Brian Hufford, CPA, CFP
A cash balance plan is a type of defined-benefit pension plan that solves a number of dentistry-related tax problems, yet is used by only a handful of dentists nationwide. As incomes in a maturing practice grow, tax problems multiply. New issues to address include the alternative minimum tax, the loss of itemized deductions and exemptions, and additional taxes on higher earnings. A cash balance plan can eliminate most, if not all, of these burdensome taxes permanently while dramatically growing retirement savings. There are two golden rules of financial planning: the Marginal Tax Bracket Rule and the Compound Growth Rule. Cash balance plans are one of the few methods of saving that benefit from both.
The Marginal Tax Bracket Rule
In a marginal income tax bracket of 40%, which has grown to nearly 50% over the past few years for federal and state taxes, a $1 deductible expenditure really costs only 60 cents. This means that saving an additional $50,000 for retirement in a cash balance plan may cost only $30,000 in real dollars after savings of $20,000 in federal and state income taxes are considered.
A recent article by the Center for Retirement Research at Boston College documented how ineffective tax-savings benefits have been as a motivator for employees to save for retirement in 401(k) plans. Policy-makers believed that by making retirement savings deductible, individuals would automatically save large amounts to replace lost employer-provided retirement benefits. This hasn't been the case, and employee adoption has largely been poor.
Our firm has witnessed a similar reality in dentistry. Over the past 10 years, we've likely submitted more than 1,000 paired 401(k)/cash balance plan studies to individual dental practices. The prospect of cutting federal and state taxes by nearly half has not been a sufficient motivator, unfortunately, for dentists to adopt these retirement arrangements profession-wide.
The Compound Growth Rule
My favorite example of the power of compound growth uses IRA account savings to illustrate the benefits of saving early. Our first IRA saver starts at age 19 and commits $5,000 per year for only eight years through age 26. Our second IRA saver begins saving $5,000 at age 27 and saves each year through age 65. Because of the power of compound growth, the first saver ends up with more savings at retirement after only eight years of contributions.
Dentists often have to play catch-up, thanks to the realities imposed by student loans and the entry-level costs of establishing a dental practice. Cash balance plans allow dentists to play catch-up with a vengeance as a reward for the extra schooling and headaches of owning a small business.
How will you implement these two golden rules in your practice?
Dentists who have implemented a paired 401(k)/cash balance arrangement in their practices must overcome two barriers to entry. The first barrier is finding an independent actuarial firm that can design a best-fit, custom study for the dentist's practice. It should deliver the right combination of total deductions and affordable staff costs to meet the dentist's goals. This is relatively easy for those enlightened firms that regularly administer these types of plan arrangements. It is impossible for retirement firms that don't have access to actuarial staff.
The second barrier for dentists is the improper cash-flow management of debt payments and large purchases. Since dramatic tax savings are a feature of cash balance plans, improper cash management could easily prevent a dentist from saving at least 20% of income each year with a paired plan arrangement. Any unwillingness to explore this retirement arrangement may be a symptom of a practice's poor cash management. Luckily, I've seen over the years how easy it is to work through these cash problems for most dentists and I've become somewhat of a crusader on the topic.
Brian Hufford, CPA, CFP, is a wealth advisor and dental practice thought leader with Buckingham, a national, independent wealth and financial advisory firm that is part of the Bam Alliance, a US community of more than 140 independent firms. To connect with a Buckingham advisor who specializes in working with dentists, visit BuckinghamAdvisor.com, email [email protected] or call (888) 470-3064.
