing. If you need an extension, aka can’t make your contributions on time, you may request an extension of 8 ½ months. If you’re on the calendar year plan, this means your contributions for the previous year would be due by September 15th.
Plan Structuring
It’s not as difficult as it seems to set up a pension or defined contribution plan and there are many benefits of doing so. If you are looking for ways to entice more talented people to work for your company or you need a tax-friendly way to catch up on your own retirement plans, the pension plan is a great idea.
The key is to have proper help. Don’t try to manage this process alone. While you try to manage and grow your business, you need qualified personnel to help you run your pension plan as there are many laws and regulations you must follow.
If you do, though, you benefit from the tax advantages, the ability to increase your own retirement savings at much higher levels, and the possibility of attracting and keeping great employees.
In summary, setting up a pension plan for your business requires the help of:
- A financial advisor – This person will help you make decisions right upfront. You’ll choose the right plan, see the pros and cons of other plans, and make contribution decisions. You’ll go over the IRS rules and regulations and decide what steps you should take, including the type of vesting you’ll offer, whether cliff or gradual.
- A third-party administrator – Once you have the plan in place, don’t let the administrative tasks take over your day. Again, focus on your business and growing it as that’s the only way you’ll keep up with your required contributions. Find a TPA that you work well with as you’ll be in constant contact throughout the year.
Setting up a Defined Benefit Cash Balance Plan
Once you have the proper help in place, the rest of the steps are easy for you to manage:
- Create your documents – You want your documents to be as straightforward and informative as possible. You want your employees to understand the plan and see it as an advantage of working with you. Of course, always have an open door with your employees, allowing them to ask questions of you or the TPA to determine where they stand with their retirement accounts.
- Be flexible – If things happen down the road (as we all know life is unpredictable), you need plans in place to freeze or terminate your plan. Don’t let your plan become a liability; instead, have plans in place with the help of your support system that allows changes to the plans that will allow your business to stay afloat while keeping you in line with the IRS rules and regulations.
Bottom Line
If you’re interested in setting up a pension plan, start today! The sooner you start the more money you’ll accumulate for yourself and your employees. Setting up a pension plan can be straightforward with the right help and following the IRS guidelines. Get yourself and your employees set up for retirement today.
