Speaker 1 (00:01.976)
Welcome to the Physician Family Financial Advisors Podcast, where physician moms and dads turn today's worries about taxes, investing, and extra money into a comfortable feeling of financial security. I'm Ben Utley.
and I'm Nate Renneke. Today we're going to talk about how to save huge taxes with a cash balance plan for physicians. So Ben, it's not often you hear about ways for physicians to save a bunch on taxes.
Yeah, usually it's just like save a bunch of money in your 401k and get a tax break and once you're done with that, you're kind of done, right? Maybe a little back or Roth in there.
Yeah, yeah, because the tax code doesn't really make that very easy for doctors. So here's the question. Is this just a gotcha title or is this real? What is the deal with the fine benefit plans?
And this is for real. So, defined benefit plans are also known as pension plans, cash balance plans. They have a couple other names that they go by, but the big catch all word is defined benefit. And the, tax savings are real and they, they can be huge. have seen older physicians save $200,000 a year into these things. And given that the, average physician is going to pay somewhere around a third of their
Speaker 1 (01:16.046)
third of their income in taxes, the savings on that would be like 60, $65,000 a year. That's real tax savings.
Wow. Okay, so compare that to, you know, the traditional 401k. You're looking at a few thousand. Six.
Yeah, you're looking at about a third of about 20, so you're looking at six or seven thousand bucks in savings. this is, well we debated about whether to make the title huge tax savings or Mongo tax savings, but this is both of those. It's huge Mongo savings.
10x the average plan that you get at work, which is 401k of 403b. Yes. Okay. So, so what are they? Like, what is a defined benefit plan?
Yeah, a defined benefit plan commonly referred to as a cash balance plan, which is a flavor of a defined benefit plan is a genre or a type of retirement plan. So, you've got your 401ks, 403 Bs, 457s, and I would even include IRA, SEPs, solo 401ks in a category called defined contribution plans. And you know, there's a limit about the amount that you can put into a 401k or into a
Speaker 1 (02:32.846)
a Roth IRA or traditional IRA, there's a limit about how much you can contribute and that's why we call it a defined contribution plan. Well, with defined benefit plans, we're looking at the promise of the guaranteed amount that's going to come out of this plan rather than the amount that goes into it. really what this is, is it's a pension plan. And with pensions, you serve a number of years and the employer promises a certain benefit.
when you retire and that that benefit's gonna be paid over the course of your life. so defined benefits slash cash balance plans are pension plans and they're just a little bit different than 401k, IRAs, those kind of things for that reason.
Right. So the way that the way that I think of these are when I hear that the kind of what I think of is how how much it might require to guarantee a benefit. Yeah. And T is kind of a tricky word in the finance world because it's hard to guarantee anything. But in order to guarantee something, you're to have to put in a lot of money in relation to kind of how much is being taken out, which is why you can get so much tax savings. Right. Because you have to put in a lot of money.
Yeah. And to be clear, it's the, the guarantor in this case is not the investment or the insurance company. The guarantor is the employer. And if you're self-employed, you're the one who's making the guarantee for you. If you're working for another company like Kaiser Permanente, then they're the ones that are backing these plans.
So how does the employer, which is sometimes the physician or Kaiser, whoever the employer is, how do they get, like what do they do to decide how much money they're putting in?
Speaker 1 (04:14.358)
Yeah, well, the first thing you need to do is figure out whether or not this plan is a fit for you. Okay. So if you are not self-employed, if you're working for a large organization, they may already have a cash balance plan or a defined benefit plan. They're not very common. I probably see them maybe one out of five employers. And it may be just a matter of looking in your employee benefit handbook and just finding this thing. You know, it might already be in there and you may not know about it.
Okay, so that's the first step. That's the big easy. Now, if you are self-employed and maybe you're in a partnership or you have several people that are in your practice and you don't have one of these, then you need to ask yourself some questions about whether or not it's a fit for you. And typically the situation that indicates the use of a defined benefit plan is where you have a large number of owners relative to employees.
So typically a large number of physicians relative to other staff. Okay. So that high ratio, where those owners are substantially older than the staff and they earn higher than the staff. so kind of the standard scenario where we see this is with radiologists, you know, there might be four or five radiologists in a group practice and they might have a one or two office staff that make a fraction of what the radiologists make.
