About Healthcare Employee Cash-Balance Plans

Posted on March 23, 2009 by Dr. David Edward Marcinko MBA MEd CMP™

What they Are – How they Work

By Staff Reportershuman-drones

Motivated by cost savings, an increasing number of hospitals, healthcare systems and large healthcare organizations are converting their traditional legacy defined benefit pension plans to cash balance plans. While the trend seems sudden, it is not surprising. Healthcare related companies are reaping substantial savings from cash balance plans. And for the most part, younger doctors and other employees are enthusiastic about the plans.

However, older employees (age 50 or above) realize  that in switching from a traditional defined benefit [legacy] plan to a cash balance plan, their retirement benefits decreased, initiating an onslaught of overwhelmingly negative publicity. Indeed, several years ago, Congress rushed to pass legislation requiring employers to provide benefits computations to affected employees.

Overview

Even though many defined-benefit plans are under/over-funded, they are calculated on an actuarial basis and are quite costly to maintain. And because plan costs can vary from one year to the next, budgeting is difficult.

However, if a healthcare company terminates a pension plan, replacing it with a defined contribution plan such as a profit sharing plan, all employees must be 100% vested, any surplus is subject to income tax, and a portion of the surplus is subject to an additional excise tax even if all of it is transferred to a succession plan. A cash balance plan is a pension plan, so the change is viewed as an amendment to the pension plan. This is true even though in many respects the cash balance plan operates like a defined contribution plan.

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A cash balance plan works in the following manner: The sum accrued in a hospital’s employee’s defined benefit plan is converted to a lump sum cash value; the employer agrees to make specified contributions to the employee’s account based on compensation; and the account earns a specified rate of interest, say 5%. The employee receives regular statements showing the current cash value of his or her account. [The amount is listed as a lump sum amount even though it is usually paid as an annuity].

If the hospital or other employer already has a defined benefit pension plan and converts it to a cash balance plan, there is no tax on the surplus. The reason, as noted above, is that a cash balance plan is treated as a pension plan. Thus, the employer merely amended its pension plan and can use the existing surplus to provide the required contributions, which are usually less than the actuarial costs of maintaining a traditional pension plan. And, in the former bull market this recent decade, many employers did not have to make contributions at all. Today, of course, the opposite may be true.

Example

Let’s say the average earnings on an investment is 15%, and the rate of interest payable to the plan is 5%. In recent years, many funds have earned 15% or more if they invested in an index fund. It was thought that, if continued, it would be quite some time before some employers are required to make any contributions out of their own funds. Not so today, however.

Clearly, the savings can be substantial, and the costs of maintaining the plan are easily budgeted for. These advantages convinced some public utilities, telephone companies, financial, hospitals and healthcare institutions to convert their plans to cash balance plans.  

Impact on Employees

The cash balance plan is actually a hybrid plan—a cross between a traditional defined benefit pension plan and a defined contribution plan. But one of the key differences between the cash balance plan and a defined benefit plan is the manner in which the benefits are calculated. In a traditional defined benefit plan, an employee’s retirement benefit grows slowly in the early years and more rapidly as he or she approaches retirement. By contrast, a cash balance plan increases growth in the early years and decreases growth in later years of employment.

Youngsters

Younger healthcare employees usually liked the change; before the recent financial meltdown. Their accounts were portable; they grew quickly; and could be rolled over into an IRA or into a new employer’s plan. And, their account balances were listed as lump sums, so they know precisely how much they’ve accumulated. Today unfortunately, they have mostly been decimated.

Oldsters

Older healthcare employees initially liked the concept because the values of their pensions (on an actuarial basis) were converted to dollar amounts so they could see how much had accrued in their accounts without having to calculate an anticipated pension award. But, after further review, it was evident that upon retirement the cash bonus plans would yield smaller pensions than the defined benefit plans. Opinions differ today?

Health Workers in the Middle

When a hospital or similar entity converts from a defined benefit plan to a cash balance plan, employees their late 40s may see their pensions reduced by 25% or more while older employees see reductions of up to 50%. If the formula for calculating benefits under the defined benefit plan is 2% times years of service, and high-five compensation, then each year of service increases an employee’s pension. More importantly each time high-five compensation increases, the amount is accrued back to the employee’s original date of employment. So, as a hospital employee gets older, the high five-has tremendous impact. An employee who is age 60 can actually accrue most of his or her pension in the last five years of employment.

www.HealthDictionarySeries.com

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No “Mo”

Cash balance plans don’t have that type of momentum [“Mo”]. The company contributes a certain amount based upon compensation and a specified interest rate. Usually, the interest rate is based on the 30-year treasury rate (approximately 2.5%).

