Dentists may not be aware of the options available to them for retirement savings beyond 401(k)s and IRAs. Cash balance pension plans are gaining in popularity, and for good reason. Read on to see if it might be a good plan for you.
WHEN PLANNING FOR RETIREMENT, you’re likely familiar with the traditional IRAs, 401(k)s, and pension plans. But these options may prove inadequate for many dentists and dental practice owners.
Fortunately, there is another, lesser known qualified savings plan option available—a cash balance pension plan. A cash balance pension plan is considered a defined benefit plan, but with some elements of a defined contribution plan. It allows dentists to save more than the 401(k) and profit sharing maximum. Cash balance pension plans are becoming popular as a way for dentists to increase their annual retirement savings by as much as four times, while reducing their taxable income. Working with their financial advisors, dentists can determine if these plans are the right fit for them.
What is a cash balance pension plan?
Cash balance pension plans, also known as hybrid retirement plans, are defined benefit plans that can be combined with a 401k and profit sharing plan to reduce taxes and maximize retirement savings. Introduced in 1985, cash balance pension plans did not get much attention until the Pension Protection Act of 2006, which removed uncertainty about their status. In 2010, the IRS provided greater clarity and expanded options for interest-crediting rates, and consequently, the number of active cash balance pension plans have risen exponentially since then.
Contributions to the plan are made by the employer and determined by a formula detailed in the plan document. The amount is determined either as a dollar amount or a percentage of salary. This is important when developing the plan.
Who is the ideal cash balance pension plan candidate?
Cash balance pension plans may be most suitable for older professionals or established business owners who are interested in deferring taxable income and accelerating their retirement savings. Professional practices, such as dental and medical, currently account for the majority of cash balance plans because these professionals often earn above average annual salaries and often get a later start in accumulating their retirement savings.
For example, doctors are often not able to contribute to retirement savings during the early years of practice because of student loans or they’re reinvesting in their practices. In these cases, cash balance pension plans may be desirable to help them “catch up” on retirement savings.
What are the major benefits of cash balance pension plans?
Because cash balance pension plan contributions reduce adjusted gross income, participants can benefit from reduced tax liability in several areas through contributing to a cash balance pension plan. For example, long-term capital gains tax rates and applicability of the new investment income tax both depend on the taxpayer’s income level.
Cash balance pension plans are also more portable than traditional pension plans. Participants are generally entitled to take their balances with them when they leave the company, whether to retire or start new employment. If a dentist sells his or her practice, the dentist can close the cash balance pension plan and roll the plan balance into an IRA, or possibly annuitize like a 401(k) plan.
What are the advantages for dental practices?
Cash balance pension plans are ideal for dentists with a large amount of income who may be 10 or so years from retirement and who want to deduct more than $54,000 per year. The plan allows for up to $200,000 per year annual contributions and can favor dental practice owners or partners, as long as the plan meets the 401(k) and profit sharing requirements for the other participants.
Cash balance pension plans allow considerable flexibility. For example, a dental practice may credit either a percentage of salary or a fixed dollar amount each year to an owner-employee’s account. While large corporations often set the amount credited at 5% of an employee’s salary, it’s easier for dentists to make their own decisions to meet their retirement savings needs.
Here’s an example. Tom, age 50, has a very successful dental practice and a high level of income. While his income is good, it has become painful for him to pay taxes—over $200,000 last year alone. Tom has a typical 401(k) and profit sharing retirement plan that he maxed out with a $60,000 contribution. By adding a cash balance plan, Tom could defer up to $217,000 of income by contributing to the combination of a 401(k), profit sharing, and cash balance plan. Assuming a 45% tax rate, that could amount to a $97,650 tax savings.
401(k) Profit Sharing and Cash Balance Plans
Age | 401(k) | with Profit Sharing Cash Balance | TOTAL | Tax Savings* |
60-65 | $60,000 | $256,000 | $316,000 | $142,200 |
55-59 | $60,000 | $206,000 | $266,000 | $119,700 |
50-54 | $60,000 | $157,000 | $217,000 | $97,650 |
45-49 | $54,000 | $120,000 | $174,000 | $78,300 |
40-44 | $54,000 | $92,000 | $146,000 | $65,700 |
35-39 | $54,000 | $70,000 | $124,000 | $55,800 |
30-34 | $54,000 | $54,000 | $108,000 | $48,600 |
*Assuming 45% tax, varies by state. Taxes are deferred.
What are the advantages over 401(k)s?
When compared to 401(k) plans, cash balance pension plans can be advantageous on several fronts. Since contributions are made entirely by the business, the plan offers more retirement benefits for participants. Plan contributions are also tax deductible, reducing the profits that will be taxed.
Retirement benefits are more stable in cash balance pension plans because investments are usually tied to a benchmark, such as the 30-year treasury rate, and are conservatively invested. Conversely, with 401(k)s, participants at retirement have only as much as their contributions have earned.
Can cash balance pension plans be combined with 401(k) plans?
Yes, the cash balance pension plan can be combined with 401(k) plans to maximize retirement savings without increasing business costs. In fact, industry reports show that 89% of cash balance pension plans are combined with a profit-sharing or 401(k) plan. Those who can take full advantage of both could have enough money to retire without taking excessive risks.
Cash balance pension plans might be worth a look
For dental practice owners with excess cash flow, cash balance pension plans might be worth considering. The higher contribution limits of these plans can be particularly appealing for dentists who want to maximize their retirement savings, particularly in their later years.
No matter what retirement savings strategy you choose, you should work closely with a team of financial and tax advisors and a retirement specialist to help ensure a cash balance pension plan is the right course of action for you.
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