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Cash Balance Plan on the Cusp of FIRE

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  • Kon Litovsky Kon Litovsky 
    Participant
    Status: Financial Advisor
    Posts: 846
    Joined: 01/09/2016

    1. No. W2.

    2. 100k in wife’s student loans at 1.9%, 200k in my student loans at 2.6%, 600k mortgage at 3.5%. Prior to this CBP talk, we have been aggressively throwing all extra money at the loans. This will slow that down a little, but at least they are low interest rate loans (thanks First Republic).

    3. TBD. This hasn’t all been ironed out yet. All I’ve been told thus far is the group will cover the initial startup cost of the CBP out of overhead we’ve already paid and that all participants will split (in some way) the 70k/yr cost of the CBP. We will only start it if >50 partners commit to the CBP for the first 3 year run.

    I was also told that rather than giving us a guaranteed return we will get a real return, with a target of 4% (cannot exceed 5%).

    Click to expand…

    Since you are W2, you should 100% join this plan. Partners are on the hook if something goes wrong with a CB plan.  W2 employees will get their guaranteed contribution regardless.

    By ‘real return’ you probably mean actual investment return vs. a fixed rate.  Actuaries don’t like this approach at all (and having spoken to a number of them, they prefer fixed return vs. actual investment return). Also, we can’t ‘target’ a specific return even with a bond portfolio, as there will be a spread that depends only on the market performance, the longer the plan goes, the bigger the possible spread.  The return will be what it will be, and participants should get a guaranteed crediting rate of say 3% or 5% depending on the plan design.

    And starting a CB plan like this sounds like a bad idea.  What if >50 partners don’t commit?  It is just silly because then you have to terminate it after 3 years, which is an extra cost and a lot of work.  A CB plan should be viable from the start.  Why not make sure that you can have 50 partners sign up?  In many cases they simply have no idea how these plans work, so it might be necessary to give them an education on CB plans and how they work with a 401k plan.  It just sounds like someone really wants to sell the group a CB plan now.  I really do hope that whoever is managing assets and advising the group is an ERISA 3(38) fiduciary rather than a broker/salesperson/non-fiduciary just trying to score a big plan and be gone in a few years because this is how you get into a lot of trouble.  A CB plan should be run for as long as possible, ideally forever, and should not be derailed by arbitrary targets such as having a certain number of partners participate.  This type of discussion should happen before the plan is up and running, and if you can’t meet the goal the first year, then don’t do this plan in the first place if the costs of running the plan are high.

    Kon Litovsky, Principal, Litovsky Asset Management | [email protected]
    -401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

    #189846 Reply
    Liked by okayplayer
    Molar Mechanic Molar Mechanic 
    Participant
    Status: Dentist, Small Business Owner
    Posts: 287
    Joined: 10/29/2017

    a target of 4% (cannot exceed 5%).

    Click to expand…

    EEEK!!!  That sounds like your going to be invested into an equity indexed annuity in the plan.  Run away, if so.  That would account for the huge fee.

     

    Kon?  (Sorry Kon, wrote the wrong letter.)

    #190098 Reply
    Kon Litovsky Kon Litovsky 
    Participant
    Status: Financial Advisor
    Posts: 846
    Joined: 01/09/2016

    a target of 4% (cannot exceed 5%).

    Click to expand…

    EEEK!!!  That sounds like your going to be invested into an equity indexed annuity in the plan.  Run away, if so.  That would account for the huge fee.

     

    Lon?

    Click to expand…

    I think the way some advisers communicate can be part of the problem.  They consider a ‘target’ return to be an average historical return of a specific portfolio, but ‘not to exceed 5%’ can be attributed to a bond portfolio though how exactly they’ll make sure that it won’t exceed 5% is a mystery to me.  It is possible to exceed 5% over a couple of years with a bond portfolio, and historically that’s exactly what happened, though in the past 15 years the highest return was about 5.5% for a conservative one.  But I think it is it simply a statement based on historical returns and perceived future returns.  In any case, I would not make no such statements about future returns.  Nobody knows what those might be, and even the ‘target’ return is a variable that moves all over the place even with bonds.  If anything, index annuity can vary a bit more than 5% with the right stock market, and if any type of product like that is used, that would be a big problem for the plan fiduciaries given its’ cost and possible surrender charges.  For the W2 employee though, none of this matters.  As long as the plan has a fixed (or variable) crediting rate, he will get his 4% (or whatever minimum return he has to get according to IRS), and the plan would have to make him whole even if the product implodes or markets go down.