Closing the Gap

Some employers are offering a grandfathered benefit designed to reverse the penalty for older workers. For example, employees within 10 years of retirement (usually age 65) will receive the greater of the cash balance plan or the pension under the original plan. This reduces the cost savings for the company.

Some employers increase the contribution percentage for employees based on age (i.e., 7% of compensation is contributed for employees aged 40—rather than the standard 5%—and 9% of compensation for those aged 50).

Assessment

Finally, some hospital employees are offered special “sweetners” in the form of additional lump sum credits when converting from an existing plan to a cash plan. The best benefit provides that all existing employees will receive the greater of the old plan or the new plan upon retirement. Only a small number of employers typically adopt this approach.

Conclusion

And so, your thoughts and comments on this Medical Executive-Post are appreciated. Nurses, hospital workers and hospitalists – please opine and subscribe to the ME-P here – it’s fast free and secure:

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Physician Retirement Threats and Opportunities

Posted on February 6, 2009 by Dr. David Edward Marcinko MBA MEd CMP™

Investing Vehicle Updates for Modernity

By Steven Podnos; MD, MBA, CFP®

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Most physicians count on their retirement plans for the bulk of their financial security. Yet, few of us understand the intricate workings of these plans, and are therefore misled or at the least miss out on a number of cost savings and benefits. Here are some examples to consider, especially during this time of financial upheaval:

1. Jim L, an endocrinologist in private practice, works with his wife as office manager and has four other employees.  Jim had a “free” prototype profit sharing plan with a well known brokerage and has been putting 15% of his total employee compensation away every year in order to fund about $35,000 dollars a year into his own plan.  He pays his wife $60,000 dollars a year in order to get a $9,000 dollar annual contribution for her, but at a social security cost of the same $9,000 dollars.  His plan is invested in a variety of “loaded” mutual funds and stocks at the brokerage, and he was not really sure how it was doing in terms of performance.

Change:

The plan was changed to a customized 401k/profit sharing plan using a Third Party Administrator at a cost of 2500 dollars.  Jim’s wife lowered her salary to $20,000 dollars, which saved over $5,000 dollars a year in social security taxes.  Yet Jim and his wife were now able to contribute over $65,000 dollars in pretax money (rather than $44,000 dollars in prior years.  His employee cost for the plan dropped from 15% of a $100,000dollar payroll to 6%, another annual savings of $9,000 dollars. 

2. Statewide Healthcare medical group had an insurance based “retirement” plan.  All of the investments allowed were wrapped in variable annuity/insurance wrappers with an annual expense ratio of between 2 and 4% annually. The plan was “free” to the group but did not allow any differentiation in benefits or contributions between the physicians and their employees

Change:

An unbundled 401k/profit sharing plan was designed that allowed physicians to contribute the maximum in salary deferral and profit sharing contributions. Using an age-weighted contribution formula, the physicians were able to put away 14% of their salary in the profit sharing plan as compared with a 5% contribution for employees.  The new investment portfolios carried an annual cost well below 1% annually and were actively monitored by a fee only fiduciary advisor, mostly relieving the group from the fiduciary responsibility for the fund investments.

3. Kirk L, an orthopedic surgeon employed his wife and 5 employees in a busy practice.  He is 55 years of age and looking towards retirement in ten years.  He had a reasonably well designed 401k/profit sharing plan advisor which let him and his wife put away about 70-75 thousand dollars a year with an employee cost of about 15 thousand dollars. He was beginning to worry about not having enough savings to make his retirement goal.

Change:

Kirk and two of his younger employees were switched to a new Defined Benefit plan, but also continued in the 401k salary deferral plan. Kirk’s wife and the remaining employees stayed in the old plan and his wife’s salary was reduced to lower Social Security costs.  With the new plan, Kirk and his wife are now putting away about $200,000 dollars in pretax contributions annually at a marginally higher cost for the employees.

Poorly Designed Retirement Plans

None of these stories are unusual, in fact they are typical.  Most physician retirement plans are poorly designed, expensive and misunderstood.  Few existing plans are updated to capture the many positive changes made in tax law over the last decade.  Many plans are shoddily designed to catch the “quick” dollar, with financially terrible consequences to the physicians.

