Challenge
A healthcare organization faced challenges in providing adequate retirement benefits for its physician owners with high annual income. The organization sponsors a 401(k) plan; however, federal law limits how much individuals and their employers can contribute to their 401(k). Physicians often begin their careers later in life due to medical school, residency and sometimes fellowship programs. In addition, they frequently retire earlier than the average worker. These factors reduce the amount of time to save and accumulate wealth for retirement. Coupled with limited contributions to the 401(k) plan, which are capped at $70,000 for 2025 (or a higher amount if over age 50), the 401(k) plan was falling short in providing a sufficient retirement savings opportunity for physicians. They explored the possibility of implementing a cash balance plan to enhance benefits and offer tax advantages to just the physician owners.
Approach
The current retirement program offered 401(k) employee deferrals and an employer-provided safe harbor nonelective contribution of 3% of compensation to all employees, along with a discretionary profit-sharing component. Implementing a cash balance plan on top of their current retirement program would allow much higher tax-deferred savings to owners/doctors. Additional profit sharing contributions to “non-highly compensated” staff would be required to enable the cash balance plan to pass required “nondiscrimination testing.” Federal law requires that contributions to tax-advantaged retirement plans not discriminate in favor of highly compensated employees, which is known as nondiscrimination testing. However, there are enough owners/doctors in this organization to set up a cash balance plan without adding additional staff to the plan, which avoided complexity of wealth transfer between cash balance members.
Outcome
Three plan designs were explored, each offering different levels of benefits while keeping the organization’s goals in mind:
- Current Defined Contribution + Cash Balance: With no changes to the current 401(k) design, this scenario provided a tiered-based annual cash balance contribution ranging from $35,000 to $50,000 per owner. This design increased owner benefits by $3,600,000 with an additional staff cost of $700,000. However, it left money on the table by not maximizing 401(k) limits first. All else equal, owners preferred to have full discretion over their investment allocation, which they have via the 401(k).
- Max Defined Contribution (Physicians) + Cash Balance: This option provided maximum owner benefits in the 401(k) plan ($70,000 annual contributions in total between physician deferrals and profit sharing) and a tiered-based annual cash balance contribution ranging from $15,000 to $40,000 per owner. This design increased owner benefits by $4,100,000 with an additional staff cost of $700,000.
- Max Defined Contributions (Physicians) + Max Cash Balance: This option provided maximum owner benefits in the 401(k) plan ($70,000 annual contributions in total between physician deferrals and profit sharing) and a tiered-based annual cash balance contribution ranging from $15,000 to $160,000 per owner. This design increased owner benefits by $6,300,000 with an additional staff cost of $1,600,000.
Additional spending on staff 401(k) benefits and adding cash balance savings helped with the attraction and retention of key staff and was tax deductible to the employer. From the owners’ perspective, this additional spend was well worth the overall benefits.
Figure 1: Three cash balance plan designs by source
| Source | Current | Current + CB |
Max DC (Phys) + CB |
Max DC (Phys) + Max CB |
|---|---|---|---|---|
| Employee Deferrals | $5,200,000 | $5,200,000 | $5,200,000 | $5,200,000 |
| Owner / Physician Profit Sharing | 1,900,000 | 1,900,000 | 3,400,000 | 3,400,000 |
| Staff Profit Sharing | 200,000 | 200,000 | 200,000 | 200,000 |
| Safe Harbor Nonelective | 2,300,000 | 2,300,000 | 2,300,000 | 2,300,000 |
| Subtotal | 9,600,000 | 9,600,000 | 11,100,000 | 11,100,000 |
| Cash Balance Contribution | 3,600,000 | 2,600,000 | 4,800,000 | |
| Additional nonelective (NHCE staff) | 700,000 | 700,000 | 1,600,000 | |
| Subtotal | 4,300,000 | 3,300,000 | 6,400,000 | |
| Increase in Owner/Physician Benefits | 3,600,000 | 4,100,000 | 6,300,000 | |
| FICA savings (3.8% of Owner/Physician Benefit Increase) |
(140,000) | (160,000) | (240,000) | |
| Grand Total Including FICA Savings | 13,800,000 | 14,200,000 | 17,300,000 |
Adding a cash balance plan to their retirement program significantly enhanced the tax-deferred savings opportunity for physician owners, as well as provided permanent Federal Insurance Contributions Act (FICA) savings for owners who receive a W-2. Some states, offer the opportunity for permanent state tax elimination when a cash balance plan is established. Overall, tailoring benefits to meet the individualized needs of key employees provided a greater savings opportunity while ensuring compliance with nondiscrimination regulations.