Cash balance plans

Cash balance (CB) plans are the hottest retirement plans going right now.

by Gene Dongieux, CIO, Mercer Advisors

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Cash balance (CB) plans are the hottest retirement plans going right now. CB plans allow doctors to save more than the 401(k)/profit sharing maximum, plus last year's Pension Protection Act improved both the maximum contribution and the doctor/staff ratio for many doctors. A cash balance plan is considered a defined benefit (DB) plan, but it has some of the elements of a defined contribution (DC) plan, too.

You can use a CB plan to increase or catch up on your own tax-advantaged saving and reward key employees. All this comes in a package that is much easier to understand and more predictable than a traditional DB plan (though you still need an actuary).

Eligibility

The plan must cover at least 40% of employees ages 21 and up with at least one year (1,000 hours) of service. Turnover is disruptive, so the plan works better if your staff is stable. Coverage among employees need not be equal. Employees may be separated into groups and treated differently. There are fairness tests to meet, but they are different and often less demanding than profit-sharing plan tests.

Contributions and accounting

Contributions to the plan are made by the practice according to a formula the dentist chooses — a percentage of compensation, dollar amount, etc. You can even base plan contributions on production or collection, but the minimum benefit is half a percent of annual compensation.

These contributions are recorded in bookkeeping entries to hypothetical individual accounts. Participants receive statements and see their balances grow, but they do not own their accounts the way they own a 401(k) account. In fact, they are creditors of the practice. An actuary will determine the amount you must set aside — less than the face value — to fund the plan.

Earnings

Here's where this plan really stands out for ease and predictability: you can choose any interest crediting rate you want, even a flat rate, between half a percent per year and “market rate,” which has not yet been defined. For example, you can choose a $5,000 flat annual contribution and 5% flat crediting rate and know exactly what the plan liability will be to that participant in any year in the future regardless of changes in market performance, interest rates, or anything else (except employment status):

Year 1 $5K credit — no interest
Year 2 $5K credit — $250 interest
Year 3 $5K credit — $512.50 interest
Year 10 — balance $62,889.50

That's a big advantage over traditional market-based DB plans, where market volatility makes it easier to accidentally underfund (reducing your own benefits) or overfund (incurring a fine).

Benefit distribution

A CB plan provides monthly benefits at retirement; some plans allow conversion to a lump sum. The plan must also provide preretirement death benefits. The plan may also provide disability benefits and postretirement medical benefits, providing financial planning options and flexibility.

Disadvantages

This year, the most obvious disadvantage is usually an advantage — no tie to market performance. This means that though the market is down, earnings are still credited. If your practice has a bad year, contributions and credits must still be credited. You can tie contributions to practice or market performance to some extent, but then you lose predictability.

Related point: as the plan benefactor, you take on a debt burden that will affect your ability to secure other credit. Yes, you have actual cash set aside for the plan, but the plan can't claim it. If you should have financial difficulties, the plan is just one more general creditor in line.

When your staff lineup changes, you may owe a cash payout, and as with other plans, you may be scrambling to reconfigure a plan that is now out of balance.

A CB plan can offer a big benefit to the right person. Talk to your financial planner about whether a cash balance plan is right for you.

Gene Dongieux is the author of “If You Have It Made, Don't Risk It: A Physician's and Dentist's Guide to Investing.” As chief investment officer for Mercer Advisors, he manages more than $3 billion in client assets. Dongieux has been quoted in The Wall Street Journal and Investment Advisor magazine. Contact him at gene.dongieux@merceradvisors.com.

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