Orthotown March 2018 - 47

Investment vehicles
In a cash balance plan, investment vehicles are
usually in two categories: securities, such as stocks or
mutual funds, and a whole life insurance policy that
normally pays a guaranteed growth percentage (4-4.5
percent per year). The death benefit payable by the
insurance policy is a key element of the plan, because
in the event of the practice owner's death before the
plan is fully funded, the life insurance proceeds would
make up the difference in plan proceeds.
Another advantage of the life insurance component is
that the cash value inside the life insurance policy can be
used to create a stream of tax-free income in future years.

Step-by-step setup
1. An employee census is prepared. This census must
include every employee, including the owner,
and show each employee's date of birth, length of
employment and income for the previous three
years. This census is then provided to a third-party
administrator (i.e., actuary), who performs an
analysis that determines the contribution level for
each employee participating in the plan.
2. You and your financial advisor then determine the
investment vehicles that will be included in the
plan, usually whole life insurance and conservative
stocks.
3. Documentation required for the plan is completed. All plan documents must be signed by the
end of calendar year in which tax deductions are
claimed.
4. The plan is funded. The practice owner has until
the tax payment deadline (including any extension) to make the first annual contribution.
5. Each year moving forward, the third-party
administrator prepares annual documentation
needed by the IRS. In addition, the practice owner
and plan participants receive a statement showing
how their individual plan contributions and value
are growing.

Running the numbers
The annual contribution to a cash balance plan
depends on the age of the practice owner and his or
her income. Usually $250,000 is the recommended
maximum. If the practice owner is five years from
retirement, $250,000 each year in pretax contributions
is a sure-fire way to catch up. By contrast, with a 401(k)
plan, the practice owner would be limited to fraction
of that amount.

Cash balance plans do come with administrative
costs, most of them related to the time spent by the
actuary in constructing the plan (which includes
conducting the employee census), drawing up plan
documents and preparing annual tax returns. The level
of administrative costs corresponds to the number of
employees participating in the plan. On average, setup
charges run around $3,000 and annual administration
fees are about the same amount.
Experts agree that for older, successful practice
owners, the tax advantages of cash balance plans far
outweigh the costs if the contributions are done correctly.
On the investment portion of the cash balance plan,
investment management fees range from 1-1.5 percent on
assets. Some business owners who love the stock market
and are able to reduce brokerage fees by handling their
plan's stock investments personally.
Let's examine one real-world example in which a
48-year-old practice owner has $243,000 in annual
income. He is contributing $18,000 a year to the
practice's 401(k) plan. By setting up a cash balance
plan to complement the 401(k)-this is perfectly
allowable and one of the flexibility benefits of a cash
balance plan-he can contribute $107,000 to the plan
annually. Part of that contribution includes a $50,000
annual life insurance premium on a whole life policy
that provides a $1 million death benefit.
Since the $107,000 plan contribution is pretax, the
physician takes that amount off his taxable income.
Moreover, since he is in the 40 percent tax bracket, he
will save $42,800 in taxes each year.

Keep in mind
Maximizing investment returns is not the goal of
a cash balance plan. Return on a 401(k) plan could be
higher if stocks are doing well. Of course, with higher
401(k) returns comes greater risk.
A cash balance plan, by contrast, is all about
predictable returns of 5-6 percent per year coupled
with the additional advantages of tax deductibility.
Two strategic keys are lowering risk and keeping more
money for yourself. At the same time, a cash balance plan
allows the practice owner who needs to play catchup on
his or her retirement savings to put retirement planning
on a faster pace. The older the practice owner is, the
more he or she can put into the plan.
Maintaining lifestyle is another retirement planning
issue related to a cash balance plan. While it might
seem like a good idea to pump up retirement savings,
this should not be done at the expense of a business
orthotown.com \\ MARCH 2018

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Table of Contents for the Digital Edition of Orthotown March 2018