Much uncertainty exists in health care due to the constantly evolving health care environment. Physicians are dealing with vast amounts of new regulations and costs because of the Patient Protection and Affordable Care Act, P.L. 111-148, and other recent legislation. Providers are looking for ways to reduce their tax burden. Many are looking at their savings and questioning whether they are prepared financially for retirement and will be able to sustain the lifestyle they envision. A cash balance plan is becoming an increasingly appealing retirement savings option for health care professionals and other business owners seeking to catch up on retirement savings or even accelerate their retirement timeline.
A cash balance plan is a type of defined benefit plan that allows an owner to determine the business's deduction and his or her own ability to defer income. These plans offer much greater flexibility than traditional defined benefit plans, which have more rigid requirements.
Unlike traditional defined benefit plans, cash balance plans have a guaranteed rate of return that is independent of the plan's investment performance. The rate can change annually and recently trends around 5%.
By deferring accumulated profits, a cash balance plan can funnel the majority of the benefit to the business owners. Here are five key facts about cash balance plans:
They can be combined with other plans and tailored for individual needs
Cash balance plans can be coupled with a business's existing traditional 401(k) plans, income distribution plans, and any other revenue-allocating method the health care practice may have, allowing plan participants to generate a larger amount of retirement savings.
These plans also can be tailored to fit the specific retirement strategies of various owners within a company, taking factors such as age and income into consideration. Calculations and estimations are made with the assistance of actuaries.
Example 1: A physician group is made up of physicians of various ages. Doctor A is 60 years old and wants to put as much money as possible into his cash balance plan so he can retire within the next five years. Doctor B, who is in the same group practice, is 35 years old and plans to retire at age 65. The actuary can design the plan so that Doctor A can aggressively fund his retirement benefits now. Doctor B needs cash currently and may not want to fund her retirement plan as aggressively until later in her career.
The cash balance plan design can be flexible enough to accommodate the individual needs of each practice owner.
Tax benefits are significant
An attractive feature of a cash balance plan is that the company offering the benefit can take an above-the-line tax deduction on contributions. Above-the-line deductions are desirable because they reduce income dollar for dollar.
Cash balance plans paired with 401(k) plans also offer tax benefits for employees, who get to defer taxes on contributions until retirement, at which point the income earned could be taxed at a much lower income tax rate. Cash balance plan participants also have the flexibility to decide how much income to withdraw during each year of retirement, and they may even choose to receive the money in one lump sum.
The maximum contribution allowance is higher
Cash balance plans allow participants to contribute significantly higher amounts than what can be contributed to traditional defined contribution plans, which currently have an annual contribution limit of $61,000 for an individual over age 50 in 2018 (these amounts are inflation-adjusted).
In a cash balance plan, participants' allocations can be significantly higher — up to $300,000 annually (depending on the participants' ages and years to retirement). A total contribution of $2.8 million is allowed.
Example 2: A two-owner practice has a $1 million profit. Doctor A takes a salary of $250,000. The cash balance plan can be designed so that Doctor A's share of the contribution is the remaining $250,000 of his half of the profit. Doctor B chooses to have her share of the contribution be $50,000. Doctor B takes a salary of the remaining $450,000. The practice's net taxable income is zero.
Cash balance plans have the IRS's approval
For those new to cash balance plans, it is important to note that they are, in fact, IRS-approved retirement plans. In 2014, the IRS issued final regulations (T.D. 9693) supporting the cash balance concept as a viable retirement plan. For many, this solidified their place among pension plan options.
They can make a life-changing impact
As already noted, cash balance plan participants can amass a large amount of savings, sometimes in a short time. This is an especially attractive feature for those who want to quickly boost their retirement savings, allowing them to retire in a manner that more closely mirrors their desired lifestyle.
Example 3: Doctor A, who is aiming to retire in five years, can, through the combination of the 401(k) plan and the cash balance plan, put as much as $300,000 per year into his retirement plans so that by the time he is ready to retire, he has saved $1.5 million. When Doctor C joins the practice as an experienced physician at age 55, the plans can be designed to allow Doctor C to receive allocations of up to the $2.7 million maximum by age 65.
Enlist the help of experts
Cash balance plans can offer significant benefits and savings opportunities while providing a great deal of flexibility. However, they also involve complicated rules and regulations. Health care providers and other business owners considering their retirement plan options should work with a tax adviser and a retirement plan consulting professional.
This article is adapted from "Cash Balance Plans: 5 Things to Know Now," which was previously published in Crowe Insights: Healthcare Connection.
Howard Wagner is a partner with Crowe LLP in Louisville, Ky.
For additional information about these items, contact Mr. Wagner at 502-420-4567 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Crowe LLP.