Everything you wanted to know about your cash balance plan
With more and more doctors getting hired by large medical groups, cost cutting is critical in order to increase the bottom line for the profitable side of the hospital group. Cash balance plans for physicians are replacing their prevalent predecessor, the traditional pension plan.
Pensions are notoriously expensive to run for many reasons and though physicians are among the few who still get offered pensions by their employers, it’s becoming a fossil of the past.
Instead, traditional pension plans are being replaced by a product called cash balance plan. This is advertised to be similar to a traditional pension plan, grouped under the term defined benefit plan, but in fact it’s quite a bit different and therefore worth understanding.
What is a Cash Balance Plan
The professional financial community regards a cash balance plan to be almost identical to a pension plan. But a cash balance plan is not a pension, at all, in any shape, or form. It’s still one hell of an awesome retirement product but, please!
These cash balance plans are considered to be defined benefit plans and not defined contribution plans (explained below). This is important because the limits of a defined contribution plan are relatively low (~$54k/year).
Because cash balance plans aren’t defined contribution plans and instead considered defined benefit plans (have I lost you yet?), they don’t have to meet the measly little $54,000/year limit.
This means that doctors who are offered a cash balance plan can set aside quite a bit of money, pre-tax.
Defined benefit plan vs defined contribution plan (for you nerds)
These 2 terms keep coming up, let’s talk about them briefly.
The only different between them is the benefit vs contribution. Here is the best way to remember them apart:
Benefit, meaning that the plan offers you a set benefit every month or every year. Think pension or cash-balance plan.
Contribution, meaning that you only get back from the plan what you contributed into the plan. Think 401k, 403b, 457, IRA, etc.
1. Who operates the cash balance plan?
A cash balance plan is a retirement account run by your employer. You cannot control the money in it, you cannot invest the money and you cannot access it until it becomes available to you upon retirement.
Your employer will often set aside a certain percentage of your salary into such an account and allow it to grow at either a fixed rate or a rate tied to the Treasury Bill rate. Often it’s somewhere around 4-5%.
Operating these suckers isn’t cheap. There are all sorts of auditings and management that have to be done on the back-end by your employer.
Furthermore, there aren’t any individual accounts, there is a huge lump sum of money sitting around for all participating doctors which the plan administrator has to invest wisely so that, come retirement time, the doc isn’t left holding nothing but his … stethoscope.
2. How can you view your balance?
There isn’t a balance, per se. Remember, the money goes into one big pile and is invested until it’s time for payout. But, each employee has a value which often gets reported in an account to which they have online access.
Most cash balance plans increase by a set percentage every year, often a touch above inflation, 4-5% is the norm, as mentioned above.
Unlike a 401k or IRA, you can’t decide what to do with that money. It appreciates at the set value above, and come retirement time, you are entitled to that amount.
So, if you had 10% set aside in 2015 and you earned $350,000 then you had $35,000 set aside into your cash balance plan. Which would then grow by 4% for every year you are employed, on top of the subsequent 10% employer contributions.
3. Do you need to vest?
Almost every doctor who I have surveyed has told me that there is some sort of vesting schedule.
Vesting means that you must work for an employer for a set period of years before you are entitled to this money.
If you work for 2 years and leave, but your vesting required 3 years, then the 10% which was taken out of your paycheck every year just goes into the coffers of the company.
4. How do you take it with you when you change jobs?
If you end your employment with a company with whom you have a vested cash balance plan, you often have the option of either rolling that money over into an IRA or leaving it with your employer.
However, if you leave it, the money won’t keep growing. Which means that it will sit stagnant and possibly decrease in value due to inflation.
5. Is a Cash balance plan protected or guaranteed?
If your company goes belly up right after you retire, PBGC would step in to cover the majority of your benefits. They do this by becoming the trustee of whatever is left of the defunct company, by using some of PBGC’s own funds, some insurance premiums from companies who are forced to pay it, and revenues from PBGC’s investments.
So yes, you have quite a bit more protection when it comes to pensions or cash balance plans than your 401k. Nice.
