By Steven Jamison, CFP®, CPA
As a high-income professional practice owner, you’ve got a lot on your plate. Between running the day-to-day operations of your business and taking care of your clients, there’s little time left to plan or manage your own finances, especially as it relates to retirement.
In fact, professional practice owners often retire later, not earlier, than their lower-income peers. Dentists, in particular, retire 7 years later than the average individual. On top of that, high-income practice owners usually have much higher tax bills to contend with, which only complicates the retirement equation.
So, what can you do to prioritize your retirement and minimize your tax bill? A cash balance plan with a 401(h) add-on is a great place to start. In our previous article we discussed the benefits of a 401(h) plan. This week, we’ll discuss how when combined with a cash balance plan it can create even more savings.
What Is a Cash Balance Plan?
A cash balance plan is considered a defined benefit plan, but it has some key characteristics that are similar to those found in defined contribution plans. Consequently, it is commonly called a “hybrid plan” since it lives in the defined benefit world, but looks and feels like a 401(k) defined contribution plan.
The beauty of this plan design is that each account holder has a balance that includes a contribution and mandatory earnings each year. These two annual additions to a participant’s account is the promise the company or firm agrees to pay when participants retire or otherwise leave.
Here’s the best part: the contribution limit is derived from the defined benefit formulas which allow high-wage earners to receive between $35,000 – $300,000 in contributions each year, depending on their annual income and expected retirement benefit. This is well above and beyond the contribution limits for defined contribution plans like 401(k)s!
Why the Cash Balance Plan?
There are three key benefits that make a cash balance plan ideal for high-income practice owners:
- It can reduce a plan owner’s tax liability.
- It can significantly accelerate their savings.
- It can be combined with a 401(h) plan for triple tax benefits.
Every dollar contributed to the cash balance plan on behalf of the owner comes right off the top of the owner’s annual income and thus lowers their marginal tax rate. In a world of shrinking tax deductions for high-wage earners, this above-the-line tax deduction is pure gold.
Second, a cash balance plan allows owners to significantly accelerate their savings. Many owners have spent their working years building their practices from the ground up, and many have neglected their personal retirement savings contributions in the process. But with a well-crafted cash balance plan, owners can squeeze 20 years of savings into 10, generating a dramatically different retirement lifestyle than would otherwise be possible.
And in case you’re wondering, these assets are not only afforded the same creditor protection that 401(k) plans have under ERISA, but they can also be rolled over to an IRA account or another qualified retirement plan, either once the owner reaches age 59½ and is still working, or when the owner retires or leaves the firm. The assets are completely portable.
Combining the Cash Balance Plan With a 401(h) Plan
If you read our previous article, then you know that a cash balance plan can be combined with a 401(h) plan to provide triple tax savings.
A 401(h) is similar to a health savings account (HSA), however, withdrawals cannot be made until retirement. What makes the 401(h) plan even more attractive is the fact that it covers dependents and beneficiaries. The funds are tax-free as long as they are used for qualified health expenses. Considering the average couple needs at least $315,000 to cover healthcare expenses in retirement, 401(h) plans can make a huge difference for high-income practice owners. Not only that, but it also provides real-time tax benefits in the years of contribution, including:
- The funds contributed are tax-deductible.
- As the funds grow in the account, the interest, dividends, and capital gains are not taxed.
- When funds are withdrawn for healthcare expenses, the withdrawal is tax-free.
How it Works
Let’s take a look at an example of a cash balance plan with a 401(h) add-on. The fictional Dr. Justin Smith is an oral surgeon with a successful practice in Oregon. He is single and makes roughly $400,000 per year, which puts him in the 35% federal income tax bracket for 2022.
As a small business owner, Dr. Smith is able to establish a qualified retirement plan and he chooses the cash balance plan with 401(h) add-on. His actuary determines he’s able to contribute $332,000 per year. He chooses to contribute $250,000 total, $100,000 of which will go to his 401(h) plan.
By making these contributions, Dr. Smith has effectively reduced his income tax by $82,425, as calculated here:
- Estimated federal income tax due on $400,000 = $112,260.50
- $400,000 (income) – $250,000 (contributions) = $150,000
- Estimated federal income tax due on $150,000 = $29,835.50
- Total taxes saved = $112,260.50 – $29,835.50 = $82,425
That comes out to roughly $20,000 in estimated taxes saved each quarter!
Start Saving Today
If you’re a high-income professional practice owner looking to reduce your tax bill while maximizing your retirement savings, the cash balance plan with a 401(h) add-on may be the right option for you. At Jamison Hanson, we have experience building custom plans for our clients who own professional practices. If you’re ready for a full-service financial plan that marries tax planning with retirement planning, schedule a 15-minute introductory call online or reach out to me at (503) 391-1040 or steven.jamison@jhadvisors.com.
About Jamison Hanson
Jamison Hanson is a full-service, fee-only financial planning and accounting firm. The firm name was changed to Jamison Hanson in 2021 when Steven Jamison and Dennis Hanson joined their firms, but the firm’s roots extend through decades of time and early founders, whose legacy the firm retains. Our mission is to make life easier for our clients by serving as their personal financial concierge and assisting with tax compliance, investment management, and other financial needs.
About Steven
Steven Jamison is President at Jamison Hanson, a full-service, fee-only financial planning and accounting firm. As a Certified Public Accountant and CERTIFIED FINANCIAL PLANNER™ professional, Steven uses his specialized knowledge of tax, financial, and investment matters to enhance the lives of personal representatives and trustees and professional practice owners (especially dentists) in Oregon and along the West Coast. With a passion for simplifying finances, optimizing opportunities, and saving money, Steven provides customized wealth advisory and accounting services, including investments, income and estate tax planning and compliance, and retirement planning, so that his clients can stress less and feel more confident about reaching their goals.
Steven prioritizes his clients, building long-lasting relationships that make a significant impact on their financial lives. He graduated cum laude from Brigham Young University with a Bachelor of Science in Accounting and is a member of the Willamette Valley Estate Planning Council and American Institute of Certified Public Accountants. Outside of work, Steven enjoys spending time with his wife, Rachel, and their five children. You can often find him adventuring in the outdoors—biking, hiking, traveling, and swimming. In addition to the Willamette Valley, they enjoy the splendor of the high desert of central Oregon and lush beauty of the Hawaiian Islands. To learn more about Steven, connect with him on LinkedIn.