Cash Balance Plan

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Topic Author
chilidawg
Posts: 17
Joined: Thu Dec 05, 2013 5:45 pm

Cash Balance Plan

Post by chilidawg »

My physician partners and I are looking at cash balance plans. We currently have a 401k with a match and profit-sharing that takes partners to the $52k/year max. We have about 20 physicians, and 40 non-highly compensated employees. The physicians all get additional income via a 1099 from an LLC each year, and we are looking to use this as a place for the cash balance, rather than in our W-2 practice income (it would eliminate all the non-HCE's).

I have heard conflicting things about how cash balance plans work, and I'm having trouble finding a good resource online for the nuts and bolts of such plans. The White Coat Investor site has an example, but I'm looking for more details. My questions are below:

1. I've heard the plan can set a fixed return per year (ie 5%), but in other cases I've read the plan can use a range with a cap (ie no less than 0%, no more than 6%). Can either method be used?

2. If various tiers are used (say $10k and $30), how often are participants allowed to move between tiers? Every year, 3 years? Every 5 years?

3. How and when do catch-up contributions happen? If the plan earns 2% over a year, instead of 5%, and there is no additional money held from previous years, when is the catch-up contribution due? I've read the catch-up contribution could be spread over a few years. How does this work if someone has jumped between investment tiers?

4. Are there particular companies that I should be looking at to administer this plan?

Thank you in advance.
ace1400
Posts: 25
Joined: Thu Jun 20, 2013 1:28 pm

Re: Cash Balance Plan

Post by ace1400 »

There is very little good information about cash balance plans available. The plans can be customized to a considerable degree and depending on your provider they will develop significantly different looking plans. A few answers I have been given during our process so far - I'm looking forward to any other who chime in with more definitive info.

1. Both options are possibilities - A more common (and better probably) option would be to define return based on 10 yr treasury.

2. I have been told because it is supposed to be "permanent", any change more frequent than 5 years is problematic.

3. Catch-up contributions for shortfalls are usually spread over 2-5 years, again, as defined in your plan documents. There should be no additional money in the plan. You cannot "save extra" in the plan to cover a shortfall in advance, if the plan has higher than expected returns, your allowed contribution the next year is smaller than planned.

Another important situation to consider is what happens if someone retires (leaves the plan) after a shortfall. By law they get their full "cash balance", not the lower actual balance due to market losses. So if someone who has 25% of the plan leave after a bad year, they will get 25% of what the balance SHOULD be, not what it has fallen to due to investment losses. The losses the remaining participants must make up in the coming years are therefore much larger. Example: 5 partners each have contributed 20% to the plan. The plan investments lose 20% of their value. One participant leave, and take their 20% with them, but because of the losses they take 25% of the plan balance with them. The remaining participants have had their 20% loss turned into a 25% loss. This is significantly magnified if you are doing the largest plan allowed, in which case partners close to retirement may be contributing 5x what younger partners are contributing and may have 60-80% of plan assets.

What this all means is the plan assets must be invested very carefully and conservatively. Home runs don't help you much but shortfalls can really hurt, so think of the cash balance plan as the bond portion of your portfolio. Beware of funds specifically designed for cash balance plans (PKCBX, I'm looking at you) with 1.8% yield and 1.5% expenses. Sometimes investment suggestions from potential providers can be very helpful - I was able to dismiss immediately the few who suggested whole life insurance.

4. I can't give any recommendations specifically.

One factor to consider very carefully: make certain you are able to have a separate organization that provides this benefit to partners only. This can be very shaky ground. If the IRS later determines that this other organization that the partners have the cash balance plan through is not really a separate entity and you have not met the nondiscrimination rules for the group as a whole (including the non-HCE), all your contributions can be disallowed and treated as taxable income, which can be a disaster. If the owners are similar between the two groups, this is significant risk and you definitely should seek real advice from a lawyer (not a semi-anonymous internet forum or worse, the guy trying to sell you actuarial/financial advising services associated with the plan you are considering.)

As always, I'm not a lawyer and this advice may be worth what you paid for it. Please keep us posted with what you discover during your due diligence.

Thanks,

Ace
Topic Author
chilidawg
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Joined: Thu Dec 05, 2013 5:45 pm

Re: Cash Balance Plan

Post by chilidawg »

Thank you for the reply.

My thought is the LLC has a defined term in this case (the practice could shut it in 10 years). That would reduce some of the risk by keeping the term a bit shorter. Everyone could roll the cash balance to their IRA. At that point, a new LLC could set the same thing up. If a group of 15 people contribute $20-50k/year to one of these, for 25-30 years, these are not small accounts!

