Cash Balance Plans for Dentists
By Cecil Staton, CFP®
Understanding Cash Balance Plans: A Smart Retirement Strategy for Dentists
As dental practice owners, your focus is likely on providing excellent patient care while efficiently managing your business. However, an equally important aspect of your professional life involves planning for a comfortable retirement. Cash balance pension plans offer dentists a unique and advantageous way to accelerate their retirement savings, provide tax savings, and secure financial stability for the future.
At Arch Financial Planning, we specialize in guiding dentists through the intricacies of benefit plans and the intricacies of the Internal Revenue Code, ensuring you make the most informed decisions tailored to your financial goals.
Arch Financial Planning is a dental-focused financial advisor that helps dental practice owners nationwide. Be sure to read our guide and hire the right team of advisors who can assist with building and selling the practice you’ve built to empower your retirement plan.
What is a Cash Balance Plan?
Company-sponsored retirement plans come in two main types: defined benefit plans and defined contribution plans. The most well-known of these is a 401(k) plan. A 401(k) plan is a qualified plan that allows employees the option to participate, and employers may choose to match employee contributions to varying extents. Participants can set their contribution levels and make their own investment choices.
In contrast, defined benefit plans do not require contributions from eligible employees. These plans resemble traditional pensions, where the employer commits to providing a specified benefit to employees upon retirement.
Cash balance plans blend features of defined benefit and contribution plans, making them “hybrid” plans. These plans offer flexibility in terms of eligibility, allowing practice owners to determine which employees qualify based on criteria like seniority or years of service.
How to Contribute to Cash Balance Retirement Plans
In a cash balance plan, the employer contributes to an employee’s account either a fixed percentage of their salary or a specific flat amount each year. The plan guarantees these contributions an interest rate predetermined by the employer. Employees or practice owners can receive a regular income annuity or a lump sum upon retirement, which can be transferred into an IRA for personal management. Like 401(k) plans, cash balance plans are also leveraged to foster employee loyalty and retention. Cash balance plans have notably gained traction within the dental industry. In fact, dental practices account for more than 10% of all cash balance plans implemented nationwide.
Pros & Cons of Cash Balance Plans
Implementing a cash balance plan offers significant advantages, particularly for dental practice owners with high incomes. These plans are an effective tool for catching up on retirement savings while also providing substantial tax deferral on earned income. This benefit is especially pertinent in the dental industry, where the substantial costs associated with education and practice establishment may delay the start of retirement investments. Cash balance plans enable owners or partners to significantly boost their retirement savings in a relatively short time by deferring taxes on amounts much larger than those allowed under traditional 401(k) plans, with annual contribution limits potentially exceeding $400,000 depending on the age of the beneficiary. Additionally, contributions can be made up until the tax filing deadline, offering further flexibility.
Integrating practices that already have a 401(k) plan with a cash balance plan can create even greater opportunities for tax deferral, accelerating the growth of retirement savings.
However, cash balance plans also come with certain drawbacks and considerations. They require adherence to complex actuarial rules and are typically more costly to maintain than traditional 401(k) plans.
Initial setup fees for cash balance plans range from $2,000 to $6,000, with annual administrative fees between $2,000 and $7,000 and investment management fees typically between 0.50% and 1.5% of assets. While these fees might seem steep, they can lead to tax savings for the practice owner that far exceed the fees.
A significant consideration for cash balance plans is their permanence; they require ongoing contributions for the foreseeable future, typically between 3 to 10 years. This commitment and promised benefit must be maintained unless altered by financial downturns, business closure, or sales, adding a layer of complexity and obligation to the practice’s financial planning.
Key Features of Cash Balance Plans
Pay Credits and Interest Credits
In a cash balance plan, the participating employees’ accounts are credited annually with a “pay credit” (a percentage of their annual salary) and an “interest credit,” which is either a fixed or variable rate linked to a specific index. This setup is more transparent and understandable for employees than traditional pension plans’ calculations.
High Contribution Limits
Cash balance plans allow for higher annual contributions than traditional defined contribution plans. These contributions grow tax-deferred, significantly reducing the dental practice owner’s taxable income. This can be an excellent strategy for older dentists to boost retirement savings later in their careers.
Tax Advantages
Contributions to a cash balance plan are tax-deductible for the dental practice as a business expense. This reduces the practice’s overall taxable income, leading to substantial tax savings. Additionally, the growth of funds within the plan is tax-deferred.
