Defined benefit plansand the market drop

I have a defined benefit retirement plan. I was right on schedule, but now with the market down, I'm substantially behind schedule.

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by Gene Dongieux, CIO, Mercer Advisors

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QI have a defined benefit retirement plan. I was right on schedule, but now with the market down, >I'm substantially behind schedule. Do I have to make up the difference now? I can't afford to make up the loss all at once. If I put in extra and the market rebounds, could I have penalties for overfunding?

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AThe big drop in the market has made many doctors question whether their retirement plans are still on schedule. If you have defined contribution plans, which allow a maximum contribution each year, the worst-case scenario will be working longer to accumulate enough to retire. Defined benefit (DB) plans, including cash balance plans, are more complicated.

DB plans start with a target account balance at retirement and a target retirement age, both of which are legally defined within narrow limits. Each year's contributions are calculated based on current balance, conservative earnings estimates, and years until retirement. DB plans are great for someone with a lot of cash to invest who is close to retirement because they allow much higher contributions than other types of qualified plans.

If your account balance at retirement exceeds the target amount by too much, you could be penalized, but that's not your chief concern right now. If your balance at retirement is too far under the target balance, your benefits are reduced. In addition, if there are others in the plan, they get priority over you to get their promised benefits, reducing your benefits even more. Historic market lows plus doctors near retirement equals understandable concern.

DB accounts should be invested in low-risk investments to smooth out return. When market return floats around the average vicinity, it works well. However, when the market suffers great losses, the conservative nature of the investments reduces the loss but makes it harder to make up that loss. This doesn't mean you should change investment strategy. It does mean you should consider your options with your plan advisor. Here I'll discuss a few options for all DB plan members.

If you were eligible to retire (age 62 to 65) with ready cash from a practice sale or other source, you would be in a great position. You could choose to amend your DB plan to reduce your retirement age to your current age. This allows you to dump a lot of money in now, retire knowing your balance is within range, and be in a position to generate much more in earnings after retirement as the market recovers.

You are allowed to make up a shortfall over as many as seven years. This means if you have at least seven years until retirement, you can factor seven years of market performance into your total — no downturn has lasted seven years — and you may not need to amend anything.

More doctors will fall in the middle. Suppose you set up your plan at age 55 with a target retirement age of 65, and you're now 61. Your target balance was $2.2 million (the maximum). You had just less than $1.5 million, but now you have just more than $1 million. Now what?

You can freeze plan benefits at their current rates, preventing more benefits from accruing. That reduces the total shortfall, and you can unfreeze the plan anytime. To make the most of this option, freeze benefits before the current year's benefit accrues, which happens at 1,000 hours or about five months into the plan year. If you have a calendar year plan, that means May 2009.

In addition to amending the retirement age, you can also amend the plan formula to create alignment. You can always change it back later if you need to. Most advisors charge for amending the plan, so it's not something you want to do (or the IRS wants you to do) regularly.

Talk to your advisor, make sure you understand all your options, then coordinate your DB plan strategy with the rest of your retirement planning.

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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