Understanding Cash Balance Pension Plans: A Comprehensive Guide for Dentists and Private Practice Doctors

As dedicated financial advisors and planners, we are constantly looking for innovative ways for our clients to save for, and secure, their retirement wishes. One unique solution that has gained popularity amongst small business owners, especially among dentists and private practice doctors, is the cash balance pension plan. This lesser-known retirement savings vehicle combines elements of traditional pension plans with the flexibility of modern defined contribution plans, offering a powerful tool for high-income professionals to accelerate their retirement savings.

A cash balance plan is essentially a hybrid of a defined benefit (i.e., pension) plan and a defined contribution (i.e., 401k) retirement plan as it comes with all of the usual defined benefit requirements and advantages yet feels more like a defined contribution plan (yet with much higher contribution limits).  What sets cash balance plans apart from their traditional counterparts is their ability to offer higher contribution limits and potentially significant tax advantages for business owners. Many think of cash balance plans as the “best of both worlds” because owners could (1) potential triple or even quadruple their tax-advantaged retirement savings, and (2) receive a tax deduction for the business.  Given that these types of plans are generally best for businesses with high, predictable revenue and fewer than 10-15 employees, cash balance plans can be particularly attractive for dentists and private practice doctors.

As we delve deeper into the mechanics and benefits of cash balance pension plans, it’s important to recognize that retirement planning is not one-size-fits-all. Each individual’s financial situation, career trajectory, and retirement goals are unique. For many of our clients, particularly those in high-income professions like dentistry and private medical practices, finding the right balance between current financial needs and future retirement security is crucial. Cash balance plans can offer a compelling option for those looking to optimize their retirement strategy and potentially reduce their current tax burden.

Let’s start by exploring how cash balance pension plans work before addressing their advantages and benefits as well as and important considerations for implementation.

How Cash Balance Pension Plans Work

First and foremost, cash balance plans are similar to traditional defined benefit plans in that they are funded by employer contributions.  The employer funds it and bears the investment risk.  However, unlike traditional pension plans that typically only promise a specific monthly benefit at retirement based on years of service and salary history, cash balance plans incorporate hypothetical individual “accounts” for each participant, which is credited with a set percentage of their yearly compensation plus an interest credit. These accounts don’t actually hold assets, but rather represent a bookkeeping entry that tracks the employee’s accrued benefit (or “balance”). This structure allows participants to see their benefit grow as a lump sum amount, making it easier to understand and appreciate the value of their retirement savings.

The growth of these hypothetical accounts is driven by two key components: pay credits and interest credits. Pay credits are typically a percentage of the employee’s annual compensation, determined by the plan’s formula. For example, a plan might credit 5% of an employee’s salary each year. Interest credits, on the other hand, are based on a predetermined interest rate or index, such as the 30-year Treasury rate. These credits are applied to the account balance, allowing it to grow over time, much like compound interest in a savings account.

One of the other distinguishing features of cash balance plans is their higher contribution limits compared to traditional defined contribution plans like 401(k)s. The exact limits are age-dependent and can be significantly higher for older participants, allowing for accelerated retirement savings. This is particularly beneficial for high-income professionals, like dentists and private practice doctors, who may have delayed saving for retirement earlier in their careers. However, it’s important to note that these contributions are not discretionary but are instead determined according to the plan’s design. Actuaries play a crucial role in cash balance plans, performing complex calculations to ensure the plan remains properly funded and compliant with IRS regulations. They determine the required annual contributions based on factors such as participant demographics, salary projections, and expected investment returns. This actuarial oversight helps maintain the plan’s financial health and ensures it can meet its future benefit obligations.

Another unique feature for cash balance plan revolves around options for the participant’s account balance upon retirement or termination.  If a participant retires or leaves the company, they can choose to (1) receive their account balance as a lump sum, (2) convert it to a monthly income annuity, or (3) roll it over into an IRA or another qualified retirement plan. This flexibility is another attractive feature of cash balance plans, allowing participants to align their retirement benefits with their individual financial needs and goals.

Benefits and Advantages of Cash Balance Pension Plans

Cash balance pension plans offer several benefits, particularly for small business owners, dentists, and private practice doctors:

1. Contributions are tax-deductible for the business.  One of the most significant advantages is the potential for substantial tax savings given that contributions are tax-deductible for employers, which may help reduce their current tax liability. For high-income dentists and private practice doctors, this can translate into considerable tax savings, especially when combined with other retirement savings strategies.
2. Higher contribution limits.  Another key benefit is the higher contribution limits compared to traditional defined contribution plans. While a 401(k) has an annual contribution limit of $23,000 for 2024 (with an additional $7,500 catch-up contribution for those 50 and older), cash balance plans allow for much higher, six-figure contributions (often exceeding $250,000 per year for older participants). This feature enables dentists and private practice doctors to accelerate their retirement savings, particularly beneficial for those who may have focused on building their practice earlier in their careers and now wish to catch up on retirement planning.
3. Transparency & Flexibility.  When compared to traditional defined benefit plans, participants can more easily understand their account balance and project future growth, providing a clearer picture of their retirement savings. This transparency can be particularly appealing to employees, potentially serving as a valuable retention tool for practice owners. Additionally, as referenced earlier, these plans offer flexibility in distribution options at retirement, allowing participants to choose between a lump sum payment, annuity or rollover to an IRA or another qualified retirement plan.
4. Tax-advantaged growth.  While contributions are solely made by the employer, the funds within the participant accounts grow tax-deferred.  It is important to note that the interest credit rate has recently been around 4%, so the expected growth is not as substantial as a 401k where your assets can potentially gain at equity market levels. However, growth from the interest credit is still shielded from taxes and compounds over time.
5. Bolt on to a 401k.  While a cash balance is its own unique retirement plan, it does not have to replace a 401k. In fact, it is most common and advantageous for dentists and private practice doctors to continue saving into their 401k while incorporating a cash balance plan on top of that. For example, if you have an existing 401k and profit sharing plan where you, as the employer, are contributing the total allowable maximum of $66,000 (for 2024 – combination of personal deferrals plus employer contributions), you can still contribute at that level into the 401k yet also making employer contributions to the cash balance plan. For the owner, this can translate to total contributions north of $250,000 depending on their age.
6. Additional employee benefit & retention tool.  For practice owners looking to provide an additional benefit for their employees, a cash balance plan can be an excellent addition on top of a 401k. For example, a practice can still provide a 401k with a match, and even profit sharing if they choose, and then also provide the benefit of employer contributions to their cash balance plan “account.” This not only helps boost their employees’ retirement savings but also can serve as an effective retention tool.

