A cash balance plan, for instance, can be an attractive option for retirement planning that is especially relevant to dental practice owners or partners. Cash balance plans allow owners to achieve annual tax deferrals of up to $300,000, as opposed to the $19,500 limit for ordinary 401(k) plan participants. Even with profit sharing and catch-up allowances, 401(k) plans allow only a fifth of the tax deferral opportunities that a cash balance plan does. Cash balance plans also can be used alongside 401(k) plans, allowing for even greater tax-deferral opportunities.
What is a cash balance plan, and how does it work?
There are two broad types of company-sponsored retirement plans: defined benefit plans and the defined contribution plans.
401(k) plans fall into the defined contribution plans category and are the best known of these types of plans. Under a 401(k), employees can choose to participate in the plan and employers can choose whether they want to match contributions made by employees and to what extent. These plans also allow participants to choose their personal contribution levels and give them some control over their own investment decisions.
Unlike defined contribution plans, defined benefit plans don’t require contributions from participants. Instead, they operate more like a traditional pension. Cash balance plans, meanwhile, are a type of defined benefit plan, in which an employer provides a specific and defined monetary benefit once the employee reaches retirement. These plans do not have to be offered to every employee; owners can decide which employees are eligible, for example by seniority or years of service. In fact, a cash balance plan can be restricted to the business owners and partners alone.
In a cash balance plan, an employer credits a participant’s account with a fixed percentage of the employee’s compensation, typically between 5% and 8% annually. Once the employee (or owner) reaches retirement, they have an option of taking an income annuity, or they can take a lump sum which can be rolled over into an IRA. From there the management of the money is up to the recipient. Like a 401(k) plan, a cash balance plan can be used to reward and encourage employee retention.
In recent years cash balance plans have become increasingly popular among dentists. More than one in 10 of all the cash balance plans in the country are used in dental practices.
Benefits and drawbacks
The main advantage of implementing a cash balance plan is that they’re a great tool that allows dental practice owners with high incomes to catch up on retirement investments. This is especially relevant in the dental industry, as the costs of education and establishing a practice may have hindered an earlier start on investing for retirement. The plans allow owners or partners to dramatically increase retirement savings over a short period by deferring tax on far larger amounts than traditional 401(k) plans allow, up to 45% of income with an upper limit of over $300,000 annually depending on the beneficiary's age. As contributions can be made up until the tax filing deadline, users of these plans have an additional level of flexibility.
If you already have a 401(k) plan in place at your practice, you can combine it with your cash balance plan for even more tax deferral opportunities that can grow your retirement savings quickly.
While the cash balance plan does offer a lot of opportunities to defer tax, it also does come with a number of potential drawbacks and considerations.
For one, cash balance plans are more expensive to maintain than 401(k) plans.
- The fees to establish a cash balance plan are between $2,000 and $5,000.
- The administrative fees come between $2,000 and $10,000 annually.
- Investment management fees are usually between 0.25% and 1% of assets.
- Actuarial reviews are required, which are an additional cost.
While these fees may seem high, traditional 401(k) plans offered by providers such as Paychex also come with annual management fees of between 1% and 3.5% of assets under management. And there are low-cost “modern” 401(k) providers, such as Rebalance, that offer plans that include reporting and employee education with fees of less than 1% of assets under management.
But the biggest potential negative of cash balance plans is that they are permanent in nature. Permanence means that the plan owner must offer a lifetime annuity option to the participants or a lump sum at retirement, which can be decades later. Such permanence can be ended under certain circumstances, including a downturn in the company’s finances, the closing of the business, or the sale of the business.
Is a cash balance plan right for you and your practice?
A cash balance plan is ideal for a practice that has consistent cash flow and steady profitability. It also is ideal for practices owned by an individual, a small number of partners, or a number of highly compensated employees in need of a way to shelter income from tax and for whom a 401(k) plan is not sufficient.
Cash balance plans also can be used by practices that offer less competitive compensation as a way to retain valuable, experienced staff.
If moving entirely to a cash balance plan doesn’t seem like the best action for now, it may be worth combining a 401(k) with a cash balance plan for select members of staff.
Editor's note: This article appeared in the November 2021 print edition of Dental Economics.
Scott Puritz is a managing director at Rebalance and serves as one of the firm’s Investment Committee members. Scott holds an MBA from the Harvard Business School and is a nationally recognized retirement investing expert. He has been quoted by the New York Times, the Wall Street Journal, NPR, Forbes, CBS, PBS, and USA Today. He has testified before the U.S. Senate on new rules designed to make retirement investing safer for all Americans. For more information, visit www.rebalance360.com.