Qualified Plans

And so, I’ll review the most common types of retirement plans available to medical practices and discuss the pros, cons and specific opportunities each type for most practices. Note that most of these plans are considered “qualified” plans by the US Government.  Being qualified means that contributions to the plans are allowed to be deducted as business expenses and that the plan assets are generally protected from creditors.  In exchange, the government requires extensive paperwork and mandatory contributions for employees on the lower end of the salary scale. 

1. SEP-IRA

The SEP-IRA allows a fixed percentage of salary (up to 25% of W2 income) to be contributed to individual IRAs of most employees (including the physicians). There can be no discrimination in what percentage of compensation is used between owner/managers and lower paid employees, making this a relatively expensive plan in terms of employee funding. There is no component of salary deferral by employees, and all plan funding is immediately “vested” (belongs to the employee immediately if they leave employment).

The advantages of the SEP plan include a minimum of paperwork and ease of setup. Generally, SEP-IRA plans are used by small family owned businesses with few to no outside employees. It does work well for physicians that act as Independent Contractors (no employees) such as many Emergency Room physicians.  However, an individual contractor with an income of less than around $170,000 dollars can actually put more pre-tax money away in a Self-Employed 401k plan.

2. SIMPLE-IRA

This plan is another relatively easy one to set up and administer. It allows companies that have less than 100 employees to open individual IRA accounts for employees. The employees may defer salary in amounts of $10,500-$13,000 (depending on age), and the employer supplies a “match.” All money in the plan is immediately vested. The match is generally (but not always) a dollar for dollar matching contribution of up to 3% of the employee’s compensation.

For example, a company owner with a compensation of 100,000 dollars would be able to defer salary in an amount of up to $13,000 (if age 50 or older), and then have the company “match” 3% or $3,000 more. A SIMPLE IRA plan is a good choice for small businesses in which the owners are highly compensated, and few employees wish to defer salary. The disadvantages of the SIMPLE-IRA are immediate vesting for the matched funds, and relatively low total amounts of contributions compared to other qualified plans. 

NOTE:

I have seen these plans work well in small practices that wish to avoid paperwork, have few to no employees that wish to defer salary, and who don’t mind the limited ability to make contributions.  Note one unusual feature of this plan, in that the 3% match has no limits. I have seen one physician with a small group of employees and an income of $600,000 dollars per year put away 13,000 in salary deferrals and another ($600K X 3%) 18K in the match at no employee cost!

3. 401k/PROFIT SHARING PLAN

This is by far the most common type of qualified plan in existence.  These plans actually have three components:

 

a)       401k salary deferral-In 2008, employees may defer between 15,500 and 20,500 dollars. This money and earnings on it are not subject to Federal income tax until withdrawn in retirement, and are immediately vested.

b)       A “match”-this is an optional part of the plan in which an employer may offer to contribute a matching amount of dollars to give employees an incentive to participate.  Matching funds are usually subject to vesting on a time schedule.

c)       Profit sharing-like the match, this is a discretionary contribution by the employer of up to 25% of payroll and usually subject to vesting.

 

It is crucial to have a skilled plan designer customize a 401K plan for your individual practice.  The most common abuse of these plans is the use of “cookie cutter” prototype plans used by brokerages and insurance companies. These prototype plans are for the convenience and profit of the person “selling” the plan, and are a solid negative for the practice. Customization allows the physicians to have maximal participation at the lowest employee cost.

There is also a self employed 401k option for small practices that have no full time employees other than the physician and spouse. They operate in much the same way, but with little expense and much less paperwork.

4. DEFINED BENEFIT PLAN

Once common, these plans are now rarely used by most companies. They are based completely on company contributions to a fund (no salary deferral) that are actuarially designed to produce a set benefit amount at retirement. All the risk for providing the promised benefit is the responsibility of the employer, which is an advantage when the major beneficiary is the physician. Defined Benefit plans work best for practices in which the physician/employee ratio is low and the physician(s) is approaching age 50 or older. The advantage of this plan is allowing much higher contributions on a pretax basis, with the disadvantage of higher administrative costs. These plans work extremely well for high income businesses employing one individual (plus or minus a spouse) who is nearing age 50 or over. However, physician practices that employ a spouse or physicians of different ages can often use a Defined Benefit Plan in conjunction with a 401k/profit sharing plan to great benefit as in example three.

Assessment

Doctors have a tremendous opportunity to review and enhance the retirement plan options. Although the article focuses on these medical professionals and related occupations, much of the material applies to other professional and business clients.  A relationship with a good Third Party Administrator [TPA] and some independent study are invaluable to your ability to perform this function well.