Characteristics that Make Dentists & Private Practice Doctors Ideal Candidates for Cash Balance Plans

As mentioned previously, cash balance plans are typically best for businesses with a lesser amount of employees and with high, predictable revenue, making them particularly attractive to dentists and private practice doctors. However, here is a more complete list of characteristics that generally make dentists and private practice doctors ideal candidates for cash balance plans:

• Successful professional employers and owner-operated businesses
• Businesses with high, recurring, and predicable cash flow
• Dentists/owners looking for larger tax-deduction that can be provided by a Defined Contribution Plan (i.e., 401k)
• Dentists/owners that are, on average, roughly 10 years older than rank-and-file employees
• Understanding that there will be some level of contribution that needs to be made for staff to pass IRS nondiscrimination testing
• Ideally fewer than 10-15 employees (although this is not a set requirement)

Implementation & Considerations

Implementing a cash balance pension plan requires careful planning and consideration. The process typically begins with consulting a qualified Third Party Administrator, or a qualified actuary and an ERISA attorney, to design a plan that aligns with your practice’s goals and complies with IRS regulations. These professionals will help determine appropriate contribution levels, vesting schedules, and other plan specifics tailored to your needs.

Once the plan design is finalized, you’ll need to draft plan documents, including a formal plan document and summary plan description for participants. It’s crucial to communicate the plan details clearly to all eligible employees, explaining how the plan works and its benefits. The next step involves setting up a trust to hold the plan assets and selecting a trustee to manage these funds. You’ll also need to choose a third-party administrator to handle ongoing plan operations, including annual testing, participant statements, and required government filings.

While cash balance plans offer significant benefits, they do come with higher administrative costs and complexity compared to simpler retirement plans. Annual actuarial valuations are required to ensure the plan remains properly funded, and there are strict funding requirements that must be met each year. Additionally, these plans are subject to non-discrimination testing to ensure they don’t unfairly benefit highly compensated employees. It’s important to consider these ongoing responsibilities and costs when deciding if a cash balance plan is right for your practice.

Regulatory compliance is a critical aspect of maintaining a cash balance plan. The plans are governed by ERISA (Employee Retirement Income Security Act) and must adhere to IRS regulations. This includes timely filing of Form 5500, providing required disclosures to participants, and ensuring the plan operates in accordance with its written terms. Given the complexity of these requirements, many practice owners find it beneficial to work with experienced professionals who can guide them through the ongoing management and compliance aspects of the plan.

How Tenet Can Help

At Tenet Wealth Partners, we specialize in cash balance plans, especially for dentists and practice owners looking to enhance their retirement savings as well as tax savings. Not only do we understand how these plans work as well as the complexities and nuances, but we can also help to simplify the process and ensure a cash balance plan is the right fit for you and your practice. We also partner with a network of qualified third-party administrators (TPA) who also specialize in the administration of these plans, taking the time and effort of searching for a TPA off your plate. Lastly, we can help manage the investments within the cash balance pension pool. Given that these plans need to align with the state interest credit rate, customizing the investment strategy accordingly is crucial, so our expertise and experience helping other clients with cash balance plans can provide more peace of mind.

If you’re considering incorporating a cash balance pension into your retirement strategy, please don’t hesitate to contact us or schedule a time to meet with us!

 

Registered Representative of Sanctuary Securities Inc. and Investment Advisor Representative of Sanctuary Advisors, LLC. Securities offered through Sanctuary Securities, Inc., Member FINRA, SIPC. Advisory services offered through Sanctuary Advisors, LLC., a SEC Registered Investment Advisor. Tenet Wealth Partners is a DBA of Sanctuary Securities, Inc. and Sanctuary Advisors, LLC. The information provided in this communication was sourced by Tenet Wealth Partners through public information and public channels and is in no way proprietary to Tenet Wealth Partners, nor is the information provided Tenet Wealth Partner’s position, recommendation or investment advice. This material is provided for informational/educational purposes only. This material is not intended to constitute legal, tax, investment or financial advice. Investments are subject to risk, including but not limited to market and interest rate fluctuations. Any performance data represents past performance which is no guarantee of future results. Prices/yields/figures mentioned herein are as of the date noted unless indicated otherwise. All figures subject to market fluctuation and change. Additional information available upon request.