Content Dam Diq Online Articles 2017 07 Taxes 1

Dentists: Want to save more for retirement and pay less in taxes?

July 6, 2017
Wouldn't it be nice to keep more of your own money and pay less to Uncle Sam? A Cash Balance Defined Benefit Plan might be the way to go. Learn about it from an expert here.

Wouldn't it be nice to keep more of your own money and pay less to Uncle Sam? A Cash Balance Defined Benefit Plan might be the way to go. Learn about it from an expert here.

For dental practice owners who would like to keep more of what they make for retirement, a Cash Balance Defined Benefit Plan (cash balance plan) could be the ideal solution. A cash balance plan can supercharge retirement savings by significantly decreasing the amount of taxes paid each year.

How it works
The retirement-building advantages of a cash balance plan start with potentially larger tax deductions, thanks to higher allowable contribution limits. A second advantage is tax-deferred growth of plan contributions. A triple retirement win can be achieved when the life insurance component of the plan is structured to produce a future annual stream of tax-free income from the policy’s cash value.

Unlike a 401(k) plan, which relies on individual contributions from each employee and can increase or decrease in value based on the performance of investment vehicles in the plan, cash balance plan contributions are funded entirely from the owner(s) of the business. Performance of investment products within the plan is not a big concern because there is a predetermined rate, usually 4% to 5%.

How does a cash balance plan supercharge retirement savings? The first way is through the annual contribution amount, which can be far greater than 401(k) contribution limits. The second is through the potentially significant tax savings that can be claimed by the practice owner(s) when adjusted gross income is reduced by plan contributions. Thanks to this one-two punch, the practice owner’s taxes can decrease substantially compared to a 401(k) plan.

Who is it for?

Cash balance plans work best for dental practice owners who want at least $60,000 a year in tax deductions. Tax deductions into the six figures can be achieved in many situations. In addition, these plans are particularly advantageous for dentists ages 50-plus because they’re likely to have the means to make larger plan contributions, and as a result, reap the greatest returns. When it comes to practice size, smaller is better because fewer employees means the owner keeps more of the money that goes into the plan and, of course, the resulting tax savings.

There are certain IRS nondiscrimination testing requirements that determine which employees must be included in a cash balance plan. Talk to your financial professional for more details.

Investment vehicles
In a cash balance plan, investment vehicles usually fall into two categories—securities such as stocks or mutual funds, and a whole life insurance policy that normally pays a guaranteed growth percentage (4% to 4.5% per year). The death benefit payable by the insurance policy is a key element of the plan. This is because in the event of the practice owner’s death before the plan is fully funded, the life insurance proceeds would make up the difference in plan proceeds. Another advantage of the life insurance component is that the cash value inside the life insurance policy can be used to create a stream of tax-free income in future years.

Setting up the plan: Step by step
1. Prepare an employee census—This census must include every employee, including the owner, and show each employee’s date of birth, length of employment, and income for the previous three years. This census is then provided to a third-party administrator (i.e., actuary) who performs an analysis that determines the contribution level for each employee participating in the plan.

2. Complete documentation required for the plan—All plan documents must be signed by the end of calendar year (i.e., December 31) in which tax deductions are claimed.

3. Fund the plan—The practice owner has until the tax payment deadline, including any extension, to make the first annual contribution.

4. Each year moving forward, the third-party administrator must prepare annual documentation needed by the IRS—In addition, the practice owner and plan participants receive a statement showing how their individual plan contributions and value are growing.

Retirement bottom line
An increasing number of dental practice owners are finding that retirement planning based on a 401(k) plan alone is not giving them enough. For practice owners who want to slash their tax bill and pump up their retirement savings, a Cash Balance Defined Benefit Plan could be the smartest way to go.

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Paul Danziger, MBA, IAR, Security Licenses 6, 22, and 65, is president of Freedom Financial Advisors of Maryland, based in Bethesda. Paul has been connected with the financial services industry for many years as a consultant, producer, and owner of his own firm. A specialist in retirement planning for owners of dental, medical, and other professional practices, Paul is licensed in life, health, and property and casualty insurance and is also securities licensed as an investment advisor representative. He can be reached at (301) 530-1399 or [email protected].