For dentists and practice owners contemplating retirement investing, the choices often boil down to a 401(k) plan, perhaps with profit sharing, a supplemental Roth IRA, or nonqualified taxable investments.
While the widespread popularity of 401(k) plans underscores their effectiveness, higher earners may discover that these plans fall short of providing the same level of tax sheltering as some alternative options.
Consider the cash balance plan — an appealing retirement planning option especially tailored for dental practice owners or partners.
With the potential for annual tax deferrals over $300,000, cash balance plans surpass the $23,000 limit set for ordinary 401(k) plan participants. Even when factoring in profit sharing and catch-up allowances, 401(k) plans only offer a fraction of the tax deferral opportunities provided by cash balance plans.
Moreover, these plans can complement 401(k) arrangements, creating even more significant tax-deferral prospects.
In the realm of company-sponsored retirement plans for dentists and physicians, there are two main categories:
401(k) plans fall under the defined contribution plans umbrella, with contributions controlled by the participant and matching or profit sharing controlled by the employer. However, cash balance retirement plans operate akin to a traditional pension and fall in the defined benefit category.
In a cash balance plan, the employer commits to providing a specific and defined monetary benefit upon the employee's retirement. Notably, these plans don't have to extend to every employee; business owners can choose eligible participants based on factors such as seniority or years of service, even limiting the plan exclusively to owners and partners.
Employers allocate a fixed percentage of an employee's compensation (typically between 5% and 8%) annually to their retirement account within a cash balance plan. Upon retirement, the employee (or owner) can opt for an income annuity or receive a lump sum, which can be rolled over into an IRA. This flexibility in managing the funds resembles a 401(k) plan and can serve as an incentive for employee retention.
The popularity of cash balance plans has surged among dentists in recent years, with over one in 10 such plans nationwide being utilized by dental practices.
The primary advantage of implementing a cash balance pension plan is its effectiveness in enabling dental practice owners with high incomes to catch up on retirement investments with large tax-deductible deposits.
Given the unique financial challenges of the dental industry, where education and practice establishment costs may delay early retirement investing, these plans empower owners to significantly boost retirement savings over a short period.
With the potential to defer taxes on up to 45% of income (with an annual cap of over $300,000 depending on the beneficiary's age), coupled with the flexibility to make contributions until the tax filing deadline, cash balance plans offer an attractive option.
If your practice already has a 401(k) plan, combining it with a cash balance plan can unlock additional tax deferral opportunities, accelerating the growth of your retirement savings.
Cash balance plans come with higher maintenance costs compared to 401(k) plans. Establishment fees range from $2,000 to $5,000, annual administrative fees from $2,000 to $10,000, and investment management fees typically between 0.25% and 1% of assets. Actuarial reviews are also required, incurring additional costs.
The significant downside of cash balance plans lies in their permanence. The plan owner must offer a lifetime annuity option or a lump sum at retirement, and this permanence can only be altered under specific circumstances, such as a financial downturn, business closure, or sale.
While a cash balance retirement plan can be terminated if needed, it is vital to ensure your practice cash flow is consistent enough to forecast several years of continued contributions. Furthermore, because of the actuarial calculations, the expected rate of return within a cash balance plan is generally less than 5% annually.
Cash balance pension plans suit individual owners, small partnerships, or practices with four essential criteria:
If a complete transition to a cash balance plan doesn't seem optimal at the moment, exploring a combination of a 401(k) and a cash balance plan for select staff members might be a prudent strategy.
SDT is here to support you and your practice through all your financial decisions.
If you are considering a cash balance plan for your practice but aren't sure where to start, reach out to one of our financial planners to learn more. They can help you understand if a cash balance plan is a good fit for you and your practice.
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Shane Tenny is the managing partner of Spaugh Dameron Tenny. Along with hosting the Prosperous Doc® podcast, Shane has a true passion for behavioral finance, helping clients and audiences understand how to develop successful strategies based on their unique temperaments. An accomplished and highly engaging speaker, Shane is regularly interviewed for television and podcasts, is actively involved in the Financial Planning Association®, and contributes to industry advisory boards.
