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Maximizing a Defined Benefit / Cash Balance Plan vs affording life expenses?

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  • Maximizing a Defined Benefit / Cash Balance Plan vs affording life expenses?

    Hello friends -- I'm seeking some wisdom regarding funding my defined benefit / cash balance plan. I am hoping some of you may have some relevant experience and can provide some guidance?

    I am currently a partner in a large physician group, and I'm trying to maximize my saving efficiency while minimizing my tax burden.

    My partnership has just informed me that I have the opportunity to invest in their defined benefit / cash balance plan. This plan has multiple contribution "tiers" I can choose from. Given my current age (almost 50), I have the option to contribute in the contribution "tier" of my choice ranging from $5K to $80K annually.

    Per the terms of the plan, I must choose my contribution amount for the coming new year shortly, and I will be "locked" into this contribution amount until the defined benefit / cash balance plan closes many years from now when the plan is discontinued (or until I retire or leave the partnership).

    As background: I currently max out my 401k (both employer and employee contribution), HSA, & Backdoor Roth. All of my additional money goes into a taxable Vanguard brokerage account. I currently have $1,000,000+ in my 401k, and $2,000,000+ in my taxable brokerage account, plus other assets that are not particularly liquid. I anticipate building a new home and getting married soon, which I anticipate will increase my annual expenses dramatically. I would love to retire within the next 10 years.

    My question is this:
    Given the multiple contribution levels/tiers of this plan, what is my best strategy to maximize my returns in the long term? The funds I contribute to this defined benefit / cash balance plan are invested in VSMGX (50-70% equity). As I see it, I have three potential choices:

    a) Contribute to the highest tier allowable each year given my age (which is $80K annually). If I do this, I anticipate I'll avoid paying tax in the 35% tax bracket on that $80K now, with a goal of hopefully being in a lower tax bracket in retirement. However, given my future life changes, I might be a little short on actual "living expenses" each year from my earned income. I would withdraw money from my taxable brokerage account to cover the shortfall, paying long-term capital gains rates on this shortfall rather than 35% (my current tax bracket). My strategy would be to draw down my taxable brokerage account for living expenses to avoid some tax on my current income.

    b) Contribute to the lowest tier allowable each year (which is $5K annually). If I do this, I'll figure I'll pay more in taxes each year in the 35% tax bracket, but I'll have more available cash available to me each year. I'll keep my "living expenses" the same, and all additional available cash will go into my taxable Vanguard brokerage account -- invested in about 90% equities.

    c) Contribute to some "middle" tier -- at a level where I still can cover my "living expenses" comfortably. I'd still be contributing to my defined benefit / cash balance plan to reduce my taxable income each year, but I wouldn't be relying on withdrawals from my taxable brokerage account to cover living expenses. I also wouldn't be necessarily contributing "new" money to my brokerage account as the money I would have previously contributed to my taxable brokerage account is now going into the defined benefit / cash balance plan.

    In any scenario, I would keep my asset allocation the same. Given the equity/bond ratio of VSMGX (which is the investment option in the defined benefit / cash balance plan), I would re-balance my entire portfolio to keep my overall asset allocation the same. Perhaps future US tax changes will increase my tax bracket in retirement and this will all have been for naught?

    Any insight / advice would be greatly appreciated. I might like the freedom of having money in a taxable brokerage account, but like the idea of decreasing my taxable income now. Also, relying on withdrawals from my brokerage account to cover living expenses makes me a little uneasy, but I realize there's enough money in there to do it if the long-term result is financially better.

    Additional opinions are greatly appreciated! I would not at all be surprised if I am missing something obvious.

    Your collective wisdom and advice is much appreciated!

  • #2
    One area that you didn't mention is due diligence on the financial security and plan features. Taking a page from the old Law & Order tagline, here are some questions ripped from the headlines (as in, news stories I've read about horror shows that hurt other pension plans).

    Defined benefit = risk of not meeting obligations because you get the same amount of money whether or not the plan is making money
    Large physician group = small pension plan = higher risk of the pensioners diverging from the average life expectancy of a larger group and reality not matching the actuarial projections.
    How well funded is the plan currently? Can the business access the pension funds for non-pension liability if they are short on funds? What happens to pensioners, and what happens to the business, if they need to reduce physician income to cover unfunded pension liabilities and nobody wants to work there any more? What kind of government guarantees backstop the pension if the plan fails? Can a company that acquires the group move the assets to one place and hive off the pension obligations somewhere else and let the plan go bankrupt?

    What happens to your pension if you die? Will your wife get survivor benefits? Or is she SOL if your pension disappeared and you spent down the rest of the money to fund a bigger pension?

    Comment


    • #3
      More info like income, savings rate, annual spending (and projected spending with your upcoming changes), would be helpful and get you better answers.

      Comment


      • #4
        Need more info on income and expenses. Will the new wife work? Any kids? If the plan checks out then I would favor c. No need to feel poor at 50.