The cost to add the non-HCEs isn't that bad, but most non-HCEs would prefer a higher salary over this benefit. I agree that these seem to rely on lawyers and accountants more than I would prefer.

Maybe the better way to rephrase this is: What are the best practices for a cash balance plan?
ccf
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Joined: Mon Mar 09, 2015 9:13 pm

Re: Cash Balance Plan

Post by ccf »

I set one up in 2015. I also found out from The White Coat Investor. It was a pain but now that I'm looking at my 2015 tax savings, I'm very glad that I did it.

My suggestion is: find a TPA who does Cash Balance Plans to go through it all with you and make a proposal for your plan.
Last edited by ccf on Fri Jan 29, 2016 8:52 pm, edited 1 time in total.
ccf
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Re: Cash Balance Plan

Post by ccf »

Also - I agree with ace1400 about the separate organizations being "shaky". I would be very surprised if it was workable. I'd expect that you'd need a TPA to handle your 401k and Cash Balance together and deal with calculating the contributions for non-HCEs across both.
jacoavlu
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Re: Cash Balance Plan

Post by jacoavlu »

My small practice (4 partners, 1 non-HCE) had a cash balance plan when I joined the group. It was confusing. It took me a few years to grasp the basics. We ended up shuttering the CBP a few years ago.

One thing to consider, which may not affect you if the CBP is associated with the LLC, separate from your group plan, is that contributions to a defined benefit plan (CBP) will affect one's ability to fund a defined contribution plan (401k-profit sharing). Bottom line, for us we couldn't put much into profit sharing because of the CBP. Actuarial stuff. Be sure to ask about this beforehand, if you do go forward.

You may consider exploring the option of a Captive Insurance Company instead of a CBP. Maximum "contributions" would be 1.2M per year (deductible to your practice).
ace1400
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Joined: Thu Jun 20, 2013 1:28 pm

Re: Cash Balance Plan

Post by ace1400 »

@ccf - any recommendations for specific TPA's?

It is true that depending on how things are set up, it may limit the amount you can contribute to a 401k plan, but it dramatically increases your total possible tax deferred space. It limits the employer, not employee portion of the 401k contribution, so you can still do the $18K contribution.

I would be extremely uncomfortable with your "separate LLC" plan. Give the employees the benefit. For us, the maximal contribution for owners (which went as high as $250K/year depending on age) required a total of 7.5% of salary contribution for non-HCE employees. The vast majority of this was to defined contribution plans, so the market risk you take on behalf of employees is quite small. For one plan we looked at, the extra contributions for non-HCE (in addition to the safe harbor plan we had) and the admin costs amounted to about 20% of the tax savings for any given year. Well worth it.

@jacoaviu - please tell us more about the Captive Insurance Co. This sounds very interesting!

Again, I'm not a lawyer and I may be completely wrong...

Thanks

Ace
Topic Author
chilidawg
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Joined: Thu Dec 05, 2013 5:45 pm

Re: Cash Balance Plan

Post by chilidawg »

After more examination, it's probably not worth putting the CBP in the 1099.

Captive Insurance was on the IRS "Dirty Dozen" last year. Seems even riskier. https://www.irs.gov/uac/Newsroom/Abusiv ... ing-Season

So the return on a CBP can be set to a fixed percentage, a range of percentage, or pegged to a floating number like the 10 year treasury?
Derby
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Joined: Tue Sep 09, 2014 1:56 am

Re: Cash Balance Plan

Post by Derby »

You might consider talking to MedAmerica, the admin branch of CEPAmerica (formerly California Emergency Physicians). They develop and administer Cash Balance and Defined Benefit plans.
http://medamerica.com/Services/HRStaffing/Benefits.aspx
Carpe Diem.
jacoavlu
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Joined: Sun Jan 06, 2013 12:06 pm

Re: Cash Balance Plan

Post by jacoavlu »

chilidawg wrote: Captive Insurance was on the IRS "Dirty Dozen" last year. Seems even riskier. https://www.irs.gov/uac/Newsroom/Abusiv ... ing-Season
There is certainly a way to form and run a Captive in an "abusive" manner. Here's another article to read: http://www.nytimes.com/2015/04/11/your- ... .html?_r=0


However, there is also certainly a legitimate way to form and run a captive for a physician practice, or any other business for that matter, that has uninsured risks. If the whole captive industry was just an abusive tax scam, states would not be competing with one another and with offshore domiciles for captive business.