And in those situations, it's typically a slam dunk to open up one of these plans. A situation where this may not make sense is, for example, let's say you're a urology practice and you've got, you know, 10 urologists that are relatively young or mid-career, and, you know, you've got 50 support staff and maybe they're a little bit older. Maybe the urologists make a multiple of what the support staff make, but...
they're not making, you know, 10 X. So that's a situation where it's less indicated. We see less of these in primary care and more of them in specializations. And the reason for that is that when you set up a defined benefit plan, have to, you have to benefit at least half of the employees, yourself included. And so there's a cost. There's a cost to contribute to not only your plan, but your employees plan. And every dollar that you contribute to the employees reduces the, the
Speaker 1 (06:38.488)
the benefit of this to you because it reduces, it offsets the tax dollars that you can save.
Right. Yeah, if it costs more to contribute to everybody else's plan than you saved in taxes, yeah, then maybe it doesn't make sense. Tax purposes, right? Yeah. OK. Whenever I hear about these, I just think, why aren't they used more often? It just seems like they're kind of complicated. You know, I've even seen people have these plans and not really understand how great of a benefit it really is.
yet is makes sense for tax purposes
Speaker 2 (07:10.67)
You know, so that's something too. If you're looking at this from the employer standpoint and you're paying your employees this benefit, they may not grasp it as well as they do a 401k. So even though they're getting a lot of money, they don't see it as a benefit, which is the whole point of giving your employees benefits so that they enjoy it or they stick around.
Yeah. And that's the, that's one of the things about the cash balance plans versus traditional defined benefit pension plans with the traditional defined benefit pension plan. You know, you're, promised a certain amount of money when you retire and it's typically expressed as an average of your high three years of compensation and it's way out in the future. so the average employee is looking at that going, well, I don't know how long I'm going to work here. I don't know how much I'm going to make, you know, I don't know when I'm going to retire.
You know, I don't know what this benefit is worth. So they don't really count that in their pay bucket, right? It's not going to be something that's going to retain that employee. By the same token, there's a thing called a cash balance plan. And a cash balance plan produces a statement that shows a notional balance. It's kind of the balance that the employee would have if they're looking at just their money. And again, it's complicated. It's not like a 401k where you truly have your own account.
what you have is a right to receive a portion of the benefits of this plan and you don't even get to direct the investment. The investment is directed by the ownership of the company. So that's a little bit more approachable because you can get a statement that says how much your portion of the plan is generally worth. So it's, but it's a little different than a 401k where you can really get your hands in there on it you can, you know, mess around with it and see it go up and down every day. You can't see that with cash balance plans.
Mm-hmm. Okay. Yeah one more little thought on that is that you know you're with your employees depends on kind of depends on who you have right so Older versus younger and younger They're not familiar with pensions whereas older employees their parents may have had a pension, right? It's all relative to who you have as employees and what your goals are, but we talked a little bit about who
Speaker 2 (09:22.08)
What should maybe consider these plans and maybe who shouldn't? Right. Can we go back to how they would work? Like, let's say someone thinks, listening thinks that this sounds really great to me. Like, where do they start?
Yeah, where do you start? So this is not a thing where you can just pick up the phone and call Vanguard and set up a defined benefit pension plan. That's not how they work. There's more complexity to it. Defined benefit pension plans are their own legal entity, kind of like a corporation. Your retirement plan has its own tax ID number, its own name, its own foundational documents. And typically these things are put together by an attorney, but sometimes a
a company called a third party administrator puts these together and they work in the attorney work altogether. And so the typical place to start with these is to find a third party administrator also known as a TPA. So the TPA's job is to help you put together the plan itself, put together the foundational documents, calculate the amount that you can attribute, file the 5,500, which is the annual tax return and kind of wrap all that stuff up.
You know, you can get a TPA for somewhere between, let's say, $4,000 and $8,000, depending on the number of participants in the plan as an annual cost. Now, the TPA will not handle the investment in most cases. It's a whole separate service. It's like most CPAs will not invest your money for you. They'll do your tax return. TPAs, same story. They'll make sure that the plan is compliant, but they won't invest the money. So you'd need to find a custodian.