        Comment


        • #5
          Am I understanding correctly that the concern with contributing at the highest tier is that the 80k is needed for living expenses and that this 80k is sitting at the 35% bracket after other deductions ($418,851)? I have to ask as this is the WCI forum, how much increased living expenses are associated with the new home and how much with the wife?

          Comment


          • #6
            Originally posted by mountainlife View Post
            Hello friends -- I'm seeking some wisdom regarding funding my defined benefit / cash balance plan. I am hoping some of you may have some relevant experience and can provide some guidance?

            I am currently a partner in a large physician group, and I'm trying to maximize my saving efficiency while minimizing my tax burden.

            My partnership has just informed me that I have the opportunity to invest in their defined benefit / cash balance plan. This plan has multiple contribution "tiers" I can choose from. Given my current age (almost 50), I have the option to contribute in the contribution "tier" of my choice ranging from $5K to $80K annually.


            Sounds like very inflexible plan. You should be able to contribute an amount up to your maximum, unless the demographics is so bad that older partners are limited on purpose to pass testing.


            Per the terms of the plan, I must choose my contribution amount for the coming new year shortly, and I will be "locked" into this contribution amount until the defined benefit / cash balance plan closes many years from now when the plan is discontinued (or until I retire or leave the partnership).


            Same thing. You should be able to change your target contribution once in about 3 years. This is not what a group practice CB plan should be like. There has to be more flexibility/customization available, unless this is a giant practice with multiple hundreds of participants. Even then it sounds like they are limiting the options of partners a bit too much.


            As background: I currently max out my 401k (both employer and employee contribution), HSA, & Backdoor Roth. All of my additional money goes into a taxable Vanguard brokerage account. I currently have $1,000,000+ in my 401k, and $2,000,000+ in my taxable brokerage account, plus other assets that are not particularly liquid. I anticipate building a new home and getting married soon, which I anticipate will increase my annual expenses dramatically. I would love to retire within the next 10 years.

            My question is this:
            Given the multiple contribution levels/tiers of this plan, what is my best strategy to maximize my returns in the long term? The funds I contribute to this defined benefit / cash balance plan are invested in VSMGX (50-70% equity). As I see it, I have three potential choices:


            That's one heck of a high risk allocation for a CB plan, even if it has an actual rate of return crediting rate. It is about 60% stocks. What happens when the stock market falls? Will the practice make up the shortfall, or will you have to do it?


            a) Contribute to the highest tier allowable each year given my age (which is $80K annually). If I do this, I anticipate I'll avoid paying tax in the 35% tax bracket on that $80K now, with a goal of hopefully being in a lower tax bracket in retirement. However, given my future life changes, I might be a little short on actual "living expenses" each year from my earned income. I would withdraw money from my taxable brokerage account to cover the shortfall, paying long-term capital gains rates on this shortfall rather than 35% (my current tax bracket). My strategy would be to draw down my taxable brokerage account for living expenses to avoid some tax on my current income.

            b) Contribute to the lowest tier allowable each year (which is $5K annually). If I do this, I'll figure I'll pay more in taxes each year in the 35% tax bracket, but I'll have more available cash available to me each year. I'll keep my "living expenses" the same, and all additional available cash will go into my taxable Vanguard brokerage account -- invested in about 90% equities.

            c) Contribute to some "middle" tier -- at a level where I still can cover my "living expenses" comfortably. I'd still be contributing to my defined benefit / cash balance plan to reduce my taxable income each year, but I wouldn't be relying on withdrawals from my taxable brokerage account to cover living expenses. I also wouldn't be necessarily contributing "new" money to my brokerage account as the money I would have previously contributed to my taxable brokerage account is now going into the defined benefit / cash balance plan.

            In any scenario, I would keep my asset allocation the same. Given the equity/bond ratio of VSMGX (which is the investment option in the defined benefit / cash balance plan), I would re-balance my entire portfolio to keep my overall asset allocation the same. Perhaps future US tax changes will increase my tax bracket in retirement and this will all have been for naught?

            Any insight / advice would be greatly appreciated. I might like the freedom of having money in a taxable brokerage account, but like the idea of decreasing my taxable income now. Also, relying on withdrawals from my brokerage account to cover living expenses makes me a little uneasy, but I realize there's enough money in there to do it if the long-term result is financially better.

            Additional opinions are greatly appreciated! I would not at all be surprised if I am missing something obvious.

            Your collective wisdom and advice is much appreciated!
            Several observations:
            1) At 50 years old, you are fine to invest in a CB plan, it will beat a taxable account over 10 years. If you are in the 35% tax bracket, it is definitely worth doing so.
            2) Do this only if you have enough cash flow for everything else. If you have to dip into savings for cash flow, that's not really a good idea.
            3) I really do not like your plan. You should be able to specify the amount to put in. For example, next 2 years you might not put anything in (if you need the money), but once you saved enough, you should be able to contribute a lot more than $80k a year, possibly as much as $150k a year. And you should be able to increase that going forward (or decrease if you choose).
            4) Your plan might have either a fixed crediting rate of an actual rate of return one. Either way, you are not getting anything more than 5% or so (depending on how old your plan is and whether it was redesigned), as the plan is funded with your contributions, so the amount you will have after 10 years will be the same regardless of the return (you put in less with higher return, you put in more with lower return). The issue is if the return is really low and you have a lot of money in the plan, you might have to contribute more than you planned. Overall design of your plan sounds very inflexible and I would find out more about it before investing (esp. what happens when there is overfunding and underfunding).

