Do you have the right pension strategy?

July 1, 2007
President Bush has signed into law no less than 13 acts affecting retirement plan law during the past six years.

by Brian Hufford, CPA, CFP

President Bush has signed into law no less than 13 acts affecting retirement plan law during the past six years. The latest, signed in 2006, made pension strategies obsolete. So, in 2007, make an effort to adjust your pension strategy to take advantage of these new laws.

The wave of the future in pension plan design is here. If you are age 40 or older, you have the ability to create substantial tax deductions in the pension environment by working with advisors to custom fit a plan for your practice. In this month’s column, I will talk about changes in the law and what these changes mean to your retirement planning.

Until the most recent pension act, the Pension Protection Act of 2006 (PPA 2006), many dentists took advantage of liberal changes in 401(k) rules that President Bush signed into law early this decade. By employing a spouse in the dental practice, a $15,500 deduction for the spouse and a $45,000 deduction for the doctor (for a total of $60,500) can be generated in 2007. Having a 401(k) plan in a dental practice is a formidable retirement strategy because of the ability to keep staff costs reasonable and create large deductible savings for the doctor. Under PPA 2006, the Roth 401(k) feature is now permanent. It had been scheduled to expire after 2010.

While you may need to consider making adjustments to your 401(k) strategy because of minor alterations under PPA 2006, the most important changes to consider have occurred in cash balance plans. Current pension plan design is focused on pairing 401(k) plans with cash balance plans to achieve very large tax deductions with minimal increases in staff costs. Until passage of the new act, cash balance plans had been involved in some controversy. It was feared that rules would surface making cash balance plans age discriminatory. These plans work like defined benefit plans, creating larger deductions as one gets older. However, the new act ended this controversy by eliminating the age-discrimination argument. It is now possible to consider adding this type of plan to a 401(k) arrangement.

In many respects, cash balance plans are more attractive to dentists than defined benefit plans. Defined benefit plans are difficult to communicate to staff since the benefits are future monthly retirement benefits and not current account balances such as with a 401(k) plan. The calculation of benefits in a cash balance plan is similar to cross-testing in profit sharing plans - one or two older staff members do not necessarily wreck the plan design. This can happen, though, in defined benefit plans with older staff members. Our company recently designed a 401(k) cash balance plan arrangement for a 50-year-old dentist. The result of this study illustrates how you can use the new law to greatly increase your pension deductions. First, since this dentist is age 50 in 2007, the dentist and his or her spouse can each contribute $15,500 - plus a $5,000 “catch-up” contribution - for a total of $20,500. Along with the $45,000 limit to profit-sharing plans, this doctor and spouse can contribute a total of $70,500 in just the 401(k) plan.

But the tax savings are just beginning. By pairing a cash balance plan with this doctor’s 401(k) plan, we can claim additional deductible pension costs of $86,096 for the doctor, with only $3,940 of additional costs for the staff. The bottom line of this paired-plan arrangement allows this doctor to save more than $50,000 in federal and state income taxes by employing his spouse and by adding a cash balance plan to the 401(k) arrangement. The new act added one more feature that made this arrangement attractive. Under the old law, paired plan deductions were limited to 25 percent of total compensation. The new law excludes up to 6 percent of compensation for 401(k) contributions. This, in effect, increases total limitation to 31 percent.

In all likelihood, your current retirement plan arrangement is based upon a law that existed five or so years ago. It’s time to get with the program and create a paired-plan arrangement. With the PPA of 2006, this is the year for you to greatly increase your tax deductions.

Editor’s Note: Footnote disclosure for this article required by IRS Circular 230 (Pursuant to IRS Circular 230, please be advised that, to the extent this article contains any tax advice, it is not intended to be, was not written to be and cannot be used by any taxpayer for the purpose of avoiding penalties under U.S. Federal Tax Law).

Brian Hufford, CPA, CFP®, is CEO of Hufford Financial Advisors, LLC, an independent, fee-only planning firm that helps dentists achieve financial peace of mind. The company is recognized as the only strategic alliance partner for financial planning services for the Academy of General Dentistry. Contact Hufford at (888) 470-3064, or at [email protected].

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