Question. I’ve heard that a cash balance plan can allow me to contribute more toward retirement and save on my current large tax bill. What do I need to know before using one of these?
A. One of the biggest deficits in physicians’ collective “financial fund of knowledge” is a lack of understanding of the various retirement accounts available to them. I have written before about using a health savings account as a “stealth IRA” and about how to contribute to a personal and spousal Roth IRA “through the backdoor.” Another little known, but very useful, retirement account for physicians is a cash balance plan.
In fact, I think the standard retirement options made available to emergency physicians should include both a 401(k) with a profit-sharing component ($53,000 contribution limit for those under age 50, with an extra $6,000 catch-up contribution for those over 50) and a cash balance plan. Most physicians do have a 401(k), which, in 2015, allows an $18,000 annual employee contribution ($24,000 for those over 50), plus up to $35,000 of employer contributions. However, surprisingly few have access to a cash balance plan.
There are two broad categories of retirement plans: defined contribution and defined benefit. A 401(k) is an example of the first type. There is no guaranteed benefit when all is said and done. All that is defined is how much you can put into it as you go along. The amount of money you will have to spend in retirement depends entirely on how much you put into the account and the performance of your selected investments. A defined benefit retirement plan works differently. The classic example is the increasingly rare company pension. You work for a company or government entity for 20 or 30 years, and after you retire, the company pays you a defined benefit for the rest of your life. The company takes all the investment risk. If the investments do well, the company can get away with putting less money into the account. If the investments do poorly, the company must contribute more to the account.
A cash balance plan is technically a type of defined benefit plan, but it can act like a defined contribution plan in two important ways. The first is that, depending on how your plan is designed, you can actually change how much you can contribute each year to the plan. The second is that upon separation from the employer, or when the plan is closed for any reason, you can transfer the money into a 401(k) or IRA, just like most defined contribution plans. For most participants, the cash balance plan is essentially an extra retirement plan allowing for additional tax-deferred retirement contributions above and beyond those allowed in the 401(k).
Most physicians do have a 401(k), which, in 2015, allows an $18,000 annual employee contribution ($24,000 for those over 50), plus up to $35,000 of employer contributions. However, surprisingly few have access to a cash balance plan.
How Cash Balance Plans Work
A cash balance plan seems complicated because, as a defined benefit plan, it must at least resemble a typical pension. That means the participants in the plan cannot select or manage investments in the plan. It also requires complicated actuarial calculations to determine the maximum contributions that can be made into the plan. The contributions also must technically come from the employer, not the employee. Due to these complications, fees on a cash balance plan are generally higher than those in a 401(k). This type of plan is not a do-it-yourself project; you will need to hire an experienced company to design and run the plan.
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3 Responses to “Cash Balance Plans Can Be an Extra Retirement Savings Account”
July 22, 2015
pete levasseurI read your cash balance plans article. A note to be made is that if you have BOTH a 401k and a defined benefit plan, your 401k is limited to 18k-24k (age dependent)plus 6% of Schedule C income, NOT $35,000 as in a solo 401K.
September 16, 2015
DOIWCI,
Looking into setting up a cash balance plan (cbp) have few questions.
1) Does your cbp provide a third party administrator (tpa)or do you have to get your own?
2) What types of portfolios does your cbp offer?
3) What do think is a fair cap on aum fees for these cbp?
4) What is going market rate for a tpa?
5) Do you have a list of cbp providers like was done in 401k comparison article?
Thanks for the great previous articles, have changed my out look on retirement!
September 21, 2015
James M. Dahle, MD, FACEP1) Generally provided.
2) Ours is a reasonable mix of mostly index mutual funds. I’ve seen portfolios anywhere from 52% to 72% stock (which I think is probably a little on the high side.)
3) As low as possible. Mine charges 0.3-0.4%.
4) Not sure.
5) No. That might be worth a future post though.