Cash Balance vs. Defined Benefit

[Zaphod]

Anyone have recent experience setting up a CB plan or DB plan? Im looking into it and it seems that in order to preserve my 53k DC I'd need to roll over to a 401K with profit sharing and then combine a CB/DB on top of that. It just seems only smaller firms do CB plans, and info is light or not super useful(especially on prices), whereas you can set up a DB plan with Schwab for very reasonable costs.

It seems a CB is more "hybrid" and offers a possible better return, but does it really make a difference? Interested in your experiences and who you use. Thanks.

[nyu04]

Zaphod, I am not an expert but I will be happy to tell you my experiences since I went through this a while back.

You may also want to read the comments on this WCI article as well - very helpful!  https://www.whitecoatinvestor.com/cash-balance-plans-another-retirement-plan-for-professionals/

Konstantin Litovsky on this forum is a professional on this type of set up but I'll just share my own experiences below:
I started with a 401k plan with profit sharing for max of 53k (I think) a year.  After running out of tax advantaged spaces, I looked all over/did a ton of due diligence before deciding on Verisight as the TPA of my cash balance plan.  Their prices were fairer than most (if you really want the fees, message me and I'll look it up for you - I think we pay about 3-5k a year for a total group of 10 but that's just a guess) and their lead actuary actually reviewed my current 401k plan (by Employee Fiduciary) before coming up with the scenarios.  Some of the "actuaries" from other firms started throwing our random scenarios without even reviewing the conditions of my current 401k and it was pretty obvious they just wanted me onboard for financial gain.

The KEY is demographics of your practice/staff.  It has to be favorable for this set up to work well for the doctor/owner.  I believe it works well when most of your staff is younger than the doctors/HCE members but only an actuary can tell you this. Our numbers were favorable (I get 96% of total contribution to the plan) so we went ahead and set the CB plan on top of the 401k.  So now Employee Fiduciary is the TPA for the 401k while Verisight is the TPA for our CB plan.  Verisight does the annual testing and comes up w the PS/CB contribution numbers.  My CB plan is set up at Vanguard and I get to pick how to invest it.  It is guaranteed to grow at 5% so if it grew less than 5% (like in 2015), I ended up contributing slightly more to bring it up to mark (which is fine with me since it's tax sheltered and mostly my money anyway).

Kon will recommend having a fiduciary advisor help you due to certain liabilities so that's something I may do in the future.

There are some definitely pros/cons to this type of 401k/CB set up but if you have the cash flow and the numbers are in your favor, you should definitely consider doing it.  It opens up additional tax sheltered space and helps you speed up retirement savings.

 

 

 

[Zaphod]

Thanks for the input. Yeah, Im interested in any place that isnt known for cranking out "unforeseen" issues  and prices. Im a sole proprietor so only me to worry about. I would love to increase my tax advantaged space. I know they always say you should be slightly older (i'll be 38 this year) but all the calculators say I can do 60k+ extra, which sounds nice to me. I would never intend to keep it for the duration, I would choose the youngest allowed retirement age, and after several years roll it over.

Its just annoying because the rules are goofy with aggregate vs. non aggregate dc plans which while it looks like you should be able to keep a SEP but most put you into a 401k c PSP (to avoid the 31% issues), I wouldnt mind a 401k, but they are definitely more expensive and sometimes less choice. I like the over contribution idea. I am looking to put the most in possible and roll it over basically.

[litovskyassetmanagement]

Zaphod wrote:

Anyone have recent experience setting up a CB plan or DB plan? Im looking into it and it seems that in order to preserve my 53k DC I’d need to roll over to a 401K with profit sharing and then combine a CB/DB on top of that. It just seems only smaller firms do CB plans, and info is light or not super useful(especially on prices), whereas you can set up a DB plan with Schwab for very reasonable costs.

It seems a CB is more “hybrid” and offers a possible better return, but does it really make a difference? Interested in your experiences and who you use. Thanks.

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As Rex said, there is much about these plans that has to be 'planned' and done so correctly.  The problem I have with the financial industry is that they don't mind selling you a plan without having any fiduciary responsibility whatsoever.  Fees are not even the worst thing that they can do.  I'm currently working with a client who wanted a CB plan as far back as last year, and we didn't let him have it because his cash flow was uneven, and we were happy we didn't - he could barely max out his practice 401k plan, even though on paper it looked like he could pull it off.  I'm currently writing a big article for WCI on DB/CB plans but I can't stress this enough: these are complex plans, and you shouldn't do a plan just because some TPA says you can do it.  For one thing, you need to have a very close coordination between your adviser, TPA and your CPA because there are many moving parts that have to be taken care of.  While 'solo' plans might seem simpler, they are not - the same questions arise (what if I'm not making as much money, when can I terminate the plan, how much can I contribute, how long will this plan last, how should investments be managed, etc).