A custodian could be like Fidelity, Schwab, Vanguard, any of those outfits. And you would need to have someone invest that money and it could be you. It could be one of your partners. You could hire an investment advisor. You could use a robo. You know, there's lots of different ways to go there. So you have to have all those parties kind of come together. And usually this starts off with a referral to a TPA who runs a kind of a cost benefit analysis to see whether or not it really pencils out and make sure that
Speaker 1 (11:24.706)
there's not going to be any compliance headaches due to other plans. And basically just kind of find the trail ahead that way with the TPA.
Yeah, that is a lot. You know what? I was kind of thinking there. So TPA custodian. What about the limits?
Yeah. So the limits, so limits vary depending on how much you make and how old you are. The older you are, the more you can contribute. So I've seen physicians that are close to retirement, be able to contribute a couple hundred thousand dollars to these. And that is in addition to the amount that they can put into a 401k. So it's not instead of it's in addition to, okay. younger physicians, the least I've ever seen someone be able to contribute is about $50,000.
and that's in addition to their 401k. But the devil's in the details. The 401k limits and the cash balance plan contribution limits are integrated to make sure that you treat your employees fairly. So again, that's TPA territory. give you an example. There's a TPA here who's here in town who sits on the American Society of Pension Actuaries. They have like 35 people in their office and this is all they do is TPA work. So it's...
It's a whole other thing and it would be practically impossible for a physician or the average financial advisor to whip one of these things up. TPA is a must have.
Speaker 2 (12:51.158)
Okay, so let's say you you dip your toe in the pension waters, right? The cash balance plan, defined benefit plan, you get in there and you realize this is just way too expensive. Like, or not even expensive. I just don't have an extra $50,000 of money coming into the business to continue to pay this out or however much it is. Can you just cancel the plan?
Well, you can, but the IRS looks askance on that. these defined benefit pension plans are intended to be permanent plans. Like you set them up, you keep them in place for years and years and years. While there's no hard and fast guidance on how long you have to have one, I have heard pension actuaries say that you should have one in place for not less than five years and it should be actively funded for three of those years.
But again, you know, there is no hard and fast rule. There's nothing in IRS regulations that says how long you must have one. It must have the appearance of permanence. And so I guess that's another thing to know about defined benefit pension plans. If you are, if you have excess cashflow year after year after year, and you've maxed out your 401k and you don't know what to do with this extra money and you're, you know, you're putting $10,000 a month away into a taxable account.
then you would be a good candidate for a defined benefit pension plan. But if some years you have an extra 50,000, some years you have zero, some years you have cashflow problems and your cashflow is real variable, you're probably not a good candidate for a defined benefit pension plan because it really is a commitment to contribute over a period of years. Now with that said, you'll hear about the cost of defined benefit pension plans and by that I mean the cost of contributing to your employees, right?
Many people that are listening right now who have employees and a 401k in place have what's known as a safe harbor 401k and they're already contributing three or 4 % to their employees pay. That might be enough to kind of buy you out of the major costs of setting up a defined benefit pension plan. You might find that the incremental or the marginal costs of a DB plan are low for you because you've kind of already met that bar of contributing to your employees.
Speaker 2 (15:02.482)
Mm-hmm, okay Okay, so this is what I'm hearing so tPA which is usually a brand new endeavor for employers
Yeah, yeah, you're not just gonna have a TPA laying around.
Right. So TPA, a custodian's involved, there's limits on how much you can and how much you must contribute and they're somewhat permanent. So it's a commitment. Yeah. So in other words, it's sometimes can be expensive and it's relatively complicated.
Yes, yeah, definitely more complicated than setting up a sep or solo 401k or something like that.
But potentially worth it, right? Because you don't just get 60, you don't get to defer $60,000 worth of taxes like we, the example we gave at the beginning of this podcast for nothing.
Speaker 1 (15:51.682)
Yeah, you're gonna have to jump through some hoops.
Yeah, but I mean, come on. If this is a good fit, you know, what we generally see is someone will call you or I and they'll say, hey, my partner brought this to the table. What should I do it? And I think the answer is you should consider it.
Yeah, you should consider it.