6. How much can you put into a cash balance plan?
A lot! I don’t want to bore you with details, but it’s based on a $2.6 million lifetime maximum allowable contribution limit. So, the older you get, the fewer years you have to retirement age, the more you can put in.
I’m 39 and I can set aside $54,000 in defined contribution plans (401k’s, IRA’s, etc.) according to the IRS. At my age, I can add another ~$75,000 towards a cash balance plan. That’s a total of nearly $130k deferred!
Of course, your employer ain’t gonna set aside that much money for you, for many reasons. First, most docs wouldn’t want to save that much, they often need that income for living expenses. Second, the more money a company has to manage, the more costly it is to run a cash balance plan.
7. What happens to the cash balance plan when you retire?
Once you hit age 59.5, you are entitled to the money in your cash balance plan.
In a traditional pension, you would have been entitled to a set payment every month until you died, it would never run out unless the company went under – in which case ERISA would help resume your income payments (I have examples of my own employers, below).
In a cash balance plan, a set amount was contributed year after year and grew at a set percentage. Therefore, there is a finite amount of money in that cash balance plan.
You can choose to take the money as a lump sum and roll it over into an IRA or you can annuitize the money in form of regular monthly payments.
8. Do you pay taxes on it?
The money going into a cash balance plan is pre-tax money.
Your salary might only show $300k of gross income, but if your employer is also setting aside 10% into a cash balance plan – you are essentially grossing $330k/yr.
The money in the cash balance plan will grow tax-free and you will owe ordinary income taxes on it once you withdraw it.
It’s important to discuss your strategy with your financial adviser because if you roll your cash balance plan into an IRA then you are stuck with RMD’s (required minimum distributions). But if you annuitize it then you might get some tax protection.
9. Is it protected the same as a pension in case of divorce and lawsuits?
A pension is considered a joint asset for a married couple. Unless your pre-marital agreement stipulates otherwise, a percentage of your pension benefits will be owed to your partner in case of divorce.
In the case of a lawsuit resulting in actions by creditors, your cash balance plan is protected and though they can come after your house, car, business, and savings, they won’t have any access to your pension.
My own 2 personal examples
When I was working for Southern California Kaiser Permanente (SCPMG), I was working my way towards vesting into their pension plan. This was your run of the mill traditional pension.
I needed to put in 10 years in order to vest in this pension. I ended up walking away at year-7. I detailed how much money I walked away from in this post.
For every year that I worked, I would get 2% pension credits for the first 10 years. Then, for the next 20 years, I would get 1% pension credits, for a total maximum of 40% pension credits.
This 40% is how much of my salary would be replaced upon my traditional retirement age of 65.
My “salary” would be the average of highest 3 consecutive years of work. So, if I worked 2010-2012 making $300k, $350, and then $400k, and assuming these were my highest salary years, then I would get 40% of $350k from age 65 until my death – $140k of gross income year after year, starting at age 65.
I know what you’re thinking, and yes, I can work those 3 consecutive high-income years and then drop down to part-time and I would still have my 40% pension credits based on those years. Cha-ching!
NWP Cash Balance Plan
Once I moved to Portland, Oregon and started work at Kaiser Permanente, I started up in a cash balance plan with Northwest Permanente. This medical group stopped offering pension plans about 2 months before I started.
Here, they set aside 10% of my gross income into this cash balance plan every year. The rate of growth was set at 4%. Meaning, that the money would grow at 4% every single year, no matter how shitty the economy was doing.
Year 1, I grossed $300k, so I had $30k set aside for me. Year 2, I grossed $200k and had another $20k set aside for a total of around $50k.
I have since ended my employment with NWP which means I need to make plans to mobilize the money in this cash balance plan, by likely rolling it over into my current IRA account.
A cash balance plan is similar to a traditional pension plan which is cheaper for employers to operate. It’s a retirement vehicle which can be offered by your employer, not something you can establish for yourself – unless you own the business. It allows you to set aside pre-tax money which will be paid out to you and taxed upon reaching retirement age.