Conclusion

Dr. Podnos is a fee-only financial planner and the author of “Building and Preserving Your Wealth, A Practical Guide to Financial Planning for Affluent Investors” (available at Amazon.com and bookstores). He can be reached at Steven@wealthcarellc.com And so, your thoughts and comments on this Medical Executive-Post are appreciated.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com  or Bio: www.stpub.com/pubs/authors/MARCINKO.htm

Our Other Print Books and Related Information Sources:

Practice Management: http://www.springerpub.com/prod.aspx?prod_id=23759

Physician Financial Planning: http://www.jbpub.com/catalog/0763745790

Medical Risk Management: http://www.jbpub.com/catalog/9780763733421

Healthcare Organizations: www.HealthcareFinancials.com

Health Administration Terms: www.HealthDictionarySeries.com

Physician Advisors: www.CertifiedMedicalPlanner.com

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Re-Managing Your IRA

Posted on September 24, 2008 by Dr. David Edward Marcinko MBA MEd CMP™

Revisiting Retirement Planning, Yet Again!

Staff Reportersfp-book

In this time of Wall Street chaos, GNP economic recession and marketplace turmoil, doctors must realize that not all investments and related activities are appropriate in IRAs for tax, legal, and investment reasons. This philosophy is an old reminder from Richard B. Toolson who wrote the classic article “Which Assets Don’t Belong in an IRA?” 

Yet, funds in IRAs, if invested appropriately, can make a significant difference in securing a safe and comfortable retirement for any physician.

So, how are thing the same, or different today; and how shall we revisit the Individual Retirement Account [IRA] in today’s environment?

Prohibited Activities

A number of prohibited activities, including borrowing from the account, could result in adverse tax consequences, including losing the account’s tax-deferred status.

An IRA also cannot invest in collectibles such as art objects, antiques, or stamps under penalty of having the cost of the items considered a constructive distribution and subject to tax. IRA accounts also need to avoid Unrelated Business Taxable Income (UBTI), which may result from ownership of an interest in a partnership or “S” corporation or from purchasing securities on margin or borrowing to acquire real estate.

Arguable Activities

The author also advises against holding tax-free, tax-deferred, or tax-sheltered vehicles inside an IRA, such as municipal bonds, Series EE U.S. savings bonds, or variable annuities. Conversely, assets that are expected to generate the greatest relative pretax returns should be held in an IRA. This would include fixed-income investments expected to yield high returns, stocks with high dividend yields, stocks expected to be held short term, mutual funds that emphasize stocks paying high dividends, and mutual funds that expect to hold stocks short term.

Assets Outside IRAs

Investments in individual foreign securities or mutual funds that hold primarily foreign securities are ideally left outside IRAs in order to receive tax credits on the foreign taxes paid. These credits reduce the physician-investor’s tax liability on a dollar-for-dollar basis, subject to certain limits. If these securities are held inside an IRA, any taxes withheld by a foreign country merely reduce the IRA’s market value. The option of receiving a tax credit is not available.

IRA Checklists

What to have in an IRA:

Generally, assets that are expected to generate the greatest relative pretax returns, such as:

  • fixed-income investments expected to yield high returns,
  • stocks with high dividend yields,
  • stocks expected to be held short term,
  • mutual funds that emphasize stocks paying high dividends, and;
  • mutual funds that expect to hold stocks short term.

What not to have in an IRA:

  • collectibles (e.g., art objects, antiques, and stamps),
  • tax-free, tax-deferred, or tax-sheltered vehicles (e.g., municipal bonds, Series EE U.S. savings bonds, or variable annuities), and;
  • investments in individual foreign securities or mutual funds that hold primarily foreign securities.

Activities to Avoid in an IRA:

  • borrowing from the account, and;
  • creating unrelated business taxable income, which may result from ownership of an interest in a partnership or S corporation or from purchasing securities on margin or borrowing to acquire real estate.

Assessment

Informed physicians and their financial advisors can play a valuable role in managing IRAs in a way that maximizes the amounts available at retirement.

Conclusion

Your thoughts and comments are appreciated, as the above is sure to generate some controversy.

Related Information Sources:

Practice Management: http://www.springerpub.com/prod.aspx?prod_id=23759

Physician Financial Planning: http://www.jbpub.com/catalog/0763745790

Medical Risk Management: http://www.jbpub.com/catalog/9780763733421

Healthcare Organizations: www.HealthcareFinancials.com

Health Administration Terms: www.HealthDictionarySeries.com

Physician Advisors: www.CertifiedMedicalPlanner.com

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com  or Bio: www.stpub.com/pubs/authors/MARCINKO.htm

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