Cash Balance Plan Common Pitfalls

In this installment, I want to identify some of the common pitfalls in the design and management of these plans. Here are some hidden hazards to keep top of mind:

Administrative costs

Cash balance plans are often implemented alongside a 401(k) to provide additional tax savings. These are separate plans that carry separate administrative fees, often ranging from $4,000 to $7,000 depending on the number of participants, complexity and plan features. When building a cash balance plan, ensure your funding target and potential lifetime tax savings are sufficient to cover administrative fees.

Employee costs

Not all qualified plans are the same. Employer funding allocations can vary widely in both 401(k) and cash balance plans. Designing plan entrance and eligibility requirements over time to maximize owner allocations of contributions is crucial. Optimizing plan design and controlling census options are not universal when setting up a plan. When reviewing plan studies, your wealth advisor and accounting team should compare your current marginal and expected future federal and state tax rates to ensure these savings exceed the “staff tax” inherent in plans.

Funding risks

Defined benefit plans are considered permanent plans by the IRS, with an expectation to remain in place and funded for at least three to five years. These plans are not for shifting profits for a single year or event. The most flexible plan designs manage future cash risk while maintaining funding options.

Overfunding a plan in the early years to increase and absorb future benefits can decrease cash risk and often provide the greatest long-term allocation to an owner and their family. If you are worried about the affordability of the plan in the first year, you likely haven’t managed cash and designed plan benefits appropriately.

Investment risks

Related to funding risks, this is the danger of an overly aggressive portfolio design. The ongoing funding requirements of defined benefit cash balance plans depend on the portfolio’s current value compared to the earned and accrued benefits in the plan. An aggressive investment allocation to variable asset classes, such as equities, can create additional funding requirements if the plan portfolio decreases relative to benefits. During economic slowdowns, patients may postpone elective surgeries, leading to lower practice revenue and profits. A cash balance plan should be managed strategically in the context of your household’s overall portfolio investment allocation to minimize funding risks and maximize lifetime tax benefits.

While a cash balance plan can provide significant tax savings and accelerate wealth creation, its implementation should be thoughtful and informed. It’s important to work with an advisor who understands your practice’s cash flow, personal lifestyle needs, long-term plans and the value of partnering with your other trusted professionals. If you have questions about building a plan, our team would love to help! Schedule a conversation with a practice integration advisor today. a conversation with a practice integration advisor today.

For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is based on third party data and may become outdated or otherwise superseded without notice. Third-party information is deemed reliable, but its accuracy and completeness cannot be guaranteed. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency have approved, determined the accuracy, or confirmed the adequacy of this information.