Benefits for Dental Practice Owners
Cash balance plans can be particularly beneficial for dental practice owners. Here’s how:
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Accelerated Retirement Savings: The higher contribution limits associated with cash balance plans can significantly accelerate retirement savings, which is particularly beneficial for those starting their retirement planning later and having higher incomes and tax rates.
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Tax Benefits: Reducing taxable income through higher, tax-deductible contributions can lead to considerable tax savings each year.
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Attract and Retain Employees: Offering a cash balance plan can enhance a dental practice’s benefits package, making it more attractive to potential hires and aiding in the retention of key staff.
Benefits for Employees
Plan participants can take advantage of employer contributions as employees of your practice and should consider this part of their total compensation. While the employee may receive upwards of 10% between safe harbor, profit sharing, and a cash balance contribution, the practice owner can also benefit from a far bigger deduction in their income taxes.
How Cash Balance Plans Compare to Other Retirement Plans
Traditional Defined Benefit Plan vs. Defined Contribution Plan
While traditional defined benefit plans promise a specific benefit at retirement, cash balance plans define the benefit in terms of a hypothetical account balance, offering more flexibility and predictability. Unlike defined contribution plans, where risks and rewards are solely on the employee, cash balance plans provide a predetermined benefit backed by the plan sponsor.
Profit-Sharing Plan Integration
Combining a safe harbor 401(k) plan with a profit sharing plan and cash balance plan provides a comprehensive retirement strategy. Dental practice owners can defer hundreds of thousands of dollars towards their retirement each year. The safe harbor 401(k) component ensures compliance with IRS non-discrimination tests, allowing owners and highly compensated employees to maximize their contributions without limitations imposed by the incomes of other employees.
When augmented by a profit-sharing plan, additional discretionary contributions can be made, which further enhances the potential for tax-deferred growth. The cash balance plan tops off this strategy by allowing even larger, age-weighted contributions, which can be particularly advantageous for older owners seeking to catch up on their retirement savings. This robust combination maximizes retirement contributions effectively and provides significant tax savings while promoting long-term financial security and stability.
Profit-Sharing Plan Integration
Investing assets in a cash balance retirement plan requires a distinct approach compared to other types of retirement accounts. The primary objective in managing a cash balance plan is to achieve a targeted rate of return specified in the plan agreement, which is crucial for ensuring the plan’s promised benefits are fully funded without requiring unexpected additional contributions from the plan sponsor.
This target often dictates a more conservative investment strategy, focusing on minimizing risk and volatility to meet or exceed the interest credit rate. This strategy typically involves a well-diversified portfolio that balances fixed-income investments with equities and other asset classes to generate steady, reliable returns. The conservative approach helps protect the plan against market downturns and ensures that the annual crediting rate is consistently achieved, providing stability and predictability in funding retirement benefits.
Choosing the Right Type of Plan for Your Practice
As a financial advisor specializing in dental practices, it’s crucial to evaluate whether a cash balance plan aligns with your business’s financial goals and the retirement needs of both the owners and employees. Factors such as the size of your practice, the age of its owners, and long-term business goals should guide the decision.
Arch Financial Planning is here to help you navigate these options. Our expertise in retirement planning for dentists allows us to offer personalized advice that considers all aspects of your financial landscape, ensuring that your retirement strategy is as robust as your commitment to dental excellence.
Conclusion
Cash balance plans represent a powerful tool in the retirement planning arsenal for dental practice owners. By offering tax efficiency, high contribution limits, and a competitive edge in employee benefits, these plans are worth considering for any dentist looking to secure their financial future while managing a thriving practice. With the right guidance and a strategic approach, you can establish a retirement plan that meets your financial goals and supports your business’s growth and success.
Before taking action, it’s crucial you engage with a fiduciary investment advisor and financial planner like Arch Financial Planning. The typical cash balance plan can get very complex very quickly. We provide a tailored level of service that is unmatched by large corporations.
Author: Cecil Staton, CFP® CSLP®
I'm a fee-only financial advisor for dentists serving clients nationwide.
I left the large financial institutions to start my own RIA. I did it so people could pay for real planning and not just an agenda to sell a hidden product. As a fiduciary, Arch Financial Planning, LLC was built on that promise by delivering non-cookie-cutter plans that provide solutions to achieve their goals.
Who do I serve?
Typical: Dental practice owners
Goals: Pay off student debt, start/sell a practice, and grow their wealth
Location: Virtually anywhere in the U.S.
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