I often speak with physicians who are looking to save taxes and maximize the personal benefits of business ownership. For many physicians, healthcare practitioners and specialists and high-income earning business owners (with no of few employees), combining a solo 401k or 401k and a Cash Balance Plan, similar to a defined benefit plan, is an ideal solution.
A cash balance plan doesn’t really have an annual contribution limit like a 401(k). This is because it is trying to reach a specific amount upon retirement (typically at 62 years old).
The amount of money in the plan at retirement is dependent on certain things. But mostly it depends on your average compensation. Assuming maximum compensation, you can have about $3.5 million upon retirement.
As an example, the maximum annual contribution for a 401(k) plan is $69,000 ($76,500 for age 50+) for 2024. However, the maximum cash balance plan contribution is as high as $420,000.
What Is a Cash Balance Plan?
A cash balance plan is a qualified employer-sponsored defined benefit pension plan. It is typically known as a “hybrid” plan, where participant accounts grow in two ways. First, there is an employer contribution, and second, a guaranteed interest credit. Employer contributions are determined by a formula specified in the plan document. A cash balance plan has much higher annual contribution limits than 401(k) or SEP IRA plans, and annual benefits continue to increase with age.
For example, participants who are over age 60 may be able to contribute more than $200,000 annually. Contribution limits are specific to the individual and must be calculated by a plan actuary. There are specific testing and annual reporting requirements for cash balance plans, which should be completed by an actuary or third-party administrator.
Who Is Suitable for Cash Balance Plans?
Business owners who are typically aged 40 or older and looking for access to higher contribution limits and tax deductions than those available in defined contribution plans would be suitable for a cash balance plan. The IRS recommends opening these plans for at least three to five years to make sure the business has enough cash flow to support these contributions.
Best of Both Worlds
Combining a cash balance plan with a solo 401(k) plan can offer Physicians business owners the ability to shelter large amounts of income for retirement while significantly lowering their tax liability. Taxes are deferred, so your original investments have the potential to grow much faster. Contributions are also deductible, which can save the business owner a significant amount in taxes. Owners would have the ability to maximize contributions on the individual level through the solo 401(k) plan while gaining access to higher limits for employer contributions and tax deductions.
Let’s review a review examples:
Example 1:
This example involves a 52-year-old Physician, Dr, Bernard, with a S-corporation (no employees) paying himself $220,000 a year. Dr. Bernard has a solo 401k set up and plans to make maximum employee contribution in 2024 in the amount of $ 23,000, plus an additional $7,500 catch-up (age 50 and older) for a maximum of $30,500.
Dr. Bernard will also be making the maximum profit-sharing contribution possible. Generally, the maximum profit-sharing contribution is 25% of W-2 compensation. However, due to IRS limits for combined plans, Dr. Bernard will be limited to 6% of the compensation limit, for a profit-sharing contribution of $ 13,200.
For Dr. Bernard, adding a Cash Balance plan is ideal.
Based on his age and income, Dr. Bernard is able make a tax-deductible contribution of $188,000 into his cash balance plan, for a combined total was $218,500.
Example 2:
Dr. Brown is as an independent contributor (1099), has an S corporation with no employees and pays himself $200,000. Dr. Brown is anticipating business profit in the $105,000 range and is looking to increase tax-deductible retirement plan contributions.
Dr. Brown will be making a $23,000 employee contribution to his solo 401k, $12,000* profit sharing contribution, and $48,000 tax deductible contribution to his cash balance plan, for a combined retirement plan contribution of $88,000.
Not too bad for physicians looking to supercharge retirement.
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