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Any reason NOT to use an individual Cash Balance Plan in my situation

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  • Any reason NOT to use an individual Cash Balance Plan in my situation

    Background: 35 yo specialist currently investing ~300k/year. I am entirely a 1099 independent contractor who just switched to an S-corp as income has continued to rise since graduating from residency (600k+ income each year and growing). Already paid off student loans. Mortgage is only liability. I have been maxing out all available tax protected space (BDRx2, HSA, i401k, 529, etc...) with extra investments in taxable. An individual Cash Balance Plan has been on my radar for years, but given my younger age and other needs for my money I haven't pursued further in the past. Now I'm looking at the accounts and it seemed to make a lot of sense in my situation. Although no one can predict the future, I don't anticipate changing jobs ever so my personal and professional life seem stable (been at current job since residency graduation).

    I had an introductory interview with one of the WCI retirement account advertisers and it further seemed to make a lot of sense. The ability to put an extra six figures (probably 150-200k) into a tax protected account, can keep at my brokerage of choice (Vanguard), can pick my own investments (3 fund portfolio...I'd put my entire bond allocation in there as I've read CBP should be conservative) all seem appealing. A little over 1k to setup the plan with annual cost ~2k but the tax deferrals make it seem like a no brainer as I'm at the highest tax bracket...although I'm well aware that the company is of course trying to sell me their product. However, they were honest about the ~3.1million lifetime max and that I can't contribute as much compared to if I were older so they anticipated it would take 10-12 years to hit that max if I contribute the max their actuaries allowed each year. This seems even more appealing as the FIRE crowd does appeal to me (or at the least the FI part) so I'm not even sure I'll be working in my 50s or 60s.

    Is there anything I'm missing here and any reason I should NOT do it?



  • #2
    Are you sure the interview and illustration reflected your age and the compensation limit for actuarial calculations? The amounts you are reporting seem inflated for a 35 year old individual.

    Cash balance plan contributions are actuarial based for a maximum defined benefit (2022 = $245K) at retirement (usually age 62). The younger you are, the lower the maximum contribution* and lower still for level contributions.

    *The maximum contribution is only for the first year and will most likely results in lower contributions in subsequent years.

    Not too mention, when paired with a one-participant 401k, employer contributions are usually limited to 6% up to the compensation limit (2022 = $305K) = $18,300. Maximum 401k contributions would be $20,500 + $18,300 = $38,800, $22,200 less than $61k.

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    • #3
      For some reason I didn’t think you’d be able to put so much away at 35. What crediting rate are they using?

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      • #4
        Originally posted by JK View Post
        Background: 35 yo specialist currently investing ~300k/year. I am entirely a 1099 independent contractor who just switched to an S-corp as income has continued to rise since graduating from residency (600k+ income each year and growing). Already paid off student loans. Mortgage is only liability. I have been maxing out all available tax protected space (BDRx2, HSA, i401k, 529, etc...) with extra investments in taxable. An individual Cash Balance Plan has been on my radar for years, but given my younger age and other needs for my money I haven't pursued further in the past. Now I'm looking at the accounts and it seemed to make a lot of sense in my situation. Although no one can predict the future, I don't anticipate changing jobs ever so my personal and professional life seem stable (been at current job since residency graduation).

        I had an introductory interview with one of the WCI retirement account advertisers and it further seemed to make a lot of sense. The ability to put an extra six figures (probably 150-200k) into a tax protected account, can keep at my brokerage of choice (Vanguard), can pick my own investments (3 fund portfolio...I'd put my entire bond allocation in there as I've read CBP should be conservative) all seem appealing. A little over 1k to setup the plan with annual cost ~2k but the tax deferrals make it seem like a no brainer as I'm at the highest tax bracket...although I'm well aware that the company is of course trying to sell me their product. However, they were honest about the ~3.1million lifetime max and that I can't contribute as much compared to if I were older so they anticipated it would take 10-12 years to hit that max if I contribute the max their actuaries allowed each year. This seems even more appealing as the FIRE crowd does appeal to me (or at the least the FI part) so I'm not even sure I'll be working in my 50s or 60s.

