A cash balance plan offers a strategic method for high-income physicians to build substantial tax-deferred savings within a limited timeframe. By 2025, a 58-year-old can potentially amass around $4 million over ten years through such a plan, making it an attractive option for those in higher tax brackets. Compared to taxable accounts, the cash balance plan has significant tax advantages, particularly if its interest crediting rate (ICR) is lower than the returns required to break even on taxable investments.
Despite its advantages, a cash balance plan also carries inherent risks. Issues arise when plan participants, such as partners in a medical practice, retire or leave, especially if the asset values decline at the time of distribution. In a poorly planned scenario, the remaining partners may need to compensate for shortfalls, which can pose financial challenges.
Additional volatility may lead to either underfunding or overfunding of the plan, each with distinct repercussions. Underfunding necessitates immediate contributions from partners, while overfunding can result in excise taxes upon plan termination. Furthermore, mismanagement of investments, particularly through high-fee actively managed funds, can exacerbate these issues.
To mitigate these risks, practices are advised to:
- Maintain a conservative investment portfolio.
- Implement a “terminate and restart” strategy after several years, if necessary.
- Educate partners about their contributions and the potential risks involved.
Ultimately, the success of a cash balance plan hinges on appropriate planning and management, tailored to the unique needs of the practice.
Why this story matters
- Offers insights into retirement planning options for high-income professionals.
Key takeaway
- Cash balance plans can significantly reduce tax liabilities but require careful management to avoid financial pitfalls.
Opposing viewpoint
- Concerns exist regarding the complexity and risk potential associated with cash balance plans compared to other retirement strategies.
