Is your cash balance plan invested properly?

Feb. 2, 2019
It’s important for dentists, as small business owners, to make wise investments for themselves and their employees. That’s hard to do in today’s market. Cash balance plans are a popular option. Is yours being handled properly?

While cash balance plans can be an incredible tool to help doctors reach their retirement goals, the recent volatility in equity markets have caused quite a bit of panic. Since employers are responsible for the shortfalls of their defined benefit plans, a stock market that isn’t constantly increasing in value leaves doctors questioning whether cash balance plans are a wise idea for small business owners. The reality, however, is that doctors should question the investment philosophy of how the plans are invested rather than the plans themselves.

What is a cash balance plan?

A cash balance plan is a type of defined benefit plan. A defined benefit plan is one in which the amounts put into the plan are based on a promised future value to the employees. Like a traditional pension, a cash balance plan provides workers with the option of a lifetime annuity. However, a unique twist is the way each employee’s account is valued.

The name cash balance plan is derived from the cash balance in the individual accounts for each covered employee, complete with a specified lump sum. While cash balance plans are great for employees, they’re even better for owners. In the right scenarios, doctors can save double, and in some cases even triple or quadruple, the amount possible compared to a more typical 401(k) profit-sharing plan.

The most conservative part of your portfolio

As mentioned, the contributions of a cash balance plan are guaranteed to the employees. While doctor-owners are typically the biggest beneficiaries of this guarantee, this does not change the fact that the benefit is mandatory for doctors to fund each year. For this reason, it’s important that, before implementing a defined benefit plan, the practice have stable cash flow to fund contributions at the required level, plus the interest crediting rate (ICR).

The ICR is the rate of interest applied to the cash balance benefit each year to reach the future value required under the plan. This rate, typically between 3%–6%, should be the targeted rate of return for the cash balance plan, rather than chasing higher returns with potentially higher losses.

While other elements also need to be considered, such as employee turnover and cash flow for the company, targeting the ICR is an essential part of cash balance planning. This allows for the investment advisor to strive for a more conservative investment allocation within the cash balance plan while focusing on risk elsewhere in the appropriate amount for the doctor. This is so that volatility in the plan can be sufficiently mitigated.

Putting it together

From a tax perspective, conservative income, such as interest payments from bonds, is taxed at the same rates as earned income. This makes retirement plans, including cash balance plans, a natural place for these investments. This allows more aggressive investments that rely on growth, such as stocks, to grow in after-tax accounts and defer gains until the stocks are sold, or when they are taxed at capital gains rates rather than the higher ordinary income rates. Additionally, if these investments decrease in value, they can be sold for a capital loss and used to offset future gains.

This means that the most conservative investments in a doctor’s portfolio don’t just help to prevent wild swings in cash balance values, which fit the needs of the plan from a cash flow perspective. They’re also better suited inside of the retirement plan as well from a total tax perspective as the investments increase over time.

Andrew Tucker, JD, Cfp, CPa, and John K. McGill, JD, MBA, CPA, provide tax and business planning for the dental profession and publish The McGill Advisory newsletter through John K. McGill & Company Inc., a member of the McGill & Hill Group LLC. It is your one-stop resource for tax and business planning, practice transitions, legal, retirement plan administration, CPA, and investment advisory services. Visit or call (877) 306-9780.

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