Editor's note: Originally published in November 2021 and updated with new financial information in April 2024.
For dentists and practice owners, retirement investing tends to come in a few different forms. Often it’s a 401(k) plan, maybe a 401(k) plan with profit sharing, supplemental Roth IRA, or nonqualified taxable investments. While the broad popularity of 401(k) plans is a sign of their effectiveness, a growing number of high earners may find that 401(k) plans simply do not allow for the same levels of tax sheltering as do some of the alternatives.
A cash balance plan, for instance, can be an attractive option for retirement planning that is especially relevant to dental practice owners or partners. Cash balance plans allow owners to achieve annual tax deferrals of up to $485,000, as opposed to the $23,000 ($30,500 for thsoe 50 and over) limit for ordinary 401(k) plan participants. Even with profit sharing and catch-up allowances, 401(k) plans allow less than a fifth of the tax deferral opportunities that a cash balance plan does. Cash balance plans are designed to be used alongside 401(k) plans, allowing for even greater tax-deferral opportunities.
What is a cash balance plan, and how does it work?
There are two broad types of company-sponsored retirement plans: defined benefit plans and the defined contribution plans.
401(k) plans fall into the defined contribution plans category and are the best known of these types of plans. Under a 401(k), employees choose to participate in the plan and employers can choose whether they want to match contributions made by employees and to what extent. These plans also allow participants to choose their personal contribution levels and give them control over their own investment decisions.
Unlike defined contribution plans, defined benefit plans don’t require contributions from participants. Instead, they operate more like a traditional pension, in which the employer provides a specific defined benefit to employees once they reach retirement.
Cash balance plans incorporate elements of both a defined benefit plan and a defined contribution plan, and therefore are sometimes referred to as "hybrid" plans. These plans do not have to be offered to every employee; owners can decide which employees are eligible, for example by seniority or years of service.
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In a cash balance plan, an employer annually credits a participant’s account with a fixed percentage of the employee’s compensation or a flat fixed amount. These assets are guaranteed an interest rate set by the employer. Once the employee (or owner) reaches retirement, they have an option of taking an income annuity, or they can take a lump sum that can be rolled over into an IRA, which will then be managed by the recipient. Like a 401(K) plan, a cash balance plan can be used to reward and encourage employee retention.
In recent years, cash balance plans have become increasingly popular among dentists. More than one in 10 of all the cash balance plans in the country are used in dental practices.
Benefits and drawbacks
The main advantage of implementing a cash balance plan is that they’re a great tool that allows dental practice owners with high incomes to catch up on retirement investments while also deferring taxes on earned income. This is especially relevant in the dental industry, as the costs of education and establishing a practice may have hindered an earlier start on investing for retirement. The plans allow owners or partners to dramatically increase retirement savings over a short period by deferring tax on far larger amounts than traditional 401(k) plans allow, with an upper limit of over $400,000 annually depending on the beneficiary's age. As contributions can be made up until the tax filing deadline, users of these plans have an additional level of flexibility.
If you already have a 401(k) plan in place at your practice, you can combine it with your cash balance plan for even more tax deferral opportunities that can grow your retirement savings quickly.
While the cash balance plan does offer a lot of opportunities to defer tax, it also does come with a number of potential drawbacks and considerations.
Since they are designed and administered in accordance with complex actuarial rules and laws, cash balance plans are more expensive to maintain than 401(K) plans.
- The fees to establish a cash balance plan are between $2,000 and $6,000.
- The administrative fees come between $2,000 and $7,000 annually.
- Investment management fees are usually between 0.50% and 1.5% of assets.
While these fees may seem high, traditional 401(k) plans offered by several well-known payroll or insurance companes often come with annual management fees of between 2% and 3+% of assets under management. And there are low-cost “modern” 401(k) providers, such as Rebalance, that offer plans that include investment fiduciary advice services, recordkeeping, and employee education with fees of approximately 1% of assets under management.
But the biggest potential consideration about cash balance plans is that they are permanent in nature. Permanence means that the plan owner must continue to make the contributions to the plan for the foreseeable future—typically no more than 10 years. Such permanence can be ended under certain circumstances, including a downturn in the company’s finances, the closing of the business, or the sale of the business.
Is a cash balance plan right for you and your practice?
A cash balance plan is ideal for a practice that has consistent cash flow and steady profitability. It is ideal for practices owned by an individual, a small number of partners, or a number of highly compensated employees in need of a way to shelter income from tax and for whom a 401(k) plan is not sufficient.
Cash balance plans also can be used by practices that offer less competitive compensation as a way to retain valuable, experienced staff.
If moving entirely to a cash balance plan doesn’t seem like the best action for now, it may be worth combining a 401(k) with a cash balance plan for select members of staff. A good retirement plan advisor and actuary can help you determine if a cash balance plan is the right fit for you, your business, and your retirement.
Editor's note: This article appeared in the November 2021 print edition of Dental Economics and was updated on April 3, 2024.
David Ranney is the VP of sales at Rebalance. In his role, he partners with small businesses across many industries throughout the country. He believes in the Jesuit ideal of “men and women for others.” He educates small businesses about how to avoid high 401(k) fees, how to optimize asset allocation, how to increase plan participation, and how to utilize retirement planning. The net result is higher employee satisfaction and greater employee retention.