        Is there anything I'm missing here and any reason I should NOT do it?

        Some considerations:
        1) Your CB contribution will be around $80k adjusted for inflation. This will reduce your 401k salary deferral + PS (6%) to about $38,800, down from $61k, but for the rest ($22,200) you can do MBR 401k (contribute after-tax and convert to Roth). They should have talked to you about that as this is not a small amount. This will require advice from the actuary, you can not just simply do this yourself without understanding the exact process for doing it, types of accounts you need to open, etc, and any actuarial firm you hire should be able to advise you so that you don't end up making mistakes.
        2) Your total maximum will be around $1.35M (adjusted for inflation). This will be reached in exactly 10 years (not 12).
        3) $3.1M (that's an old limit, it is now at about $3.4M) can only be reached if you either do this from age 58 to 68, or if you keep this plan open until age 68.
        4) You will need to have a 401k plan with a custom plan document to allow for MBR 401k option as well (so you can't use a solo 401k plan at Vanguard for example, it would have to be a fully customized 401k if you want a CB plan and MBR 401k option).
        5) You will want to run this plan for at least 5 years (but ideally the full 10). There are advantages for maxing out a CB plan now vs. later in your situation, but this will definitely depend on what you are going to do in the next 10-20 years. For example, if you join another practice as a partner, you might be able to open another CB plan and max it out as well without regard for your prior plan (this can get tricky with continuity issues, as not all circumstances will allow this, but it is possible).
        6) I would not recommend Vanguard any longer. Their support/help is terrible. These days they have a call center in the Philippines (which is less than helpful), so I would consider doing this elsewhere (esp. that you need multiple accounts and potentially need to speak with support).

        They should have explained all of this to you in detail. If not, it might be better to use a specialist actuarial firm that only runs combo plans. They should be able to walk you through the MBR 401k steps and types of accounts you need to open, and you should be able to talk with the actuary directly, not through an intermediary. In your case it might be a good idea to set up a Combo 401k/CB plan as long as you understand the pros and cons and have good actuarial support to run this plan.
        Kon Litovsky, Principal, Litovsky Asset Management | [email protected] | 401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

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        • #5
          Kon, how do you account for the likely lowering credit rate in the CB plan compared to what you might expect if you’re portfolio was originally 100% stock? Tax benefits are great but over the last few years, vtsax has done quite well…
          Last edited by Turf Doc; 06-16-2022, 10:56 AM.

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          • #6
            Originally posted by Turf Doc View Post
            Kon, how do you account for the likely lowering credit rate in the CB plan compared to what you might expect if you’re portfolio was originally 100% stock? Tax benefits are great but over the last few years, vtsax has done quite well…
            Great question, according to my analysis it would take anywhere between 10% and 11% return guaranteed for someone in the highest tax brackets to beat a 3% crediting rate for a CB plan. Let's not forget, your CB plan benefits are fixed/guaranteed, but your taxable account return is not and can go anywhere in 10 years (after which you simply reallocate any CB assets to stocks). So if you are 100% in stocks, I'd say that for 10 years you are still in a great position as your CB plan will work as intended by providing a tax shelter that allows you to build up your tax-deferred allocation. This is part of a long term tax diversification strategy. I've outlined some benefits of having large tax-deferred accounts here:

            https://www.whitecoatinvestor.com/me...sa-401k-plans/

            For high income younger docs your CB allocation won't be that large. For older docs you do want it to be large. The endgame is doing a massive Roth conversion in retirement, as well as having a sizeable taxable account to make it happen. By investing in a CB plan you are actually increasing your chances of having better tax diversification. If you are all in a taxable account, you will be stuck with any future higher taxes imposed on this type of account (and there are already plenty of taxes applied to it to worry about). So if your assets are split 50:50 between taxable and tax-deferred you will have more options (some of which are outlined in the article above). Roth conversions also have an effect of significantly minimizing your average tax rate in retirement, and this can go even lower than taxable account rate, thus the tax diversification discussion.
            Kon Litovsky, Principal, Litovsky Asset Management | [email protected] | 401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

