When dentists consider retirement planning, they often consider a 401(k) plan. These plans are great options but come with contribution limits that fall short for many people.
This is where a cash balance plan could be considered. They come with contributions that can top $300,000 annually, depending on your age and compensation.
However, before we examine the details of cash balance pension plans, let’s first understand the two types of retirement structures: (1) defined contribution plans; and (2) defined benefit plans.
Retirement Plans for Dentists
The most popular type of defined contribution plan is a 401(k). These plans specify a contribution that the employee and employer can make. Participants’ benefits upon retirement in a defined contribution plan depend on the cumulative plan funding and investment gains or losses, interest, and dividends. Depending on the age and annual limits, the combined contribution limits are approximately $60,000.
| Basic Structures | Advanced Structures |
|---|---|
| Solo 401k | Cash Balance Plan |
| SEP IRA | Traditional Defined Benefit Plan |
| Traditional or even Roth IRA | Safe Harbor 401(k) |
| SIMPLE IRA | Money Purchase Plan |
Defined benefit plans aim to provide a designated benefit at retirement for plan participants. This is generally a monthly payout similar to Social Security. The benefit amount is independent of employee contributions. It’s a specified amount typically based on the participant’s compensation.
Upon retirement (typically age 62), distributions will be taxed at the employee’s ordinary tax rate. In most situations, this rate will be substantially lower than the income tax rate during their high-income employment years.
But a cash balance plan is structured a little differently. It falls under the defined benefit plan umbrella. But to the employee, it has the look and feel of a 401(k) plan. This is because, unlike a pension, the payout amount is stated as an account balance rather than a monthly income stream.
As a result, a cash balance plan is typically called a “hybrid” plan. Like any pension withdrawals, cash balance pension distributions at retirement are taxed at the taxpayer’s ordinary income tax rate.
How do cash balance plans work?
A cash balance plan is a type of defined benefit retirement plan that looks and feels like a 401(k) to participants. Instead of promising a monthly pension, the plan promises a “hypothetical account” that grows with annual pay credits and interest credits.
The pay credit is usually a percentage of pay or a flat dollar amount. The interest credit is defined in the plan document, often using a fixed rate or an index like treasury yields.
An actuary calculates the required annual contributions based on age, compensation, and plan design. Because of this structure, older business owners can often contribute far more than in a typical 401(k) alone.
For employees, the plan is easy to understand because they see a growing account balance on statements. At retirement or termination, that balance can usually be taken as a lump sum rollover to an IRA or as an annuity.
For business owners, the big appeal is the combination of large tax-deductible contributions and accelerated retirement savings. When paired with a 401(k) profit sharing plan, a cash balance plan can significantly boost retirement plans for dentists.
How cash balance pension plans differ from traditional pension plans?
Both cash balance plans and traditional defined benefit plans offer employee benefit payments based on a series of payments over the employee’s expected life. For traditional defined benefit plan structures, the payments would begin at retirement.
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Cash balance plans will define the employee benefit based on a stated account balance. This account is generally called a “hypothetical account” because it does not reflect the actual account contributions or balance. They merely state an account balance under the plan document.
Behind the scenes, a cash balance plan is still a true defined benefit plan under IRS rules. That means the employer is responsible for funding the promised benefits, not the employees.
Why is a cash balance plan such a great retirement structure?
It allows plan participants to make large contributions and take a large tax deduction. Contribution limits are indexed annually by the IRS and based on age. Most dentists can make contributions from $100,000 to $300,000. These contributions compare favorably to the approximate $60,000 annual limitation of a 401(k) plan.
Let’s look at an example. Assume a 58-year-old dentist earns $500,000 yearly and seeks to maximize a retirement contribution. For simplicity, let’s also assume that the physician has no eligible employees (if the dentist had employees, they would be subject to minimum contributions under the plan).
Because of compensation and age, this dentist can contribute approximately $230,000 to the cash balance plan in the first year. When the cash balance plan combines with a 401(k) profit-sharing plan, the dentist can contribute an additional amount equal to the maximum employee deferral and the allowable profit-sharing amount. That’s why this is one of our favorite retirement plans for dentists
Contribution Requirements
Along with the rules for establishing annual contribution limits, defined benefit and defined contribution plans also have varying specifications for contribution requirements. In addition, to have inconsistent rules for setting yearly contribution limits, these plans have varying specifications for contribution requirements.
| Advantages | Disadvantages |
|---|---|
| Tax-Deferred Contributions | High Administration Costs |
| Rollover to IRA or 401(k) | Mandatory Contribution Levels |
| Flexible Contributions | Permanent Structure |
| Tax-Deferred Growth | Complex Plan Design |
Within a defined benefit plan, there is typically an annual contribution obligation. The employer must fund the amount determined by the actuary to sufficiently support the benefits specified. However, if the plan has been overfunded, the annual funding requirement may be decreased. If there is an inability to afford the funding requirement, there is potential for the benefits to be amended.
Is a Cash Balance or Defined Benefit Plan Right For You?
In contrast, within a defined contribution plan, contributions are typically at the discretion of the individual. This is true when it comes to corporations with only owner-employees. As a result, the business owner may determine annually whether or not they will contribute to the 401k.
Defined Benefit and Cash Balance Plans for Dentists
Plan contributions are fully tax-deductible. In addition, you can make contributions as late as the tax return if filed by September 15th (for a calendar year plan). Assuming a federal and state tax rate of 40%, this is a tax saving of $102,000. A good deal. This amount grows tax-deferred but will be subject to taxation at his (presumably lower) tax rate in retirement.
Consider the above example of the dentist. As you can see, only a few retirement options allow for such a significant contribution. A 401(k) plan does not come close.
Cash balance pension plans are great for:
- Companies with historically consistent profits.
- Professional service businesses (dentists, physicians, attorneys, CPAs, etc.).
- Businesses that are interested in improving morale and employee retention.
- Owners who are behind on retirement planning and are looking to “catch up” on retirement contributions.
- Owners in high tax brackets who are looking to maximize income tax deductions.
If you think a plan is right for your business, ensure that you review your financial and tax situation with your CPA and a retirement administrator. Hopefully, the cash balance plan will become an effective tool in your retirement arsenal.
Bottom Line
For many dentists, the challenge is not earning income but keeping enough of it after taxes. A well-designed defined benefit or cash balance plan can turn today’s high tax bills into tomorrow’s retirement security.
By channeling large, deductible contributions through the practice, you shift money from the IRS column to your future self. Over time, that consistent funding can create a powerful second asset alongside the value of your practice.
Of course, these plans are not “set it and forget it” structures. They require careful design, ongoing actuarial oversight, and coordination with your existing 401(k) or profit sharing plan.
Eligibility, employee costs, and long-term funding commitments all need to be modeled in advance. When you approach them thoughtfully, though, the combination of high contribution limits and tax deferral is hard to match.
If you are a dentist in your peak earning years, now is the time to explore whether a defined benefit or cash balance plan fits your situation. With the right team and design, these plans can become the cornerstone of your retirement strategy and a key tool for reducing your lifetime tax burden.
