Design the Best Pension Strategy for Your Cash Flow

So far in this blog series, we’ve shared with you wealth building strategies focused primarily on your practice and personal cash flows: where money comes from, where it goes and, finally, where it should end up. The key to your financial success may ultimately come down to devoting 20 percent of your net cash flow to saving for long-term goals, like your children’s education, your dream home and, ultimately, a comfortable retirement.

Let’s say you’ve committed to a long-term savings plan. The challenge now becomes to design and implement the best pension strategy possible. As a small business owner, you are in a unique position to take advantage of pre-tax retirement savings plans. But, before we get into any specifics, let’s quickly review the benefits of pre-tax versus after-tax savings.

In the following table, we see a dentist who has identified $360,000 in gross income annually before savings and taxes. Assuming our 20 percent savings goal, he has targeted savings of $72,000 a year.

The Advantage of Tax-Deferred Savings

As you can see, the first column calculates taxes on the full $360,000 in income and then sets aside savings of $72,000. After taxes, his net cash flow is $144,000. The second column is identical except in that he is contributing to a pre-tax savings plan. Note that the tax-deferred savings strategy saves nearly $29,000 in income taxes and frees up this amount for his after-tax cash flow. We have found that the majority of our clients can shelter a significant amount of their earnings from income taxes thanks to these tax-deferred savings plans.

The most popular tax-deferred savings plan today is the 401(k) defined contribution plan. In 2017, participants in a 401(k) plan are eligible to defer up to $18,000, pre-tax, from their salaries. In addition, participants 50 and older may defer up to another $6,000 (this is called a catch-up deferral). Employers may also contribute to participant’s account under certain circumstances. Under current rules, a plan participant may save a combined total of $54,000 per year in deferrals from their salary and employer contributions.

Let’s take a look, for illustrative purposes only, at the abridged census of a hypothetical dental practice.

Here we see Dr. Jack and his spouse, Diane, working in the practice along with a staff of six. Each year, the practice must provide to the 401(k) administrator an employee census containing employees’ names, salary and other vital information. Now let’s see what happens when he adopts a 401(k) plan optimized for his circumstances, again for illustrative purposes only.

Because Jack’s overall savings goal is $72,000, the plan administrator applies the discrimination rules in such a way as to maximize his pension benefit while keeping the staff portion of the plan costs at a minimum. In this example, Jack and Diane deferred $18,000 each of their salaries into the 401(k) plan while the practice paid $35,000 into the plan on Jack’s behalf. As a result, Jack received the $54,000 maximum contribution limit combined with Diane’s $18,000 salary deferral, which resulted in their $72,000 savings goal.

The plan administrator determined that the practice must make contributions of $7,744 to the staff‘s 401(k) accounts for Jack and Diane to achieve their $72,000 savings goal. In this scenario, Jack received more than 90 percent of the annual contributions to this plan. Imagine how your retirement savings plan would grow if you contributed $72,000 year after year!

It is also important to point out that staff members are not required to defer any of their salary into the plan to receive the employer contribution. However, it is a great benefit to your team should they elect to save money for their retirement in your 401(k) plan.

By now you probably have some questions. Here are some of the most common we hear from our clients about 401(k) plans.

As an employer, how much must I contribute to this plan each year?

Salary deferrals and profit sharing contributions are discretionary. However, “safe harbor” contributions are required each year. The amount of these required contributions is calculated annually based upon each participant’s compensation.

Is this illustration the same kind of 401(k) plan offered by my payroll company?

A word of warning here: Not all plans are designed the same. Many payroll and insurance companies offer pre-designed plan types that do not take into account your unique census demographics. As a result, employer contributions may be much higher and the dental practice owner may not gain the same benefits as we described in our example. As a general rule, the practice owner should be able to receive 85 percent to 90 percent of total contributions to the plan. Our firm’s Retirement Plan Services team, for instance, works with a number of approved pension administrators that have the means to custom design a 401(k) plan that meets your personal savings objective.

Are these plans expensive?

It all depends on what you mean by expensive. Plan administrators play an important role in establishing your plan and then performing the annual plan administration and reporting. You can expect to pay a one-time fee to establish the plan and then an ongoing annual fee to maintain it. We’ve found, however, this to be a competitive market with a number of competent players. The key question to ask is: Given the cost, is this a good value? In our illustration, Jack’s share of total pension contributions was more than 90 percent and he saved nearly $29,000 in taxes. Do these benefits combine to represent a good value for the fee paid? A good place to start answering this question is to compare your share of total pension contributions and the tax savings offered by each competitor to their proposed fee.

We also recommend checking the references of a plan administrator. Customer service after the sale is very important. Administrators that don’t return calls and fail to deliver on time can be a real problem in the long run.

Can I save even more tax-deferred dollars than the 401(k) maximum?

Yes! We haven’t discussed another tax-deferred savings vehicle called a Cash Balance Defined Benefit Plan. When paired with a 401(k) plan, a cash balance plan enables practice owners to contribute even more tax-deferred dollars into their retirement savings.

Still have questions? Please reach out to any of Buckingham’s Practice Integration Advisors. We are here to help you find the best pension solution custom built for your unique situation.

Also, stay tuned for our next strategy: Make peace with how much you can afford to spend.

This commentary originally appeared November 8 on


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Michael T. McAninch, CFP®, CPA

As a practice integration advisor with Buckingham Strategic Wealth, Mike helps clients develop a plan, which he sees as a roadmap to financial goals and objectives. Mike specializes in the implementation of strategies for business and personal cash flow tax efficient saving, income and estate tax planning, personal and professional debt review, and business transition planning and execution.

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