We’ve written about investing and planning for retirement since this column’s 2019 debut. One topic we haven’t addressed is the Cash Balance Plan. Under the right circumstances, there’s no better strategy for veterinary practice owners who want to accelerate their retirement savings and substantially reduce income taxes.

Ideally, a Cash Balance Plan syncs with a Safe Harbor 401(k) profit-sharing plan. Unlike a traditional defined benefit plan, a Cash Balance Plan has the look and feel of a 401(k) program, where each participant has an account that grows each year through contributions and interest credits.

Let’s first review the alternatives to see how a Cash Balance Plan fits into the retirement plan landscape. Most practices begin with a SIMPLE IRA or Safe Harbor 401(k).

SIMPLE IRA

A terrific starter plan, the SIMPLE IRA’s contribution limits are $16,000 annually per person or $19,500 for those ages 50 or older. In addition:

• The business must contribute on behalf of its employees, either a dollar-for-dollar match up to 3% or a 2% non-elective contribution to eligible workers, whether they contribute or not.
• Employer contributions are 100% vested immediately.
• Loans aren’t allowed, but employees may make a withdrawal at any time. Recent legislation allows for Roth contributions, but many SIMPLE IRA managers cannot accommodate it yet.
• It’s the best fit for practice owners who aren’t ready to contribute as much as a 401(k) plan allows but who desire a basic retirement plan for themselves and their staff.

Safe Harbor 401(k)

This plan is a logical next step because of higher contribution limits ($23,000 annually or $30,500 for those ages 50 or over). Also:

• Roth contributions are allowed.
• The company must contribute to employee accounts in one of three ways: a 3% contribution to everyone, a 3.5% matching contribution (must be coupled with automatic enrollment) or a 4% matching contribution. The contribution is 100% vested immediately.
• Withdrawals may be restricted to financial hardship cases or the termination of employment.
• It’s the best fit for practice owners who wish to contribute more than a SIMPLE IRA allows but aren’t ready for profit-sharing.

Safe Harbor 401(k)Profit-Sharing Plan

This option has higher contribution limits and greater tax deductions.

Discretionary profit-sharing enables practice owners to ramp up their funding to $69,000 annually or $76,500 for ages 50-plus. Other features include:

• Profit-sharing contributions may be made after Dec. 31 up until the filing of the corporate tax return. The tax deduction applies to the prior year.
• If employee demographics are favorable, a custom-designed profit-sharing provision may allow owners to skew the contribution in their favor. For example, if 80% of a $70,000 profit-sharing contribution goes to the owners, employees must get 20% ($14,000).
• It’s the best fit for mature, more profitable practices interested in increasing retirement funding.

All three options above are defined contribution (DC) plans. As the name suggests, the contribution is defined, and the retirement benefit varies.

Cash Balance Plan

An alternative to a DC plan is the defined benefit (DB) plan, which can provide a practice owner with significantly higher deductible limits. One DB example is the Cash Balance Plan, which provides considerably higher tax-deductible contributions (as much as $409,000 per person in 2024).

We recommend augmenting a traditional defined contribution plan, like a Safe Harbor 401(k) profit-sharing plan, with a defined benefit Cash Balance Plan. Doing that allows for stacking contributions into a practice owner’s accounts, provided the owner is older than many employees. Each participant’s account is maintained by a plan actuary, who calculates allowable contributions annually and produces statements.

The accounts grow annually through actuary-determined contributions (generally a percentage of pay or a flat dollar amount) and an annual investment or interest credit. Terminated participants may receive their vested balances in the Safe Harbor 401(k) profit-sharing plan and Cash Balance Plan.

Another noteworthy takeaway is that contributions are flexible. With the help of an actuary this year, we helped a client (two brothers who are 50/50 business partners) double their cash balance contributions for 2023. They and their accountant loved the move, as it allowed for a much larger income tax deduction.

Visit go.navc.com/3ySH14E to see the 2024 contribution limits for combined 401(k) and Cash Balance Plans.

Stashing the Cash

A Cash Balance Plan’s most important component is the plan document. While a brokerage account usually holds the plan monies, the document promises a future retirement benefit. The business is responsible for funding some or all of it. Retirement plan fiduciaries generally recommend a broadly diversified, conservative to moderate mix of investments. The goal is to earn a competitive return while minimizing volatility.

Other Considerations

Cash Balance Plans provide business owners with retirement savings and tax advantages significantly more than traditional defined contribution plans. Practice owners should also be aware of these points:

• Permanency: Unlike defined contribution plans, the Cash Balance Plan should exist for at least three to five years. This best practice guards against an IRS challenge.
• Requirement: Contributions are mandatory during the first three to five years. The plan may be amended in later years to reduce or eliminate contributions.
• Investment return: The plan’s assets fund the defined benefits. Therefore, a practice owner offering a Cash Balance Plan should work with a fiduciary adviser familiar with such plans. Managing risk is critical with a Cash Balance Plan because asset losses might require higher contributions in future years. Conversely, asset gains may reduce later contributions.

Is It for You?

Ideal candidates for a Cash Balance Plan are:

• Independent practices that aren’t selling to a corporate entity.
• Practice owners ages 45 or older who see a bright future for themselves over at least the next five years.
• Practitioners with no employees. (This has broad application for self-employed veterinarians.)
• Practices with fewer employees, not more. If just one or two owners, the ideal employee number is under 20.
• Practices with income and wage disparities between the owners and employees.
• Practices with profitability of 15% or more.
• Owners seeking additional income tax deductions.
• Owners with earned income of $345,000 or more.

We thank ERP Retirement Services, FuturePlan by Ascensus and October Three for sharing their expertise on this subject.

DID YOU KNOW?

A study indicated that over 60% of Cash Balance Plans are at businesses with nine or fewer employees.