See here, Vermont wants your captive business. So does Montana. So does Oregon. The list goes on.

Most major corporations have a captive, or more than one. Allstate Insurance began as a captive of Sears. The nature of the industry is such that it is now more feasible for small to medium sized businesses to form and run a captive in a legitimate manner.

Startup and ongoing costs are likely to be higher than a cash balance plan, but there may be significant advantages of a captive over a cash balance plan for you and your partners. If nothing else, it may be worth it to speak with a professional who could provide more specifics. Your business manager and accountant should also be involved.
ccf
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Re: Cash Balance Plan

Post by ccf »

ace1400 wrote:@ccf - any recommendations for specific TPA's?
I use Plan Design Consultants Inc.

It has only been 6 months or so but I am happy so far. The initial setup went very well and we just finished up our 2015 contributions.

The most aggravating part was moving our 401k plan away from our old administrator.
TheGipper
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Re: Cash Balance Plan

Post by TheGipper »

Our group has had one for almost 3 years now. My thoughts.

1) Our defined benefit is 5% Seems fine on the surface but the AA is 60/40, with a fund ER of 0.33 and advisory AUM fee of 0.2. I seriously doubt we will achieve long term 5% return, so will be constantly dealing with "catch up". I didn't know it was legal to define the benefit as a range (i.e 0%-6%). If it is, this would be MUCH better. Otherwise I would lower the benefit to 3% or 4% id it were up to me.

2) We have 3 year cycle where you must stay locked in to your deferral amount, (i.e 25k, 50k, 100k). If you hit a personal cash flow issue you can not change, but must instead dial back your normal 401k/PSP which is presumable maxed already to 53k (or why bother be in the DCBP).

3) There was an initial "grace period" for the first year or two in which there were no "catch-up" 'contributions. Don't think this was wise, ?maybe a legal provision. The plan as expected is currently lagging behind the 5% benefit and our first test case partner retiree is happening soon before the three year cycle is up. I am assuming this will require this person to catch up his own account to the 5% level before he rolls over the funds into an IRA, but I'm foggy on how this will work.

4) It might be wiser to have a continuous, rolling "catch up" of the prior years deficit spread evenly over the following year if the plan can be set up this way.

5) If there is a surplus, Ii would personally prefer banking it for future down years, rather than slowing contributions (again if this is legal?) to avoid losing tax-free deferal $.

6) I figure even if I get 0% return in the long run, this is still a no-brainer if I can defer an extra 25-100k now and save 40% federal and state taxes and hopefully withdraw in retirement at an effective tax rate between 10-20%. We shall see.
bkh8
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Joined: Thu Sep 06, 2012 1:54 pm

Re: Cash Balance Plan

Post by bkh8 »

We had a defined benefit plan that we just closed and I rolled my contribution into the group 401k. We are now setting up a cash balance plan and i can put in a lot more money close to 150k a year if I want for the next 6-7 years. The plan is to roll those contributions into the 401k and setting up another one at that time.

I dont want to put in 150 a year but I was thinking i could put in 50k and still do backdoor Roths. Does it makes more sense to prioritize the Cash balance balance plan and put the 11k (actually closer to 20k i could afford because its pre tax) and forego the backdoor roth for the next few years?

I guess the question is where do you prioritize cash balance contributions? Above or below backdoor roths. I have also been doing some taxable investing, which I like because of the liquidity, should i not do any taxable and only CB?

I am in the 39% federal and 7 % state brackets.

THe immediate tax break is very appealing.
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g$$
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Re: Cash Balance Plan

Post by g$$ »

Pension actuary here. It's been a few years since I worked on a cash balance plan for partners, but I'll try my best to provide some commentary.
chilidawg wrote:My physician partners and I are looking at cash balance plans. We currently have a 401k with a match and profit-sharing that takes partners to the $52k/year max. We have about 20 physicians, and 40 non-highly compensated employees. The physicians all get additional income via a 1099 from an LLC each year, and we are looking to use this as a place for the cash balance, rather than in our W-2 practice income (it would eliminate all the non-HCE's).

I have heard conflicting things about how cash balance plans work, and I'm having trouble finding a good resource online for the nuts and bolts of such plans. The White Coat Investor site has an example, but I'm looking for more details. My questions are below:

1. I've heard the plan can set a fixed return per year (ie 5%), but in other cases I've read the plan can use a range with a cap (ie no less than 0%, no more than 6%). Can either method be used?

