White Coat Investor Cash Balance Plan Article: Why We Wrote It

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I often speak with physicians who are looking to improve their retirement situation. But more importantly, they are looking to save money on taxes. My goal is to help them with both.

When it comes to retirement planning, there are many different solutions. There are many ideal situations if a physician has few or no employees. It usually involves a 401k with a profit-sharing component and a cash balance plan.

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 real-life example.

Our White Coat Investor Article

We always have enjoyed working with the folks over at white coat investor. We received a lot of feedback on an article we wrote about some aspects of these plans. You can find the article here:

Top 10 Cash Balance Plan Mistakes to Avoid

In that post, we discussed many of the plans’ disadvantages. We know these plans are home runs for the right clients.

A few people asked why we wrote an article discussing these plans’ negatives instead of referencing the positives. The reality is that many people know these plans are the number one tax and retirement strategy for most physicians. However, people often focus on the positives and don’t examine any plan disadvantages. For that reason, we felt it was necessary to make sure that we address these comments.

Of course, you know we’re big fans of these plans. But we also feel it’s important to review some of the highlights of these significant retirement structures. We want to ensure that people are educated before setting one up.

Many people reached out to us regarding that post, and we’re just looking for a general overview of these plans and how they’re structured. So, we wanted to give you some details so you can make an educated decision.

The Hypothetical Account

Each cash balance plan has a hypothetical account for each eligible employee. The plan administrator oversees the account reconciliation. The employer pays a pay credit based on a percentage of the employee’s salary plus a predetermined interest rate.

The company sets the interest credit rate, subject to IRS guidance. An employer can choose a fixed interest rate or variable. If they choose a variable rate, it’s tied to an index and varies along with the interest rate selected.

Can You Have a 401(k) Plan and a Cash Balance Plan?

Employers can offer multiple retirement account options, including a 401K plan with a cash balance plan add-on.

The limits for the 401K versus the cash balance plan vary greatly.

In 2022, the maximum 401K contributions are $20,500, with an add’l $6,500 catch-up contribution allowed for employees over 50 years old.

The limits for the cash balance plan are based on the total lump sum limit allowed for withdrawal, which is $3.15 million or $245,000 in annuity payments.

Cash Balance Plan Vesting

Cash balance plans can have a vesting period of up to 3 years. This means employers can require three years of employment before an employee is vested. The employee is then 100% vested at the end of three years.

Suppose an employee leaves the company before the three years are up. In that case, they forfeit the cash balance plan entirely, and the employer uses the accumulated funds to offset future cash balance account requirements.

Employers are optional to instill a 3-year vesting schedule, though. It is up to each employer.

Cash Balance Deadlines

Cash balance contributions by an employer are due by the earlier of the following:

  • Business tax return due date with extensions
  • 8 ½ months after the end of the plan year

Contributions are required annually and typically stay the same unless significant fluctuations occur in your annual income and investment performance.

Investing the Assets

You can choose where to invest the assets as an employer, keeping the typical interest rate credit in mind. Most cash balance plans pay an interest rate credit of 4% – 6%. This means your returns must equal at least that much. If they don’t, you must make a difference with your contributions.

It’s important to understand that employees must have individual investment accounts with a say in where the assets get invested. All funds are in a ‘pooled’ account in the name of the cash balance plan.

The employer funds the account annually to ensure enough contributions to meet the hypothetical account balance. The plan advisor manages the investments to ensure the return is at least as much as the interest credit promised to each employee.

Most plan advisors use the following guidelines:

  • Keep a conservative portfolio to prevent significant losses, putting the employer’s responsibility to make up the difference for the promised amounts.
  • Keep the account manageable, so the balance is higher than the necessary balance for eligible employees.

The target return is 5% for most cash balance plan investment accounts.

Terminating the Cash Balance Plan

The cash balance plan is a defined benefit plan that is permanent. Typically, you cannot terminate the plan unless you have a significant change in your business, including:

  • Restructuring your business
  • Changes in the law
  • Financial issues
  • Replacement with another benefit plan

Tax Benefits

It’s no surprise that the number one reason people set these plans up is for the tax benefits. Most of our clients are in high-taxing states like California and New York. But we have clients spread out nationwide.

When your income is in a 50% tax bracket, like many of our California clients, getting an initial tax deduction for your contributions is a significant benefit.

These plans will allow you to take a significant deduction upfront and reduce or take this money out of the plan at retirement when you’re in a much lower tax bracket. The important part to note is that you can take advantage of the deductions in years when you have a high income. You also receive a flexible funding range, allowing you to contribute up to a maximum amount in a given year.

I began structuring these plans for clients of mine, physician clients, over a decade. Given their age and income, there needed to be a better tax, deduction, or structure.

Most physicians we work with are at least in their 40s and are taxed at the highest tax bracket. As such, it’s a simple plan to structure it to ensure it works for you.

Final Thoughts

The cash balance plan is an alternative to the defined contribution plans or can be utilized in conjunction with it. The cash balance plan has replaced traditional pension plans in most cases and gives employers a little more leeway when preparing themselves or their employees for retirement.

There are vesting requirements, deadlines, and contribution limits you must abide by, along with rules regarding what you must offer your employees once you commit to the cash balance plan.

Paul Sundin

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