“Terminating a cash balance plan and starting a new one seems to be the theme of this year for us,” Jake Ruston said when asked about what’s new with his practice.
The vice president with Utah-based TrueNorth Retirement Services works almost exclusively with doctors and dentists; high-income earners that require more sophisticated strategies, with cash balance plans one arrow in the quiver. While an effective planning tool for the demographic, it’s not without challenges, something he’s quickly learning.
“Once it hits a point where they want to terminate, it’s a ton of work, and I’m underwhelmed with the process at most TPAs,” Rushton explained. “It’s very time-consuming and sometimes takes up to a year, which can be frustrating for the end participant.”
For that reason, he recommends advisors overcommunicate with plan sponsors and participants to set expectations moving forward.
A cash balance is a pooled account typically with a fixed rate of return (a variable rate is sometimes available but very low). More can be put away in addition to 401k contribution limits, making the tax advantages beneficial. The catch is the lower fixed rate of return for the defined period. After at least three years, the sponsor can terminate the plan and roll the accumulated amount into a 401k or IRA, granting more control to the individual over how it’s invested.
“When you add everything up in taxes—state, federal, all of it, they’re losing half of every dollar for every last dollar earned.”
“Going from maybe a conservative 4% return annual return but with tax benefits to now having more control and getting more market upside is appealing to people,” Rushton added.
There must be a good reason for terminating the plan, like a new partner hire of one that retires, yet they can then start a new cash balance plan to again take advantage of the tax benefits for another defined period of time.
“When you add everything up in taxes—state, federal, all of it, they’re losing half of every dollar for every last dollar earned. When we do a cash balance and put a couple of hundred thousand away, it’s a minimal impact to their take-home pay, which is good, but they lose investment control. That bothers them because they see the market doing 20%, and they’re getting 4%.”
PBGC pain
The cash balance plan is technically a defined benefit plan and falls under the auspices of the Pension Benefit Guarantee Corporation (PBGC), yet another frustration because “It’s super slow and takes a lot of time. You must give 60 days notice. And then there’s just a lot of actuarial work that any advisor jumping into cash balance plans might not expect to have to walk through. It could take time to get the money out, and they have to educate the client to be ready for that.”
It makes one wonder if, as an advisor, it’s worth the headaches. Rushton doesn’t hesitate to note the fees charged from higher AUM/AUA and its differentiating factor, especially for doctors, dentists, lawyers, architects, and other professionals.
“We get paid on the higher dollar amounts put away on the 401k/cash balance combination rather than just the 401k. But the amount of time and effort to transition is substantial. To tell that to an aggressive, market-loving doctor, that they’re going to sit in cash with a million dollars for a year, it’s not going to make them happy, even though they saved 40% or 50% on taxes going in.”
The mainstream 401k space still focuses on auto-enrollment, auto-escalation, and getting people to save more in the 401k, but cash balance plans will take on added importance as taxes continue to rise.
“It’s going to be a hot topic for many years to come,” Rushton concluded. “So that’s where I’m going.”