When it comes to retirement planning, dentists face unique challenges due to the nature of their profession. While they may have high incomes, they often have a shorter earning period compared to other professionals. In addition, dentists are usually self-employed or own small practices, which means they are responsible for creating their own retirement plans. One option that dentists should consider is a defined benefit or cash balance plan. In this article, we will explore the benefits of these plans and how they work, as well as the factors to consider before choosing a retirement plan.
Explanation of Defined Benefit Plans and Cash Balance Plans
Defined benefit plans and cash balance plans are both types of employer-sponsored retirement plans that guarantee a certain level of retirement income for employees. A defined benefit plan is a traditional pension plan, where the employer promises a specific retirement benefit based on the employee’s salary and years of service. In contrast, a cash balance plan is a hybrid between a defined benefit plan and a defined contribution plan, where the employer sets aside a certain amount of money each year for the employee’s retirement, and the employee receives a guaranteed benefit based on that amount.
The purpose of this article is to inform dentists about the benefits of defined benefit and cash balance plans and encourage them to consider these plans for their retirement. By taking advantage of these plans, dentists can benefit from higher contribution limits, tax savings, guaranteed retirement income, and plans that are favorable to solo practitioners or small business owners.
The Benefits of Defined Benefit Plans and Cash Balance Plans for Dentists
Higher Contribution Limits
One of the biggest advantages of defined benefit plans and cash balance plans for dentists is the higher contribution limits compared to other retirement plans. In 2021, the contribution limit for a defined benefit plan is $230,000, while the limit for a cash balance plan is $290,000. These higher limits allow dentists to contribute more towards their retirement savings, which can be especially beneficial if they have a shorter earning period.
Tax Savings
Defined benefit plans and cash balance plans also offer tax savings for dentists. Contributions to these plans are tax-deductible, which means dentists can reduce their taxable income and save money on their taxes. In addition, these plans offer tax-deferred growth, which means the earnings on the investments in the plan are not taxed until the money is withdrawn during retirement.
Guaranteed Retirement Income
Another benefit of defined benefit plans and cash balance plans is the guaranteed retirement income they provide. With these plans, dentists can be certain they will receive a certain level of income during retirement, which can provide peace of mind and financial security. In addition, the income from these plans is not affected by market fluctuations, which can help protect dentists from the risks of market volatility.
Favorable to Solo Practitioners or Small Business Owners
Defined benefit plans and cash balance plans are also favorable to solo practitioners or small business owners. These plans allow dentists to contribute more towards their retirement savings compared to other retirement plans, and they can be customized to meet the specific needs of the business. In addition, these plans can be used to maximize retirement savings for a business owner and their spouse, which can be especially beneficial for dentists who are married to a non-working spouse.
How Defined Benefit and Cash Balance Plans Work
Defined Benefit Plans
Defined benefit plans are designed to provide a specific retirement benefit for employees based on their salary and years of service. The employer is responsible for funding the plan and managing the investments, and the employee receives a guaranteed benefit at retirement. The benefit is usually calculated as a percentage of the employee’s salary multiplied by their years of service.
Cash Balance Plans
Cash balance plans are a type of defined benefit plan that operates like a hybrid between a defined benefit and a defined contribution plan. In a cash balance plan, the employer sets aside a certain amount of money each year for the employee’s retirement. This amount is typically a percentage of the employee’s salary, and it grows with interest. At retirement, the employee receives a guaranteed benefit based on the balance in their account.
Key Differences between Defined Benefit Plan and Cash Balance Plans
The main difference between defined benefit plan and cash balance plans is how the benefits are calculated. In a defined benefit plan, the benefit is calculated based on the employee’s salary and years of service, while in a cash balance plan, the benefit is based on the balance in the employee’s account. In addition, cash balance plans offer more flexibility and portability compared to defined benefit plans, as employees can take their account balance with them if they leave their job.
Factors to Consider before Choosing a Retirement Plan
Before choosing a retirement plan, dentists should consider several factors, including their age, income, risk tolerance, and other retirement accounts they may have. For example, younger dentists may benefit more from a defined contribution plan like a 401(k) or a SEP IRA, while older dentists may prefer a defined benefit or cash balance plan that provides a guaranteed retirement income. In addition, dentists should consider their risk tolerance and their other retirement accounts when choosing a plan, as some plans may offer more flexibility and investment options than others.
How to Set Up a Defined Benefit Plan and Cash Balance Plan
Setting up a defined benefit plan or cash balance plan can be a complex process that requires the expertise of an actuary and a plan administrator. Here are the steps involved in setting up these types of plans:
Choosing an Actuary
An actuary is a professional who specializes in calculating and managing the financial risks associated with retirement plans. Dentists should choose an actuary who is experienced in designing and managing defined benefit and cash balance plans.
Selecting a Plan Administrator
The plan administrator is responsible for managing the day-to-day operations of the plan, including contributions, distributions, and investments. Dentists should choose a plan administrator who is knowledgeable and experienced in managing defined benefit and cash balance plans.
Completing the Required Paperwork
Setting up a defined benefit plan or cash balance plan requires the completion of several forms and documents, including a plan document, a trust agreement, and an annual IRS Form 5500. Dentists should work with their actuary and plan administrator to ensure that all required paperwork is completed accurately and on time.
Conclusion
In conclusion, dentists should consider defined benefit plans and cash balance plans as a retirement planning option. These plans offer higher contribution limits, tax savings, guaranteed retirement income, and are favorable to solo practitioners or small business owners. Dentists should consider their age, income, risk tolerance, and other retirement accounts when choosing a plan, and should work with an actuary and plan administrator to set up the plan. By taking advantage of these plans, dentists can secure their financial future and enjoy a comfortable retirement.