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            • #7
              Yea, that's a heck of a contribution for a 35 year old. Doesn't mean you shouldn't still do it, but I bet it won't be as much as you think.
              Helping those who wear the white coat get a fair shake on Wall Street since 2011

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              • #8
                Originally posted by The White Coat Investor View Post
                Yea, that's a heck of a contribution for a 35 year old. Doesn't mean you shouldn't still do it, but I bet it won't be as much as you think.
                Usually I recommend waiting until they are older if someone is a 1099 for life. But the issue is that one never knows, in a few years they get an offer to join a practice, or get a W2 job, etc, so income stability is always an issue these days. So one part of this equation is pricing this type of risk. On one hand, if the risk exists, doing it now vs. later is appealing. On the other hand, if you can do it later, you'll save a lot more on taxes.
                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


                • #9
                  Thanks for all the input. I'm not sure how/why they gave me such high anticipated contributions...actually about 200k/year which admittedly did seem high to me from what I've read myself. Now from what I'm reading on this thread, this seems to only confirm some of my suspicions.

                  Kon - when you say "waiting until a later age", generally what age do you think it makes sense to really start considering it? Also, does your firm do CBP for individuals as you seem to have a better handle on this than the other firm I found on the WCI listed option?

                  Thanks.

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                  • #10
                    Originally posted by JK View Post
                    Thanks for all the input. I'm not sure how/why they gave me such high anticipated contributions...actually about 200k/year which admittedly did seem high to me from what I've read myself. Now from what I'm reading on this thread, this seems to only confirm some of my suspicions.

                    Kon - when you say "waiting until a later age", generally what age do you think it makes sense to really start considering it? Also, does your firm do CBP for individuals as you seem to have a better handle on this than the other firm I found on the WCI listed option?

                    Thanks.
                    One way to have contributions as high as that is when you are age 53 or so. There are some life insurance funded plans that might have contributions that may appear to be large, but other than that, it is not possible to do so unless you are overfunding the plan in 4-5 years. So for example, if your contribution is overfunded over the initial 4-5 years (and it might be $200k for all I know), then you simply max out the plan in 4-5 years, but keep it open for 10 (or longer) to use up all of the contributions. One issue is the uncertainty - can you use up the contribution in 10, or do you have to keep the plan open for longer? That's not a good thing to do as you are paying the actuaries for the extra years unnecessarily. Your plan should be done in 10 years, and that's all there is to it. Overfunding is not a recommended strategy precisely because of the income uncertainty, and this can result in potential issues (if you terminate the plan too soon, you might have to pay excise taxes, that is fork over some of that money to the government as penalty for overfunding).

                    I have no problem when a 35 year old sets up a CB plan as long as they are in good hands and know what to do (or at least the actuary knows what to do). As far as when is best to contribute, it is a tricky question due to our inability to price your specific risks. I wouldn't have an issue if you start it at 35 and be done in 10 years - after the 10 years you can simply invest that money and call it a decade. There is no need to wait another 10 when you may or may not have a chance to open this type of plan, but these considerations will be different for different docs, so this would be your individual decision.

                    I recently started to refer individuals to an actuary who is very well versed in all aspects of solo plans (including MBR 401k part mechanics) as I don't work with solo plans, only ERISA plans for group practices or owner and staff. Some of the solo plan complexity stems from using custodians where MBR 401k requires some legwork. I work entirely with record-keepers where this type of work is unnecessary but the cost is higher. Also, solo to ERISA plan transitions are important so I want to make sure that the actuary understands that this might be happening down the line. Sometimes what starts as a solo plan needs to be merged with several other plans if there is a group forming (which happens quite often), so this has to be handled properly as it is not trivial. Solo plans are tricky because of the MBR 401k aspect, and most actuaries are not well versed in MBR 401k mechanics (at least not at the level where they can advise you on how to do it properly). If you email me I can provide you with a referral - I still prefer to screen all potential CB plan candidates even though I don't gain anything from it because I don't want docs to end up with something they didn't want given how complex this plan is (and how these plans can be 'sold' without presenting the entire picture).
                    Kon Litovsky, Principal, Litovsky Asset Management | [email protected] | 401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

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