Defined benefit pension plans as well as cash balance plans are generating a lot of interest with medical practices, both large and small. Medical practices find that these retirement plans are a great way to increase retirement savings and reduce taxes at the same time.
Defined benefit pension plans as well as cash balance plans are generating a lot of interest with medical practices, both large and small.
Medical practices find that these retirement plans are a great way to increase retirement savings and reduce taxes at the same time. As an additional benefit, the plans provide asset protection for doctors. In addition to reducing income taxes, the significant contributions are a great way to catch up if you have not saved enough in the past or if your retirement account balances are down due to market losses during the recent economic turmoil.
Comparing to 401(k)s, profit-sharing plans
In 2010, someone under age 50 can defer $16,500 into his 401(k) account. With matching and profit-sharing plan contributions, the total can be increased to $49,000. If the person is over age 50, he can defer an additional $5,500.
In comparison, a doctor in his mid 50s could contribute and deduct as much as $200,000 or more in a properly designed defined benefit or cash balance plan. This allows you to turbo-charge your retirement savings. You can accumulate upwards of $2.4 million in the plan at age 62.
First Plan Year End
Income Tax Rate
Dr. John Owner
Defined Benefit Pension Plan with 401(k)
Profit-Sharing Plan - Cross-Tested Design
Total Plan Contrib
Total 401(k) Profit Sharing Contribution*
Grand Total Contribution
% of Total
Dr. John Owner
(Exhibit 2) * Includes 3 percent Safe Harbor, additional profit-sharing contribution and $20,500 salary deferral for owner and spouse.
Pension Protection Act of 2006
Defined benefit and cash balance plans have become much more popular since the Pension Protection Act (PPA) of 2006. The act did several things to make these plans more appealing. First, the PPA clarified the legality of cash balance plans. Second, the PPA explained how a company, such as a medical practice, might be able to sponsor both a 401(k) profit-sharing and a defined benefit plan to take advantage of the unique characteristics of each and benefit from the combination of the two. Third, the PPA explained how to cross-test the benefits from both types of plans and be able to weigh the contributions more heavily toward the professionals/business owners if the demographics were right.
A sample case is provided showing a medical practice where a physician’s spouse is employed along with seven employees (Exhibit 1). When a defined benefit plan is added to an existing profit-sharing plan, contributions can be significantly increased, while keeping financial obligations to non-owner employees to a minimum (Exhibit 2). A comparison of “before and after” is provided to illustrate improvement of plan design from one year to the next (Exhibit 3).
ABC Company - Comparison of Plan Designs
Previous Year Design
Proposed New Design
Dr. John Owner
Increase in contribution to Dr. and Wife
Increase in total contributions
% of increase for Dr. and Wife
Historically, defined benefit plans were thought to be fixed and inflexible. The Pension Protection Act brought with it a new funding method that gives rise to a range of funding options. The contributions in the range, from maximum to minimum, are all acceptable and income tax-deductible. With the proper plan design and this new funding method, there can be tremendous year-to-year funding flexibility.
As a result of these changes, business owners - such as doctors - can now have larger retirement plan contributions that are income tax-deductible. The plan designs are doctor-friendly, allowing a contribution level that fits the needs of the business. This increased funding flexibility can also allow more predictable contribution totals from year to year.
Another important change brought about by the PPA is the inherited IRA. Prior to the PPA, in the event of a participant’s death, a spouse beneficiary could roll the account into his own IRA, stretch the benefits over his lifetime and pass them on to future generations, which provided for the deferral of the income tax for possibly decades. If the beneficiary was a non-spouse, the taxation was either in the year of death or no later than the end of the fifth year following. Taking a lifetime of accumulations and taxing them over a short time was not a good result.
The PPA changed this and allows a non-spouse beneficiary to receive this inherited IRA, and stretch out the payments in a similar fashion to a spouse, putting non-spouse beneficiaries on a more equal footing. With a high rate of divorce or the possibility that your spouse might predecease you, this is an important change.
If you want to find out if a defined benefit pension plan or a combination of plans is right for you or if your current plan provides for an inherited IRA, call OJM Group and speak to one of its retirement plan specialists. You might be very surprised at how a few changes can enhance your retirement and income tax planning.