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Greg Farber, CIMAÂ®, AIFÂ® is a Vice President and Senior Wealth Advisor for Calamos Wealth Management. He has more than twenty years of experience helping successful individuals and families develop a sophisticated process for managing risk and taxes while striving to meet their present and future financial goals. Learn more at www.calamoswealthmanagement.com.
This type of plan can help you lower your taxes, increase your savings and create a happier staff.
Take one minute and ask yourself the following few questions. If you answer “yes” to any of them, it may be financially beneficial to continue reading.
Yes, those questions are skewed toward a positive response! However, they are legitimate qualifying questions for beginning to explore if a cash balance pension plan is right for your practice.
First, we will explore the basics about cash balance pension plans. Then, we will get more specific about how you might address the three questions you considered earlier.
What is a cash balance pension plan?
Cash balance pension plans are technically a traditional defined benefit plan (pension), but they resemble the more familiar defined contribution plan of a 401(k). More specifically, the investments are professionally managed while participants have a promised benefit at retirement. The benefit is reflected as a 401(k)-like account balance that is easy for you and your employees to understand and includes rollover and annuity options at retirement age. Cash balance pension plans are growing in popularity among dental and other health practices. In 2016, the number of cash balance plans increased by 19 percent and total assets now surpass $1 trillion, according to Kravitz.
How does the plan work?
During plan setup, investors often choose a target rate of return, such as 3 or 5 percent, that will drive the contributions. Thereafter, plans require some administration work by an actuary each year to determine funding levels. Once determined, contributions are invested into a pooled investment account. Your wealth adviser should help develop an asset allocation focused on managing risk and striving to meet your target rate of return. Too much volatility in either direction can have an impact on how much the owners contribute and/or the potential income tax advantages. It is very prudent to hire an investment adviser familiar with cash balance pension plans to help keep a consistent cash flow to stay in compliance with plan rules.
What about reducing my federal income tax?
The tax burden is best illustrated through an example: Let’s assume you have “maxed out” your 401(k) and profit sharing contributions for 2017 ($60,000). You have generated enough extra cash in your practice to contribute $125,000 to a cash balance pension plan. At current income tax rates (approximately 32 percent), you would save more than $40,000 in federal income tax. This savings more than covers the likely contributions to your staff and the cost of actuarial services. Further, if you work in a state that has income taxes, your tax savings could be even greater.
Would another $1.5 million to $2.5 million saved for retirement be good for you?
This is not a trick question! A cash balance plan, depending on your age and how long you plan to work, can build an additional retirement nest egg up to $2.5 million. Many professionals in the medical field need to play catchup when saving for retirement in the mid to later parts of their careers. You went to school and built a career. At the same time, you may have started a family. If saving for retirement needed to be delayed, cash balance plans present an opportunity. At retirement, you can roll your savings into an IRA or other qualified plans. These dollars can have a significant impact on your chosen retirement age, lifestyle and how much you leave for your heirs.
Are you interested in making your staff happier?
While it is generally true that owners/partners reap the vast majority of benefits from cash balance plans, there is a meaningful benefit provided to employees, too. For example, consider a long-time member of your team that makes $55,000 per year and is 50 years old, contributing very little, or nothing, to his or her 401(k). Profit sharing and cash balance plan contributions can be an effective way to help employees feel valued and reward their loyalty. If there is a “safe harbor” 401(k) contribution, this employee could be getting about $6,000 per year in tax-deferred compensation while the owner(s) enjoy the benefits described earlier.
One more question…
Should you be concerned about the additional money paid to employees and the cost of actuarial services “eating up” the tax savings? Of course you should! While the costs to the partners may sound prohibitive, these costs can be determined before creating a cash balance plan. Therefore, owners can decide upfront if the financial benefits for themselves and employees outweigh the plan costs. In many instances, partners are surprised to find that their situation leads to the win-win scenario cash balance plans often present.
So, what should you do?
It does not take a lot of time or effort on your part to determine if a cash balance pension plan is right for your practice. Simply engage an investment adviser who is experienced with these plans. That person will quarterback the process of working with an actuary to determine the benefits, costs and factors to be considered. A cash balance pension plan may be an attractive option that reduces your taxes, increases your retirement savings and thrills your employees.