There's hoops, but who doesn't want to defer $60,000 this year and next year and every year, you know, their taxes if they're in the right situation.
Yeah, like you say, we typically see this when there's a specialist in a group practice, there's maybe five or six specialists in that group that are physicians, and one of them will bring this idea to the group and the others will be like, what is this thing? And they come to me and they're like, hey, should we do this thing? And I'm like, well, let's look into it a little bit. But usually these are, they work out well for physicians, provided that they're managed correctly.
Speaker 1 (16:47.968)
and provided that the paperwork is done correctly and that you have a solid TPA in place. Usually they've turned out to be a good thing.
Okay, so consider it. worth the time. You know, a lot of times too, it's let's kick this off until next year or something, because it's just complicated. Yeah. So it's worth the time. I think that's the bottom line. It's worth the time to consider. I think we hit everything.
Yeah, absolutely. Yeah, yeah, we did. think that we hit all of it. There's one thing I want to leave folks with. There are folks who have a pension plan that are underestimating the value of that plan. So for example, I serve a couple of physicians, they're married. He has a defined benefit pension plan through the VA, right? So basically a VA pension and she's self-employed.
At one point they were kind of laughing about his pension thinking, yeah, you know, he'll never get it. And it's not really worth that much. But when we did the math and we calculated how much that pension was worth, it was kind of like the equivalent of the VA just handing this guy check for about $2 million at retirement. it was real money.
And it made it such that they don't have to save as much for retirement. And with folks who have these pension plans, particularly through the military or the VA, we see this on a regular basis. Those are really valuable benefits. And like we said earlier in the show, many people don't value that benefit because it's kind of in the future. you know, they've heard about some of the pilots who got screwed out of their pension and they're like, I'll never get that money. But the fact of the matter is that people do retire on these things and it really is worth a lot of money.
Speaker 1 (18:22.668)
So before you walk away from a VA job or a government job where there is a pension or before you leave an employer where there's a pension benefit, you really need to weigh this because it's a very valuable thing in most cases.
And what, you know, something that as a planner, when I'm, when we're writing these plans, can make you nervous as if someone leaves that plan without considering anything. Cause imagine you leave and you know, you're in middle of your career and you haven't really saved much cause you have that pension. And the reality is that that pension, your retirement hinges on what's going on with that pension. So if you're going to leave, really think about how much you got saved on the side and, and,
consider what you're going to do next.
Exactly. It's a decision I would weigh as carefully as a decision to refinance a student loan and walk away from PSLF, know, walk away from a job with a good pension is it's going to make a seven figure difference in your, in your overall financial life at some point. Yeah. So I think that's it for today. So, gosh, you know, Nate, one of the things I love about working with you is you tend to sum everything up really well as we go along. do you want to hit the, the.
The high points on this is before we go out.
Speaker 2 (19:37.794)
Sure. cash balance plans, defined benefit plans, pension plans, have the potential to save you a ton in taxes. That's, that's number one. but it has to be the right fit because if it's not the right fit, you can find yourself, sort of handcuffed to a plan that is expensive, and complicated. Yeah. And not only that, but if you are the employer,
for all the work you're doing may not be appreciated because it's misunderstood. get yourself someone who can analyze one of these options with you and decide if it's a good fit for you to save a bunch of taxes.
Perfect.
Speaker 1 (20:22.924)
Excellent. So I will wrap us up. I'd like to thank everybody for listening today. I'd like to thank everyone who's given us feedback and talked to us about the podcast. are, I believe that we're a little bit further than a year along in our podcasting. So thank you for all the folks who've given us support and advice about how to run the podcast. If you'd like to contact us, you can call us at 503-308-8733.
Probably the best way to hook up with us is to to PhysicianFamily.com and grab our newsletter, which will let you know every time our podcast is out, as well as there's some other content in there that sometimes has value. so just want to encourage you to pick up our newsletter as well at PhysicianFamily.com. Thanks a bunch.
Thank you for listening to the Physician Family Financial Advisors Podcast. Is there a question you would like answered on our next show? Go to PhysicianFamily.com to record your question. While you're there, sign up for our newsletter and gain access to tools you can use to turn worries about taxes, investing, and extra money into a lifelong feeling of financial security. That's PhysicianFamily.com.
