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  • Writer's pictureStephen Boatman

When do Cash Balance Plans Make Sense?: For Dentists, Endodontists, and Orthodontists

Updated: Jan 20

A cash balance pension plan is a great tool to save significant amounts of tax-deductible money during your later high-income years as a business owner. A cash balance plan or CB plan is a defined benefit plan that allows for high ($75k - $300k) annual contributions. The plan receives contributions via a salary deferral and interest credit. This means that if someone earned $100,000, they could have a $5,000 salary deferral and 5% ($5,000) interest paid on the account balance. However, CB plans shift investment risk to the employer, unlike your typical 401k plan. The CB plan assigns a set interest rate guaranteed by the employer every year. So, if the market increases faster than expected, the employer doesn't need to contribute as much. But if the market drops, your contributions can be much higher than expected. Especially if the plan has been around for a few years and account balances have grown.


Example: After three years, your company's cash balance plan has accrued $1 million. However, the underlying investments lost 7%, and the business owner guaranteed a 5% return. You'll then need to pay $120,000 or 12% of the $1 million on top of your contributions to keep the plan in good standing. Not only that, but this contribution is coming at the end of a down market, which likely isn't great timing to have an extra hundred thousand dollars lying around.


This is why you need to work in a business with consistent and high cash flow before considering a CB plan. Also, it's recommended to invest in a conservative allocation to reduce the risk of a cash outlay this high. CB plans are recommended after a practice owner has reached the extent of reinvestment in CE and business expansion and is seeking a new shelter from income taxes.


Cash Balance Plan Pros and Cons


Pros


  • Pre-tax contributions and deductions on 37%+ tax rates depending on your state.

  • High contribution limits (up to $300k/yr).

  • Can roll funds from the CB plan into an IRA.

  • You can have a 401k and a CB plan in the same year to increase deductions even more.


Cons


  • Market-dependent contributions – As seen in the example above, market conditions can drastically increase or decrease the cash contributions required depending on the underlying investment performance.

  • Admin costs – You need an actuary to run annual testing for the plan to ensure you are compliant, a CPA to ensure you are reporting these contributions correctly, and a financial planner/investment manager to help manage the plan. Costing $2-4k to start the plan and $2k-$4k annually to manage the plan. This doesn't include investment management costs, which range based on the size of the plan.

  • Employee structure dependent – If you have a lot of age 50+ employees, then the plan will be more expensive than if you have a small number of younger employees.

  • Age matters – This is a positive for individuals over 50 and a negative for those under 40. Someone in their mid-30s may only be able to contribute $80k/year, and someone in their 60s could contribute upwards of $300k/yr. Remember that you can contribute a lifetime limit of around $3.5 million (2024) to a CB plan.


Cash Balance Plans


Who is a CB plan best for?


A cash balance plan is excellent for high-income ($600k+) individuals over age 50 with less than six young employees. Your contribution rules are mainly based on your age and income. The younger your fellow plan members are and the lower their income, the less you must contribute to them, decreasing the overall CB plan cost.


Who is a CB plan not for?


If you are under age 40, have 10+ employees, and earn income under $500k, then a CB plan likely isn't the next best option for you.


Outlier


A good candidate could be someone under age 40 who consistently earns over $600k and has less than three, young employees. Then, a CB plan may benefit that business owner.


Best practices


  • Try to use a variable credit rating vs. a fixed credit rating so there is less volatility in your required annual contributions based on the underlying investment performance.

  • CB plans should last at least 3-5 years and likely no more than 10 years, depending on your scenario.


Summary


CB plans are great for someone in today's 37% income tax bracket and a lower tax bracket in retirement. Let's remember the whole point of these deductions. It's to receive a 37% deferment today to draw the funds out at 24% in a few years and find some tax arbitrage in the investment vehicles we weave our money through. But before embarking on a significant decision like a CB plan, please speak with a financial planner or tax professional.

 

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