2. If various tiers are used (say $10k and $30), how often are participants allowed to move between tiers? Every year, 3 years? Every 5 years?

3. How and when do catch-up contributions happen? If the plan earns 2% over a year, instead of 5%, and there is no additional money held from previous years, when is the catch-up contribution due? I've read the catch-up contribution could be spread over a few years. How does this work if someone has jumped between investment tiers?

4. Are there particular companies that I should be looking at to administer this plan?

Thank you in advance.
1. Yes, either method can be used.

2. Depends. Whatever the participant enters at is supposed to be permanent. You could set this up so the tiers vary based on pay -- that at least provides a bit more flexibility. You can probably skirt the rules by allowing a change once every 5 years, but I would say it's frowned upon. You couldn't build the ability to choose a new tier into the plan document. You would need a plan amendment each time they switched from one tier to another.

3. The minimum contribution rules are... complicated. In a very few words, I would say they can be spread over ~7 years legally. Most plans like this include some sort of covenant outside of the pension plan that requires the plan to be fully funded over 1-2 years by the partners at the firm.

4. The only consulting firm I know of that specializes in plans like this is October Three (I'm not affiliated).

Someone else noted that their company had a plan and one partner retired while the plan wasn't fully funded. Most LLC's would require that the retiring partner fork up the cash to cover any shortfall as a result of their retirement. This isn't required by the IRS or any other government organization and can be negotiated between you and the other partners.

-g$$
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g$$
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Re: Cash Balance Plan

Post by g$$ »

chilidawg wrote:Thank you for the reply.

My thought is the LLC has a defined term in this case (the practice could shut it in 10 years). That would reduce some of the risk by keeping the term a bit shorter. Everyone could roll the cash balance to their IRA. At that point, a new LLC could set the same thing up. If a group of 15 people contribute $20-50k/year to one of these, for 25-30 years, these are not small accounts!

The cost to add the non-HCEs isn't that bad, but most non-HCEs would prefer a higher salary over this benefit. I agree that these seem to rely on lawyers and accountants more than I would prefer.

Maybe the better way to rephrase this is: What are the best practices for a cash balance plan?
Most cash balance plans for partners are terminated after 10-11 years. This allows participants enough time to reach the 415(b) limit. Note that the 415(b) limit is pretty high (spit balling here... maybe a $2.5 million lump sum?).

Once the plan is terminated a new one is set up for new partners. I think participants in the old plan are usually excluded because they could hit the 415(b) limit. Unfortunately I don't remember all the intricacies here because I've been drinking tonight.

:beer
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g$$
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Re: Cash Balance Plan

Post by g$$ »

TheGipper wrote:Our group has had one for almost 3 years now. My thoughts.
5) If there is a surplus, I would personally prefer banking it for future down years, rather than slowing contributions (again if this is legal?) to avoid losing tax-free deferal $.
Yes, this is legal.You can put a lot of money into one of these plans each year. The problem is that you might accidentally put in more than you need.
bkh8
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Re: Cash Balance Plan

Post by bkh8 »

What do you mean put in too much? Ie save too much money?

Seems like the way we are setting up the CBP it will be rolled into a 401k in 10 years and is a way to put in more money pretax with the hope of being in a lower bracket when you retire.

Seems like I might want to priorize this even over backdoor roth contributions.
ubermax
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Re: Cash Balance Plan

Post by ubermax »

ccf wrote:
My suggestion is: find a TPA who does Cash Balance Plans to go through it all with you and make a proposal for your plan.
This is good advice , I'm a retired pension actuary but in order to design a solid pension benefit program for Chili , IMO a TPA or consulting firm would of course need the census data for Chili's group but also have expertise and a lot of solid experience in plan design ; I'm too far removed from the day to day .

Someone mentioned October Three , that's one and Kravitz headquartered in California is another one that does a ton of Cash Balance work , Pinnacle in Arizona is another , the list goes on and on ; Chili , what state and city within are you near ?
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g$$
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Re: Cash Balance Plan

Post by g$$ »

bkh8 wrote:What do you mean put in too much? Ie save too much money?

Seems like the way we are setting up the CBP it will be rolled into a 401k in 10 years and is a way to put in more money pretax with the hope of being in a lower bracket when you retire.
The answer is complicated because:
A) This is a defined benefit plan, and
B) Partners are simultaneously "plan participants" and "employers".

The participant's benefit at retirement needs to be defined as a formula somehow in the plan document. The Plan can't give each participant too much control over the size of their benefits. Also, there are limits... the limit on the maximum allowable benefit is not the same as the limit on the maximum deductible contribution. I would reason to guess that you (as the employer) can fund more than the maximum benefit you could get back (as the participant).