So in short, I recommend the following working with a fiduciary adviser (compensated by fixed/flat fee rather than an asset-based fee) who can help you

a) Determine whether you can afford a DB/CB plan in the first place (and if so, the type of plan that would work best - in some cases having a solo 401k with a spouse on the payroll may be enough).  If you have employees, that's another ballgame, and here it is really important to do a design study before going forward.

b) Help you select the best TPAs and custodians for the combo/paired plan (the TPA is key here - they should absolutely be responsive and have top notch design experience in these types of plans) and there should be ZERO in asset based fees!  This can be done - there is no reason to pay any asset based fees for your retirement plan providers and services.

c) Help you manage investments in both 401k and DB/CB plan.  This is not as easy is it might seem.  And when you have employees, it is key to manage your investments prudently in both plans.

While Schwab has a 'solution', they seem to forget to do simple things like file form 5500 for their solo 401k clients (at least they did for a client of mine), and I don't know if they will design paired plans for you (or how good their designs are).  At the end of the day, they are just a record-keeper and they will sell you a plan if you want one.  Don't expect them to help you with absolutely anything else (or take any type of proactive responsibility for your plan or make any changes if your financial situation changes).  You'd have to know everything there is to know about your plan and be your own adviser, as well as direct Schwab to do what's necessary, unless you hire a competent TPA (and adviser) to do this for you (which will cost more than what Schwab is charging). You get what you pay for, and for the fees they charge, that's not very much at all.

[litovskyassetmanagement]

Also, another key point to consider is that solo 401k plans at major brokerages have a 'off the shelf' plan document that will most likely not work well with a DB plan, so you'll need to amend it, and at that point you might as well get a custom plan document and open two separate 'trust' accounts, one for the 401k and one for the DB plan and let the TPA handle the administration. Schwab has decent ETFs, but I don't use these for DB plans, and their fixed income index funds are lacking, so I prefer to use Vanguard as the custodian.

Whether one uses an adviser or not for the plan depends on one's level of comfort with managing investments.  You absolutely do not want any volatility inside a DB plan because that will not work well with your ability to defer taxes so the portfolio has to be designed to avoid over- or under-funding (in one case you can't contribute as much as you wanted, and in another case you need to contribute a more than you planned). There are other considerations involved beyond managing investments. Because solo 401k and solo DB plans are not ERISA, they fall under 'personal' advisory services, which would include comprehensive financial and tax planning, investment management for all of the accounts, debt repayment, insurance and estate planning, etc., so you don't have to hire an adviser just to manage the solo plans by themselves (which would not be the best idea without looking at your overall financial situation anyway).  Advice provided to paired plans should be part of a comprehensive advice including the feasibility of adopting a DB plan, selecting the best TPA, custodian, when to terminate the plan, selecting the best plan design, hiring a spouse by the practice, and managing this plan as part of a comprehensive investment strategy that takes into consideration all of your other accounts and investments.

[litovskyassetmanagement]

Rex wrote:

The volatility isn’t a big dea for those of us with solo or small number of employees and willing to take on some risk especially if younger. I keep mine very heavy on the stocks. Now if I were someone closer to retirement (which is more of an ideal candidate mostly bc fewer years of paying for the plan), I’d allocate differently.

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Well, therein lies a problem.  If your return is significantly higher than the crediting rate, your plan would close much sooner, therefore, you will lose the benefit of the tax deduction for the assets that won't make it into the plan because it is overfunded.  If the stock market crashes for a prolonged period of time, the opposite problem arises: the plan becomes significantly under-funded, thus you would have to contribute significantly more than you planned. With too much volatility, you will potentially have periods of both of these happening in sequence.  To get the best benefit out of a DB plan, both of these scenarios are to be avoided.  The 401k is where one can invest more heavily in stocks - DB plans should not be invested in stocks at all precisely because of the above considerations (it gets more complex when you know a plan might last for 20+ years, and some stock exposure might be warranted).  A good TPA/actuary should have told you about that prior to starting a plan. The actuary I work with (who's one of the foremost experts in the field) told me exactly the same thing.

[Zaphod]

If youre younger (near 40), and there is any inflation in the next several years, it seems you would have a hard time (and not really a bad problem anyway) over funding it as the maximum payout should grow. I'd close it and roll it over if one were to be so lucky. Since a younger person cant put away several hundred thousand per year, over funding seems kinda moonshot of a problem, and an amazing one at that.