    Kon Litovsky, Principal, Litovsky Asset Management | [email protected]
    -401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

    #190113 Reply
     Steven Podnos MD CFP 
    Participant
    Status: Physician, Financial Advisor
    Posts: 107
    Joined: 09/21/2017

    Kon, a question.   If a DB/Cash balance plan does not achieve it’s investment goals of a certain return (say 5%), don’t the highly compensated potentially take the “hit” of the lower return, while the non highly compensated must be made whole?

    #190117 Reply
    Kon Litovsky Kon Litovsky 
    Participant
    Status: Financial Advisor
    Posts: 846
    Joined: 01/09/2016

    Kon, a question.   If a DB/Cash balance plan does not achieve it’s investment goals of a certain return (say 5%), don’t the highly compensated potentially take the “hit” of the lower return, while the non highly compensated must be made whole?

    Click to expand…

    No plan achieves exactly 5%.  Some are under, some are over. Both can be problematic if the under/over is very high.  If it is relatively small, not a big deal at all.  If return is less, partners put in more money into the plan, and most of it goes to them anyway by design (and they get an extra deduction).  If there is a higher return, they can’t put in as much for themselves (but $1 in return is definitely better than tax deduction on $1).  Excessive return over target will be taxed at 100% by the IRS if the plan has to be terminated quickly, thus ‘low volatility’ is the best approach for these types of plans.  Ideally of course you want the highest return possible (and some solo docs gamble with that, which means that you have to constantly adjust your allocation, which is simply a bad idea as you don’t want to end up with excise tax on the exit, and over a short term you might as well end up with a big loss), but given that these plans can be closed on a very short notice, you don’t want any stocks in CB plans for most medical/dental group practice plans (unless it is a plan that can be reasonably expected to run ‘forever’). One scenario with a volatile portfolio would be when a partner with a lot of money leaves the plan and the market then crashes badly, they would be owed the partner his share, and the other partners would have to put in the money to ‘bail’ him out.  The plan might not allow distributions if it is underfunded, but this is a scenario that you don’t want to happen especially in a relatively small plan. So the bottom line is that with a low volatility portfolio there won’t be any issues for the partners whatever the market does.

    Kon Litovsky, Principal, Litovsky Asset Management | [email protected]
    -401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

    #190127 Reply
     BladeRunner 
    Participant
    Status: Physician
    Posts: 42
    Joined: 07/03/2017

    Might be a stupid question, but is there a scenario for someone on the cusp of FIRE with a large taxable account like the OP, but at a lower income to expense ratio, that it would be beneficial in the long term to contribute the absolute maximum to the plan for the last few years, even if it means subsidizing their daily living expenses from the taxable account in order to do so?

    #190238 Reply
    Kon Litovsky Kon Litovsky 
    Participant
    Status: Financial Advisor
    Posts: 846
    Joined: 01/09/2016
    Earnest refinancing bonus

    Might be a stupid question, but is there a scenario for someone on the cusp of FIRE with a large taxable account like the OP, but at a lower income to expense ratio, that it would be beneficial in the long term to contribute the absolute maximum to the plan for the last few years, even if it means subsidizing their daily living expenses from the taxable account in order to do so?

    Click to expand…

    Your taxable account should be able to provide income once you retire, and also to pay for any Roth conversions that you might want to be doing in retirement.  If you deplete it too much this can be an issue as you want to start converting to Roth right away as your tax bracket drops and use your taxable account to pay the taxes, and also continue providing income for living expenses.  So it depends on whether you will have enough to do it all, in which case that’s exactly what a CB plan is for – contribute at the highest bracket, convert at the lowest.

    Kon Litovsky, Principal, Litovsky Asset Management | [email protected]
    -401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

    #190417 Reply

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