            Some background on how CB plans are set up for other group practices (as yours is not very typical):
            https://www.whitecoatinvestor.com/ca...oup-practices/

            If this is a huge practice (or a hospital), then you might not have a lot of leverage to make any changes, and you will simply need to take what's given to you. In that case you may want to evaluate your plan on its merits, as every other plan that I've seen is mostly better in terms of contribution amounts, ability to change contributions and risk management profile.
            Kon Litovsky, Principal, Litovsky Asset Management | [email protected] | 401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

            Comment


            • #7
              Thank you! I really appreciate the responses.

              Kon - your article was excellent and very informative. I really learned a lot. Thank you so much for the link!

              https://www.whitecoatinvestor.com/ca...oup-practices/

              Given my concerns and the items brought up by everyone, I am reaching out to the cash balance plan administrators and trying to dig into the details much more deeply.

              Given the possibility of potential poor market while this plan is being funded, I think I would be responsible to make up any shortfalls. This might be a reason to 1) not fund my plan at the highest tier, and 2) perhaps be less aggressive with my investment in this plan. Instead of roughly 60% equity with the VSMGX option I was going to select, I believe I can dial this down to a fund within the plan with decreased equity exposure to hopefully prevent a shortfall and additional money owed. I think perhaps putting the majority of my cash balance plan contribution into bonds might make sense. Like Kon has suggested in other posts, decreasing volatility in a cash balance plan seems prudent.

              Between my taxable brokerage account and my self-directed 401k, if I dial up the fixed income percentage in my cash balance plan, I can adjust my other accounts to keep my overall asset allocation / risk the same. It seems like there is no significant advantage to increasing my risk in the cash balance plan. I should enjoy the tax benefits of contributing a significant amount to the cash balance plan while I am in my current high tax bracket, and take any real portfolio equity risks with my 401k and/or taxable account.

              Based on previous comments, I tried to dig up some numbers to look at the various scenarios.

              As I'm getting married and planning to cut back on work a bit, I anticipate my gross working income moving forward will be about $350K.
              My current annual expenses (including federal/state taxes, 401k contributions, mortgage, malpractice insurance, healthcare, and all living expenses) is about $240K
              This leaves me with $110K of "extra" income yearly. Historically, I've been putting all "extra" money into a Vanguard taxable brokerage account.

              After getting married and building a house, I anticipate my gross working income moving forward will still be about $350K.
              Anticipated annual expenses with the new mortgage/construction costs and new wife (including federal/state taxes, 401k contributions, malpractice insurance, healthcare, and all living expenses) I suspect will be closer to $300K.
              This leaves me with $50K of "extra" income yearly.

              This leads to my original question.

              a) Should I contribute $80K to the defined benefit / cash balance plan? This will leave me with a -$30K ($50K - $80K) shortfall of income yearly, but I could withdraw from my taxable account a long-term capital gains rates to make up this difference & pay for my living expenses. Correct me if I'm wrong but I'd be saving about $28K in taxes annually in a 35% tax bracket ($80K x 35% = $28K) Again, my goal is to be in a lower tax bracket in retirement. I would pay $4500 in capital gains by withdrawing from my taxable brokerage account to afford my life expenses ($30K x 15% = $4500) with this plan.
              The net result would be a savings of $23,500 annually.($28K - $4500 = $23,500).
              There would be some opportunity cost ($4500 taken out of my taxable brokerage account missing out on an "average" 7% market equity return) = $315.

              b) At the other end of the spectrum, if I contribute the minimum to my defined benefit / cash balance plan = $5000.
              I will save $1750 in taxes ($5K x 35% = $1750).
              I'll have $48,250 "extra" each year to invest. ($50K - $1750 = $48,250)
              I'd put this in my taxable brokerage account. Assuming an "average" 7% market equity return, I'd gain $3337.50 ($48,250 x 7% = $3337.50)
              The result would be a net benefit of $5087.50 ($1750 + $3337.50 = $5087.50) in this scenario.

              c) A third option would be somewhere in between, where I put in an amount where I can cover my annual expenses and cost of living, without having to draw funds out of my taxable brokerage account.

              I know these are just very rough "back of a napkin" types of estimates, but it seems like option A is financially much better than option B. And option C would be somewhere in between. I'm assuming my entire portfolio asset allocation across all of my investment accounts would be the same in all scenarios. I'm also assuming I'll retire in the next 10 years and hopefully "roll over" my defined benefit plan to an IRA upon departure from my partnership.

              I'm certain I'm missing something here. Can anyone weigh in on my projections and logic (or lack thereof)?

              I certainly want to make the right financial decision. Another set of eyes on this would make me feel so much better.

              Thank you everyone for your thoughts. Your knowledge is absolutely invaluable.

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