Question. I’ve heard that a cash balance plan can allow me to contribute more toward retirement and save on my current large tax bill. What do I need to know before using one of these?
A. One of the biggest deficits in physicians’ collective “financial fund of knowledge” is a lack of understanding of the various retirement accounts available to them. I have written before about using a health savings account as a “stealth IRA” and about how to contribute to a personal and spousal Roth IRA “through the backdoor.” Another little known, but very useful, retirement account for physicians is a cash balance plan.
In fact, I think the standard retirement options made available to emergency physicians should include both a 401(k) with a profit-sharing component ($53,000 contribution limit for those under age 50, with an extra $6,000 catch-up contribution for those over 50) and a cash balance plan. Most physicians do have a 401(k), which, in 2015, allows an $18,000 annual employee contribution ($24,000 for those over 50), plus up to $35,000 of employer contributions. However, surprisingly few have access to a cash balance plan.
There are two broad categories of retirement plans: defined contribution and defined benefit. A 401(k) is an example of the first type. There is no guaranteed benefit when all is said and done. All that is defined is how much you can put into it as you go along. The amount of money you will have to spend in retirement depends entirely on how much you put into the account and the performance of your selected investments. A defined benefit retirement plan works differently. The classic example is the increasingly rare company pension. You work for a company or government entity for 20 or 30 years, and after you retire, the company pays you a defined benefit for the rest of your life. The company takes all the investment risk. If the investments do well, the company can get away with putting less money into the account. If the investments do poorly, the company must contribute more to the account.
A cash balance plan is technically a type of defined benefit plan, but it can act like a defined contribution plan in two important ways. The first is that, depending on how your plan is designed, you can actually change how much you can contribute each year to the plan. The second is that upon separation from the employer, or when the plan is closed for any reason, you can transfer the money into a 401(k) or IRA, just like most defined contribution plans. For most participants, the cash balance plan is essentially an extra retirement plan allowing for additional tax-deferred retirement contributions above and beyond those allowed in the 401(k).
Most physicians do have a 401(k), which, in 2015, allows an $18,000 annual employee contribution ($24,000 for those over 50), plus up to $35,000 of employer contributions. However, surprisingly few have access to a cash balance plan.
How Cash Balance Plans Work
A cash balance plan seems complicated because, as a defined benefit plan, it must at least resemble a typical pension. That means the participants in the plan cannot select or manage investments in the plan. It also requires complicated actuarial calculations to determine the maximum contributions that can be made into the plan. The contributions also must technically come from the employer, not the employee. Due to these complications, fees on a cash balance plan are generally higher than those in a 401(k). This type of plan is not a do-it-yourself project; you will need to hire an experienced company to design and run the plan.