The Cash Balance Retirement Plan Solution:
Accelerate Savings and Reduce Taxes
By James J. Di Gesu
Although April 15th was weeks ago, the impact of paying income taxes may still have a lingering affect for many doctors. Many of these same doctors find themselves with a retirement plan dilemma. They have high earnings, pay high income taxes, but have inadequate retirement savings. This is due to limits on 401(k) tax-deferred savings and because they have invested heavily in building their practices. If you happen to find yourself in this situation, and would also like to save on paying income taxes with a significant tax deduction, adding a Cash Balance Plan may be the perfect solution.
Keep in mind that a Cash Balance Plan must be established by December 31st to take advantage of tax deduction in 2015, although the plan doesn’t need to be funded until the firm’s tax return is due.
Cash Balance Plans provide participants an annual pre-tax contribution limit of up to $275,000, typically double or even triple what is allowed in a 401(k) profit sharing plan ($59,000 for 2015 if age 50 or older). Since the contributions are tax deductible, it is possible to accumulate a retirement plan benefit of $2.6 million over 10 years without consideration of investment growth potential. If income tax rates rise in the future this tax deferral feature becomes more attractive.
Within a Cash Balance Plan, each participant has a hypothetical account which is credited with annual pay credits (contribution) and interest credits (typically around 5%). Furthermore, unlike a 401(k) plan the participant does not have any investment risk. The nature of Cash Balance Plans and the investment structure typically insulates them from market volatility. The investment goal for a Cash Balance Plan is to protect the tax deduction rather than maximize investment returns. The investment goal for the investment manager of the Cash Balance Plan is to optimize the returns by meeting the interest credit rate each year.
When paired with a 401(k)/profit sharing plan, the two are combined for nondiscrimination testing. The Cash Balance Plan combination arrangement allows maximization of benefits to doctors and other “key” participants while keeping employee contribution costs relatively low. Contributions can be a percentage of salary or a flat dollar amount and are stated in the plan document.
Since Cash Balance Plans are “defined benefit” plans the contributions and interest credits are not discretionary and require an actuary to provide the funding requirement to the plan sponsor. Employers can designate different contribution amounts for various participants which allows for greater flexibility. Once participants retire or terminate employment, they are eligible to receive the vested portion of their account balance. Cash Balance accounts are portable and can be rolled over to an IRA. READ MORE