Seems overkill to have all that oversight. I dont use a cpa anymore, and dont really want anyones opinion (professional or otherwise) on the rest of my affairs, and certainly wouldnt pay for it. All the other junk is a huge turn off, I just want to stash away some more tax deferred dollars for a few years and roll it over, and maybe do it again.

[litovskyassetmanagement]

Rex wrote:

That’s not true

I will be super happy if I have lower deductible contributions in future

Just means I paid less for the same benefit

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But you can't have one without the other (kicking in more money when you have underperformance, as when the market crashes 50%).  Volatility is not a good thing inside DB plans, period.  Like I said, you might want to discuss this with an actuary.  These are not DIY plans, that's for sure.

[litovskyassetmanagement]

Zaphod wrote:

If youre younger (near 40), and there is any inflation in the next several years, it seems you would have a hard time (and not really a bad problem anyway) over funding it as the maximum payout should grow. I’d close it and roll it over if one were to be so lucky. Since a younger person cant put away several hundred thousand per year, over funding seems kinda moonshot of a problem, and an amazing one at that.

Seems overkill to have all that oversight. I dont use a cpa anymore, and dont really want anyones opinion (professional or otherwise) on the rest of my affairs, and certainly wouldnt pay for it. All the other junk is a huge turn off, I just want to stash away some more tax deferred dollars for a few years and roll it over, and maybe do it again.

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There is a limit to DIY approach, and when you get into complex retirement plans, that's about where it ends, because if you don't know what you are doing, it might end up costing you big if you make mistakes that bring the IRS into the game.  These plans should be done cleanly without drawing too much attention to yourself.  Your TPA is not going to be in a fiduciary capacity, so if they screw up (and don't tell you when you do the same), then you are still responsible, and not them.

[Zaphod]

I dont think anyone here is saying they are looking to set up their own firm to specifically try to DIY a db style plan, or for that matter put every penny into the biotech index or the high beta etf (sphb). All I was saying is this is the only area id be looking to utilize someone for, and why if that is the case would I have to listen to them about my loans, mortgage or other general finanacial interests. I'd rather pay a fee to not have that, it doesnt bring me any value as I am already doing excactly what I plan and am comfortable with in that regard, and its obviously a part of my overall plan.

I dont get how one could get to this point of considering a db plan and not already have that kind of thing straightened out, wheres the extra cash flow coming from? All of these topics are things I have been aware of for over a year and it would be strange to get oneself into such a plan with zero due diligence or asking your tpa etc...to run a couple of scenarios to see what combination of contributions and volatility offers you the most flexible scenarios given income variability than youre just exceedingly naive, which I dont think anyone here does. Dont you also have up to like seven years to pay back a shortfall? That also assumes it happened your first year or you have zero in the reserve, etc...

Are these plans complex? Yes, much more so than standard dc plan of course. However, they are not overly or prohibitively complex and to make them seem so nuanced as to be non understandable with persistent due diligence does not do yourself any favors. It comes off as a hard scare tactic.

[litovskyassetmanagement]

Rex wrote:

Again not a big deal for people with few employees with the income we are talking about and if it were then any DB plan is a mistake period.

Yes you just kick in more. No big deal and better than in your 401k where you can’t “make it up”. If you have lots of people then making up for shortages is harder bc more money.

If it was such a big deal one would avoid stocks in their 401k as well just for concerns of not having enough in retirement.

It’s not even like you have to make it all up in 1 year. They give you a range every year what u can do.

You need a new expert friend.

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I'm glad that you are an expert on DB plans and know exactly what to do, because I wouldn't start a plan without having a top notch actuary on my team.  My replies are for those who would read these threads and think that it is a piece of cake (and then proceed to mess things up, which might result in their plans being disqualified).  But before anyone starts a plan they should really ask their actuary about what the implications are of underfunding and overfunding of their plan, among other things.

[litovskyassetmanagement]

Zaphod wrote:

I dont think anyone here is saying they are looking to set up their own firm to specifically try to DIY a db style plan, or for that matter put every penny into the biotech index or the high beta etf (sphb). All I was saying is this is the only area id be looking to utilize someone for, and why if that is the case would I have to listen to them about my loans, mortgage or other general finanacial interests. I’d rather pay a fee to not have that, it doesnt bring me any value as I am already doing excactly what I plan and am comfortable with in that regard, and its obviously a part of my overall plan.

