Kim Sturges, ERPA, CPC, QKA, Retirement Plan Consultants, Fresno
Clyde W. Ford, MBA, CEBS, AIF, Chairman, CalPac Advisors, Inc.
Cash Balance Plan – “Plan the Design”
For physicians and practices desiring to catch up on retirement savings or have as a goal the ability to
shelter more income from immediate taxation than a traditional Defined Contribution Retirement
Plan,(including 401(k) Plans), a Cash Balance Defined Benefit Plan can be an attractive option.
Recent articles in the popular press have debated the relative merits of Defined Contribution Plans and
Defined Benefit Plans, including Cash Balance Plans. The more important question is which type of plan,
or combination of plans, is the best fit for your unique retirement planning situation. In order to determine
the best approach, an understanding of how a Cash Balance Plan works is required.
Higher Contribution Level
The level of funding in a Cash Balance Plan can be significantly greater for the principal than the
allocation available in a Defined Contribution Plan, like a 401(k). For example, if a physician adopts a
new Cash Balance Plan at age 60, the estimated maximum funding for the physician could be in excess
of $200,000 compared to $56,500 in a Defined Contribution Plan. The Cash Balance Plan is a great
vehicle for accumulating larger savings quickly.
A 401(k) Plan can also be maintained in tandem with a Cash Balance Plan, which would allow even
greater retirement savings, and a means of providing at least a portion, if not all, of the required staff
funding.
If the physician participates in both the Cash Balance Plan and the 401(k), the employer is subject to a
combined plan deduction limit. Internal Revenue Code Section 404(a)(7) restricts the amount of
employer contribution that is deductible each year to the Defined Benefit funding and employer
contributions of 6% of considered compensation in a Defined Contribution Plan. In other words, the
Internal Revenue Code does not allow certain sponsors to maintain both a maximized Cash Balance Plan
and a maximized 401(k) Plan. This restriction does not apply, if the physician has more than 25 eligible
employees, then the deduction limit would be determined separately for each type of plan.
The employee salary deferral of $23,000 for a participant, who has attained age 50, is in addition to the
6% cap. In applying the 6% cap, the Internal Revenue Code only allows the first $255,000 (indexed
annually) of a participant’s compensation to be considered.
Minimum Funding Requirement and Actuarial Certification
A Cash Balance Plan is a Defined Benefit Plan and is subject to Minimum Funding Requirements and
annual certifications by an Enrolled Actuary. Unlike a 401(k) Plan, where funding is determined annually
on a discretionary basis, with the exception of some contributions mandated to satisfy testing, Cash
Balance Plans will have a required contribution, which is determined each year by the Enrolled Actuary.
After the initial year of the Cash Balance Plan there is usually a range of contributions available and there
are means of adjusting the required funding on a prospective basis, but a sponsor of a Cash Balance
Plan should be comfortable with funding at a minimum level, while the plan is maintained. Since the
Cash Balance Plan is subject to the minimum funding requirements, failure to fund in a timely manner will
result in a 10% excise tax penalty.
Staff and Partner Coverage
Defined Benefit Plans are subject to a special participation rule, which requires that at least 40% of the
eligible employees, or at least 2, receive “meaningful” benefits under the Plan. If the practice is just
comprised of two partners, both would need to participate in the Cash Balance Plan, but the Plan could
be designed to provide significantly different contribution levels, depending on the retirement goals for
each physician.
If the practice includes staff, then the Plans can be designed to maximize the physicians, while minimizing
the staff rate at a level needed to pass the annual non-discrimination requirements. In many groups, the
minimum staff rate can be satisfied with total employer provided benefits of 7.5% of pay. Normally, a
Cash Balance Plan is combined with a 401(k) Safe Harbor Plan, which has a minimum required
contribution for staff that allows the physician to make the maximum salary deferral contribution ($17,500
or $23,000 for those, who have attained age 50). As with stand alone Cross-tested 401(k) Plans, the
combination of a Cross-tested 401(k) and a Cash Balance Plan provides greater leveraging to the owner,
when the physician is closer to retirement age than the staff is.
Distribution Restrictions
Unlike a 401(k) Plan, Cash Balance Plans do not allow for in-service distributions prior to age 62. In
addition, the plan may be restricted from processing lump sum distributions to participants, unless the
plan satisfies minimum funded percentage requirements.
Participant and Plan Termination
When a participant terminates, their distribution from a Cash Balance Plan is equal to their Hypothetical
Account Balance, which is based on the annual allocations and the interest credit rate (usually around 4%
to 5%) defined in the plan document. Physical individual accounts are not maintained in the Cash
Balance Plan and all assets are available to provide benefits.
When the plan terminates, if the assets are less than the Hypothetical Account Balance, due to
investment return less than the assumed rate or reduced funding levels, staff would receive their
Hypothetical Account Balance and the owner could elect to forgo a portion of his Hypothetical Account
Balance or an additional contribution could be made to the Plan, subject to the deduction limitations. If
the assets exceed the value of the Hypothetical Account Balances, then the excess could be reallocated
to all participants, subject to Internal Revenue Code limits.
Investing Guidelines
When investing funds for a Cash Balance Plan, steady and moderate gains should be the goal. In
determining the required and available funding each year, the Enrolled Actuary compares the value of the
plan’s assets to the value of the benefits (generally, the hypothetical account balances in a Cash Balance
Plan). In small Cash Balance Plans, an assumed rate of return of between 4% and 5% is usually used.
Large swings in the value of the plan’s assets can result in required funding significantly greater or
smaller than desired, as well as create issues upon plan termination, since all investment risk is borne by
the plan sponsor.
Sample Cash Balance Illustration
The following example is for illustrative purposes only.
Physician
Nurse
Assistant
55
45
30
Considered
Compensation
Cash Balance
Allocation
255,000
50,000
30,000
175,000
1,250
750
401(k)
Employer
Provided
Allocation
14,450
3,500
2,100
Total
Employer
Provided
Allocation
189,450
4,750
2,850
Employer
Allocation
Percentage
74.3%
9.5%
9.5%
In addition to the Employer provided allocations reflected above, the physician can contribute a salary
deferral contribution of $23,000, for total allocations of $212,450. The above design includes a Cash
Balance Plan with a 2.5% Pay Credit for Staff combined with a 401(k) Safe Harbor Plan with a Profit
Sharing Contribution.
If you are interested in discovering whether this type of design would be beneficial to your retirement
planning, please contact Clyde Ford at [email protected] or Kim Sturges at [email protected]
for a personalized proposal.
Securities and advisory services offered through Financial Telesis Inc. Member FINRA/SIPC. Financial
Telesis Inc. and CalPac Advisors are not affiliated.