Brian Driscoll: Cash Balance Plans are an effective way to help you:
• Potentially significantly increase the amount you save for your retirement;
• Reduce taxes;
• Implement tax deferred investing strategies; and
• Protect your assets from creditors.
While many medical professionals are aware of tax-deferral opportunities available through defined contribution plans, such as a 401(k), they can only do so much. Individual 401(k) deferrals are limited by the IRS to $18,000 annually plus a catch-up provision of $6,000 for participants over age 50. These plan amounts are generally too low for equity partners and even those limits may not be reached unless the plan meets certain criteria.
Cash Balance Plans are a type of hybrid defined benefit plan that allows higher annual contribution limits when properly combined with defined contribution plans. In the right circumstances, the amounts contributed to a Cash Balance Plan can be substantial. The contributions to all qualified plans including Cash Balance Plans are tax-deductible, all growth is tax deferred and the assets enjoy certain protections from potential creditors.
Question: How do Cash Balance Plans work?
BD: As hybrids, Cash Balance Plans are designed to combine the benefits of selective participation and higher contributions, with greater flexibility that is normally associated with traditional defined contribution plans.
Contributions are made to a Cash Balance Plan annually through a “pay credit” and then an “interest credit” accrues to the account based on assets. The “pay credit” can be either a percentage of the participant’s pay or set dollar amount. The “interest credit” is a fixed or market rate of return the plan has promised to credit to each participant’s account. Fixed rate crediting (usually based on a U.S. Treasury security) is a steady if conservative, amount of interest that is owed by the Plan each year, while the market rate formula (using the actual performance of the portfolio) provides some flexibility for both upward and downward movement over time.
Considering all of your plan design options is critical to determine if a Cash Balance Plan is right for you. A study of employee census data by an actuary is the first step in identifying the partners and key employees and determining if the potential benefits outweigh the costs. This study considers the unique demographics of each practice and helps determine what design decisions will result in the maximum benefits with the least possible cost.
Question: Is this typically available to all employees?
BD: There are usually three different groups of employees:
• Class A: Owners;
• Class B: Highly Compensated Employees; and
• Class C: All other Employees
The plan can be designed to include everyone but they are most often designed to optimize the benefits for a targeted group, such as the Owner and Highly Compensated Employees. The contributions for Cash Balance Plans are calculated based on the employees’ ages, compensation and grouping. Owners and Highly Compensated Employees are usually able to contribute higher percentage of pay than other employee groups. It’s important to note that annual contributions are required, not discretionary. The flexibility to adjust percentages is particularly attractive to physicians looking to increase tax-advantaged retirement plan funding.
Question: Are the assets sheltered from creditors?
BD: Yes. Cash Balance Plans are “qualified” plans under the Employee Retirement Income Security Act (ERISA) and are generally not available to creditors.
Question: When does a Cash Balance Plan make sense for a medical practice?
BD: Partners and owners of medical practices who are contributing up to the profit sharing/401(k) limit and have the desire to contribute more, are excellent candidates for this type plan. Cash Balance Plans work well when the staff/partner ratio is high, since it allows the principals of the practice to make higher tax-deferred contributions based on age and service. While many Cash Balance Plans are established for the benefit of equity partners and key staff, some other employees may benefit as well. Adding a Cash Balance plan can allow physicians the ability to rapidly accelerate savings with pre-tax contributions that will grow tax-deferred. It’s important to remember that Cash Balance Plans are a multi-year commitment and must be funded annually. Consistent cash flow and profitable practices provide a solid foundation for this type of plan.
For many medical practices, the combination of Cash Balance Plans and defined contribution plans is a useful tool in recruiting and retaining employees. These plans usually allow vested participants who leave the company to take their account balances in a lump sum. This lump sum can be rolled into an individual retirement account (IRA) or into their next employer’s plan, an attractive option for younger, highly qualified employees.
The information provided herein is for general informational purposes only. The views expressed herein are those of J.P. Morgan Securities Financial Advisor Brian P. Driscoll and may differ from other J.P. Morgan Chase & Co. affiliates and employees. The information is not intended as a recommendation for any product or service. The strategies, products and services described herein may not be appropriate for all clients. Past performance is not reliable indicators of future results. This material is distributed with the understanding that J.P. Morgan is not rendering accounting, legal or tax advice. You should consult with your independent advisors concerning such matters.
Investment products: Not FDIC insured • No bank guarantee • May lose value
Brian P. Driscoll is an Executive Director/Financial Advisor at JPMorgan Securities LLC. His email address is brian.p.driscoll@jpmorgan.com and his direct telephone number is (212)272-2093. Information about Brian is available on his website www.jpmorgansecurities.com/DTgroup.