I dont get how one could get to this point of considering a db plan and not already have that kind of thing straightened out, wheres the extra cash flow coming from? All of these topics are things I have been aware of for over a year and it would be strange to get oneself into such a plan with zero due diligence or asking your tpa etc…to run a couple of scenarios to see what combination of contributions and volatility offers you the most flexible scenarios given income variability than youre just exceedingly naive, which I dont think anyone here does. Dont you also have up to like seven years to pay back a shortfall? That also assumes it happened your first year or you have zero in the reserve, etc…

Are these plans complex? Yes, much more so than standard dc plan of course. However, they are not overly or prohibitively complex and to make them seem so nuanced as to be non understandable with persistent due diligence does not do yourself any favors. It comes off as a hard scare tactic.

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You are probably in a tiny minority of those who have everything straightened out, so again, I'm posting for the benefit of those who are nowhere near as good as you are in taking care of their finances.  That's more of a rule than an exception.  If you are a high earning doc working crazy hours with a spouse who might also be a doc (I see this very often), then you have the earnings but not the time.  So in most cases it is really trading one for the other - getting good advice is always worth it if you have no time to do it yourself.

Of course, if everything is under full control, then there is no need to fix anything. But seriously, I'm yet to find someone who has full control over their finances, and many of those that ask for a DB plan have plenty of things that have to be cleaned up (starting from high expense 'managed' accounts, nothing really set up as far as an overall investment strategy, etc).

You can find advisers to do just about anything, from just doing your investments, just the planning, a combination of the two, or anything in between.  My point is that when someone comes to me with a DB plan request, I absolutely have to evaluate their overall financial situation to make sure that this plan is right for them.  Do you know how many times I've had practice owners come to me requesting a 401k plan, only to be told that a) they should instead have a SIMPLE for a while and b) they should not have ANY retirement plan until they pay down debt, max out other accounts such as Roth and HSA and have the ability to contribute more before they even consider a SIMPLE or a 401k?  DB plans are even worse because you have to commit to making contributions, so I'm even more careful with recommending them.

Are DB plans complex?  You bet.  Prohibitively complex?  No, and I bet some docs might be just fine doing this themselves (if they have a decent TPA who explains the details to them).  That won't be most of them though.  As I mentioned before, I don't sell DB plans, so I'm simply going to turn down someone who wants a plan and should not have one, but if you go to any TPA and ask for a plan, they'll gladly sell you one.

 

[Zaphod]

I dont doubt those points, and evaluating is of course prudent. I also bet if you have a full practice and employees it can be extremely complex. The committed nature is certainly more concerning than otherwise, mostly as if there is some sort of economic calamity and you cant quickly reallocate to whatever asset has been demolished, aka housing in the last one. That does concern me.

[Zaphod]

Rex wrote:

Top notch actuary…,just a competent one. That’s all one needs. Scare tactics aren’t helpful.

You are the one claiming that it’s absolutely necessary to have little volatility and thus claiming to be an expert or friend of an expert and that the TPA I use isn’t good.

Using very rough fingertip estimates….

A typical contribution for a DB plan for a young person with retirement set at 62 is around 50k per year. Maximum you could deduct might be around 200k that same year. If you put in 200k and you also had domesday 50% stock drop then in the following year you still have a 100k balance and guess what your required contribution will be less than 50k even if you had to make it all up next year. If you are appropriate candidate for a DB plan and can put 200k in then if you have few employees it’s not a big deal to be heavy stocks. If you are close to retirement then it’s definitely more risky to be heavy in stocks just like any other investment plan.

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Whats young?

[litovskyassetmanagement]

Rex wrote:

Top notch actuary…,just a competent one. That’s all one needs. Scare tactics aren’t helpful.

You are the one claiming that it’s absolutely necessary to have little volatility and thus claiming to be an expert or friend of an expert and that the TPA I use isn’t good.

Using very rough fingertip estimates….

A typical contribution for a DB plan for a young person with retirement set at 62 is around 50k per year. Maximum you could deduct might be around 200k that same year. If you put in 200k and you also had domesday 50% stock drop then in the following year you still have a 100k balance and guess what your required contribution will be less than 50k even if you had to make it all up next year. If you are appropriate candidate for a DB plan and can put 200k in then if you have few employees it’s not a big deal to be heavy stocks. If you are close to retirement then it’s definitely more risky to be heavy in stocks just like any other investment plan.

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We'll agree to disagree on this one - you are free to do whatever works for you.  Risk management isn't scare tactics.  If/when one lands in a huge 10+ year recession, then very bad things will happen to one's plan if it is invested heavily in stocks, and it doesn't require an actuary to see why.