Cash balance pension plans for medical groups present the opportunity to rev up retirement plan contributions, which caused a huge amount of interest in them starting 10 years ago.
It has been almost 10 years since our firm experienced the first wave of popularity of Cash Balance Pension Plans (CBP) for medical groups. At that time every practice that was remotely a candidate to adopt a CBP was in the process of adopting or getting a study done to see how it would work.
The opportunity to rev up retirement plan contributions, well in excess of the limitations imposed on defined contribution plans, was a benefit too good to pass up. Because of the initial rush to adopt, we tend to think that everyone who might be a candidate for a CBP already has one, but that may not be true.
If you are not familiar with the concept, CPBs are a type of defined benefit plan that looks and acts in many ways like a defined contribution plan. Contributions are determined on a hypothetical benefit basis, which enables them to be much greater than a standard defined contribution plan.
The benefit to the employee-participant is the actual balance in their account at the time they retire, or separate from service at the practice. The plan is generally combined with a defined contribution plan and many physicians are able to get a combined allocation in the two plans over $100,000 per year with a relatively small incremental employee cost.
In the intervening years experience has shown some things about CBPs that we should consider when adopting a new plan. We found out that CBPs are expensive to administer. Between attorney fees for drafting and maintaining the plan document, actuary fees for performing the annual valuation and administrative fees for ongoing government compliance, costs can be significantly greater than what plan sponsors are accustomed to with their defined contribution plans.
We discovered that some aggressive investors are not satisfied with the CBP emphasis on fixed income investments. During good years of equity investments, sponsors thought they were missing out with their cash balance money.
We have also seen resistance to the pooled money aspect of CBPs. Many physicians like the prospect of self-directing their retirement plan money, and they may not like the required pooling of money in the cash balance plan.
We discovered that plan demographics that look good one year may not be so good the next year. CBPs work best when the physician group has a somewhat older average age than the non-physician group. If a plan were to lose a few of the youngest employees or admit a young partner, the result can be an adverse impact on the allocation of contributions from year to year, making them somewhat unpredictable.
We also discovered that the eyes of some adopters of CBPs were larger than their stomachs. Plan sponsors who initially wanted to maximize the tax shelter opportunities of a CBP sometimes had a different outlook when it was time to write the check to fund the plan.
While all these are issues anyone considering adopting a CBP should be aware of, the initial attraction of the plan is just as valid today as it was 10 years ago. The annual addition limit for defined contribution plans will be $50,000 for 2012, but there is no other tax efficient vehicle other than a CBP to increase retirement contributions well over the defined contribution limit.
At a time when there are few real tax shelters available, and with the value of tax deferral looking only to increase in the coming years, the CBP remains one of the most effective ways to shelter significant income from taxation now and in the future.
What should someone considering adoption of a cash balance plan keep in mind during the evaluation process?
Make contributions large or don’t make them at all
We already acknowledged that the cost of maintaining a cash balance plan is not insignificant. The more you contribute to the plan, the lower the cost will be as a percentage of the benefit.
At the same time you should consider the funding of the plan on an annual basis. Contributions have to fit within the cash flow of your practice and the sponsor should be able to make the contributions without effecting other obligations. The deposit to the cash balance plan should be money that would have been paid as taxable compensation and the net invested on an after-tax basis.
Understand the effect of interest rates
CBPs assume the funds will earn a certain target interest rate and contributions are then in part determined on investment performance in relation to the target rate. The current interest rate environment on fixed income securities has caused issues in some plans, so moving forward we need to be sure that the target written into the plan and investment allocation are in alignment.
Be sure all parties are comfortable with the fixed income emphasis of CBPs. There is no requirement that investments be fixed income, but losses must be made up by increased contributions. Consequently, risk moderation is important.
Have a good advisory team
An experienced ERISA attorney is needed to draft the plan. The investment advisor should understand CBPs and be able to select an investment mix that will coordinate with the targets written into the plan. The actuary should provide timely contribution allocations and participant reporting. The actuary should also be willing to run multiple projections to obtain the most efficient allocation of contributions. The third-party administrator should be able to integrate the CBP with the existing defined contribution plan and put it all together.
With some upfront understanding and information in the hands of potential CBP adopters there is no reason why these plans should not be as popular now as ever.
Joseph M. Lassiter, CPA, is a Director with Pearce, Bevill, Leesburg, Moore, P.C. He has been heavily involved in retirement plan and employee benefits consulting, as well as providing tax and accounting services to closely held businesses and professional practices. Joe can be reached at (205) 323-5440.
Pearce, Bevill, Leesburg, Moore, P.C. is also a proud member of the National CPA Health Care Advisors Association. HCAA is a nationwide network of CPA firms devoted to serving the health care industry. Members provide proactive solutions to the accounting needs of physicians and physician groups. For more information contact the HCAA at email@example.com.