Editor's note: Originally published in November 2021 and updated in April 2024 with new financial information.
Retirement investments for dentists and practice owners come in a few different forms. Often it's a 401(k) plan, a 401(k) plan with profit sharing, a supplemental Roth IRA, or non-qualified tax investments. The popularity of 401(k) plans is a testament to their effectiveness, but more and more high-income earners are finding that 401(k) plans don't offer the same tax savings as other options.
For example, cash balance plans are an attractive retirement planning option that is especially important for dental practice owners and partners. Cash balance plans allow owners to realize tax deferrals of up to $485,000 per year. This contrasts with the $23,000 limit for regular 401(k) plan participants ($30,500 if age 50 or older). Even with profit sharing and catch-up allowances, 401(k) plans achieve less than one-fifth the tax deferrals of cash balance plans. Cash balance plans are designed to be used in conjunction with 401(k) plans, providing even greater tax deferral opportunities.
What is a cash balance plan and how does it work?
There are two types of retirement plans offered by companies: defined benefit plans and defined contribution plans.
401(k) plans fall into the defined contribution plan category and are the most well-known of these plans. With a 401(k) plan, employees choose to participate in the plan and employers can choose whether and how much to match employee contributions. These plans also allow participants to choose their individual contribution amounts and have control over their own investment decisions.
Unlike defined contribution plans, defined benefit plans do not require contributions from participants. Instead, like a traditional pension, employers provide employees with a specific defined benefit upon retirement.
Cash balance plans are sometimes called “hybrid” plans because they incorporate elements of both defined benefit and defined contribution plans. These plans do not have to be offered to all employees, and owners can decide which employees are eligible based on factors such as length of service or seniority.
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In a cash balance plan, the employer deposits a fixed percentage or a fixed amount of the employee's compensation into the participant's account each year. These assets are guaranteed an interest rate set by the employer. When the employee (or owner) retires, he or she can choose to receive a pension or a lump sum that can be rolled over into an IRA to be managed by the beneficiary. Like 401(K) plans, cash balance plans can be used to reward and encourage employee retention.
Cash balance plans have become increasingly popular among dentists in recent years, with more than one in ten cash balance plans in the country being used by dental offices.
Advantages and disadvantages
The main benefit of implementing a cash balance plan is that it is a great tool for high-income dental practice owners to catch up on retirement investments while deferring taxes on the income they earn. This is especially true in the dental industry, where education and practice expenses may not allow them to start investing for retirement early. By deferring taxes on a much larger amount than a traditional 401(k) plan, this plan allows owners and partners to significantly increase their retirement savings in a short period of time. The limit is $400,000 or more per year depending on the age of the beneficiary. Contributions can be made up until the tax filing deadline, giving users of this plan even more flexibility.
If you already have a 401(k) plan in place, you can combine it with a cash balance plan to gain even more tax-deferral opportunities and grow your retirement savings quickly.
Cash balance plans offer many opportunities to defer taxes, but they also have some potential drawbacks and considerations.
Cash balance plans are designed and administered according to complex actuarial rules and laws, and therefore are more expensive to maintain than 401(K) plans.
- Fees to set up a cash balance plan range from $2,000 to $6,000.
- Management fees range from $2,000 to $7,000 per year.
- Investment management fees typically range between 0.50% and 1.5% of assets.
While these fees may seem high, traditional 401(k) plans offered by some well-known payroll and insurance companies often charge annual management fees of 2% to 3% or more of assets under management, and low-cost “modern” 401(k) providers such as Rebalance offer plans that include mutual fund advisory services, recordkeeping and employee education for a fee of about 1% of assets under management.
However, the biggest potential consideration with cash balance plans is that they are perpetual in nature. Perpetual means that plan owners are required to continue contributing to the plan for the foreseeable future, usually no more than 10 years. Such perpetuity can be terminated under certain circumstances, such as a company's declining financial condition, closing down, or selling the business.
Is a Cash Balance Plan Right for You and Your Practice?
Cash balance plans are ideal for practices with steady cash flow and consistent profitability. They are ideal for practices owned by individuals, a few partners, or highly paid employees who need a way to avoid income taxes and for whom a 401(k) plan is not enough.
Cash balance plans can also be used by healthcare organizations that offer less competitive compensation as a way to retain valuable, experienced staff.
If you don't think going all-in on a cash balance plan is the best option at this time, it may be worth combining a 401(k) with a cash balance plan for some employees. A good retirement planning advisor and actuary can help you determine whether a cash balance plan is right for you, your business, and your retirement.
Editor's note: This article appeared in our November 2021 issue. Dental Economics Last updated on April 3, 2024.
David Lunney I am the VP of Sales at Rebalance and work with small businesses across the country in a variety of industries. I believe in the Jesuit philosophy of “doing good for others.” I teach small businesses how to avoid high 401(k) fees, optimize asset allocation, increase participation rates, and leverage retirement plans. The result is higher employee satisfaction and retention.