My advice here is to hire a consultant that will work with you to figure out these issues from the start. This basically boils down to an exercise in "plan design" and "non discrimination testing", so make sure your consultant is strong on those two fronts.

-g$$
ubermax
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Re: Cash Balance Plan

Post by ubermax »

g$$ wrote:The participant's benefit at retirement needs to be defined as a formula somehow in the plan document.
Are you sure ??
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g$$
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Re: Cash Balance Plan

Post by g$$ »

ubermax wrote:Post by ubermax » 2016-12-18 Sun 11:59 am

g$$ wrote:
The participant's benefit at retirement needs to be defined as a formula somehow in the plan document.

Are you sure ??
I'm using the word "formula" loosely here. Yes though, it's a defined benefit plan, so whenever the participant retires someone should be able to calculate his benefit based on historical information and the terms of the plan document. You can set up a complicated formula for sure, using all sorts of tables and variables, but the benefit is not simply $x, because that's how much is in the trust. With sufficient planning you can design a cash balance plan so the trust value is very close to the benefit value, but there is almost always some mismatch. The few plans that I worked on like this had a mismatch between $0 and $100 per person depending on the size of the benefit and how long they were in the plan.

I'd summarize it like this:
For a defined contribution plan, like a 401(k), benefits at retirement are a function of the contributions. Bigger contributions -> bigger benefits.
For a defined benefit plan, like a cash balance, contributions are are a function of the benefits at retirement. Bigger benefits -> bigger contributions.
ubermax
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Re: Cash Balance Plan

Post by ubermax »

ubermax wrote:Post by ubermax » 2016-12-18 Sun 11:59 am

g$$ wrote:
The participant's benefit at retirement needs to be defined as a formula somehow in the plan document.

Are you sure ??
g$$ wrote:I'm using the word "formula" loosely here. Yes though, it's a defined benefit plan, so whenever the participant retires someone should be able to calculate his benefit based on historical information and the terms of the plan document.
The "defined benefit" in a Cash Balance(CB) plan is the hypothetical or notional account balance not the "actual" account balance as in Defined Contribution plans ; the elements of the hypothetical account balance are pay credits and interest credits which are defined in the plan document of the CB plan ; the accrued benefit under a CB plan is based on that same account balance and at termination or retirement participants in a CB plan can opt for the account balance or an annuity equivalent of that account balance.

I would say that the Traditional Defined Benefit plan can more accurately be described as having a "formula" to describe the benefit , e.g. dollars times years , a percent of final average earnings, etc.

If you prefer to think of the CB plan as defined by a formula that's fine but I have never read about or heard about it being described that way ,that's all ; maybe you're equating "historical information and plan terms" to formula ???

And I think the plan document for a CB plan also provides guidance on what happens when distributions occur and plan assets are insufficient to cover the hypothetical account balance(s) ; and on the flip side if assets are more than sufficient to cover all the balances , then it's a plus for the plan's funding requirement

I think it would be interesting to eventually find out if Dr. Chili makes an appointment with a consultant and pays the co-pay or deductible :happy
Topic Author
chilidawg
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Re: Cash Balance Plan

Post by chilidawg »

I thought I'd give some follow up as I did indeed go ahead with the cash balance plan.

W-2 is the way to go, there was no reasonable option to do the plan under 1099 income. Overall this is a complex process to set up. I consider myself fairly savvy with personal investing, but this really does take some time to understand. It's even harder to explain to people who barely grasp the 401k and match concepts. You need a lawyer, actuary, and third party administrator who are familiar with this stuff. Making the plan fit with an existing 401k match and profit sharing also can present some challenges.

The plan is invested as one lump - ie you have no investment control over your individual share. Each participant signs a legal side agreement essentially making them responsible for their own share. If someone retires, and their share is $20k short of the defined benefit amount, they must make up the difference, or the company can withhold $20k from their final pay to make up the difference. If the plan is doing better than expected at retirement, and someone has $20k over the defined benefit, that extra amount is paid in taxable income. Once someone retires, they typically take the cash balance amount and roll it over to an IRA.

The fees to set up and maintain these plans are not trivial, but when you have people in high tax brackets it can make sense.
Nitinol
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Re: Cash Balance Plan

Post by Nitinol »

Chilidawg, would you mind sharing who you ended up using as TPA and what your experience has been like? Thank you in advance
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