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Understanding Cash Balance Plans – Podcast #223

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A defined benefit cash balance plan is a somewhat unusual and surprisingly physician specific retirement account. It is a type of a defined benefit plan. On one end you have a defined contribution plan like a 401(k) and on the other a defined benefit plan or pension plan. A cash balance pension, a subtype of defined benefit plan, lies as kind of a hybrid between the two. It still falls in the category of a defined benefit plan, but its purpose is designed not so that you have an annual income distribution after you retire but that you take the lump sum. Confused? Don’t worry, we have Victor Mangona, who has developed an expertise in these plans, as our guest this episode. We discuss who should consider a cash balance plan, how much money can be put into a plan, the tax savings from using this plan, how to invest these assets, what happens if there is a loss in the account, and most importantly how to get your practice to adopt a cash balance plan so you can take advantage of these great accounts. 

 

What is a Cash Balance Plan?

A defined benefit cash balance plan is a type of defined benefit plan. When we look at retirement accounts, we basically have our defined contribution plans, like a 401(k) where you define how much you’re putting in at $19,500. You have on the other end, defined benefit plans or pension plans, old school pensions, like what people would have gotten at Chrysler, Ford, GM, where you get a certain amount of money per year after you retire.

A cash balance pension, a subtype of defined benefit plan, lies as kind of a hybrid between the two. It still falls in the category of a defined benefit plan, but it’s purpose is designed not so that you have an annual income distribution after you retire but so that you take the lump sum.

“That lump sum is a lump sum at any point, during the entire time you hold onto this, when your account gets credited, there’ll be a certain amount of dollars, a cash balance, that you have assigned to you that you know that your balance is worth.

As opposed to other traditional annuities, where it’s kind of a black box where you don’t really quite know how much your pension is worth. For example, social security. You know kind of how much we put into it, but there’s no lump sum option to social security. You don’t know at any point in the process what it is really worth. A cash balance defined benefit plan has a clear balance directly associated to each individual person who is participating in the plan.”

Essentially, it’s another 401(k) masquerading as a pension. Victor likes to call it a mega side door, mega backdoor 401(k). So much extra capital that ends up in your 401(k).

Recommended Reading:

Cash Balance Plans: Another Retirement Account for Professionals

 

Who Should Consider a Cash Balance Plan?

Anyone who has extra money to invest beyond their 401(k). This is for people who are able to save extra, preferably people who are at a high tax bracket. These are really more for people who are at the higher tax bracket and trying to save more in taxes. If you’re trying to seek early financial independence, this is also an excellent vehicle to stash money away tax free or pre-tax and have that growth, allowing you to reach a net worth number sooner based on saving on that tax.

This works well for older doctors who are putting lots of money away. What about younger doctors? Is this worthwhile if you’re still in your 30s?

“Absolutely. If you’re in a high tax bracket and you’re not able to take a lot of other deductions like businesses deductions, if you’re paying a high marginal tax rate, it is very difficult to beat the savings of a pre-tax investment, no matter how you invest, especially when you look at it from a risk adjusted net return perspective. Even at the age of 35, potentially you could get $77,000 into a cash balance pension based on last year’s numbers. And that’s still a lot of money. Is that as much money as some of the older docs? Certainly not.

But if you’re able to put that money in, and the cost to you as a participant is zero or negligible in comparison to their tax savings, it definitely is something to look into. If you have a cash balance pension that’s offered to you without any cost to you and you can participate in it and take advantage of pre-tax investing, then absolutely.”

Private practice partnerships are where I typically see them. He has not seen anyone in a university or academic setting with a cash balance plan. They often already have some sort of a pension plan in place that is more on the traditional benefits side, which is what we often see in government organizations.

“Now, certainly there could be a transition to a cash balance type of defined benefit plan. And I know a lot of for-profit institutions have tried to convert because it decreases the liability risk to the company of having to pay out an annuity at the time someone retires, but that’s much more difficult, in general, once you have a plan in place. This is a lot easier for places that don’t have something in place already. You can just start it up and set it up this way.”

 

Can an Independent Contractor Use a Personal Cash Balance Plan?

You can go to Schwab or some other places and get a personal defined benefit plan, a personal cash balance plan. Do you think it’s worthwhile?

“If you are a 1099 contractor, you’re one of the best people to probably consider it because one of the biggest downsides of having a cash balance pension is that your money is pooled with other people. But if you are the entire pool, then this really becomes an extension of your 401(k).

So, in a lot of ways, they are the best people to take advantage of them. Now, there are some other things that do come into play. The profit-sharing portion of your 401(k) may be decreased. You may not be able to get that full $58,000 between your 401(k) employer and employee contributions. You might have to decrease the employer contribution. But if you can open up that cash balance side, it can be well worth it.”

Schwab recently updated their pricing, but it was like $2,250 to set it up and only $1,750 a year going forward. So, that’s pretty cheap. That is an expense to the business so it is tax deductible. If you’re putting in $50,000 and saving $20,000, that’s an incredible benefit to you. Unfortunately, due to the fact that actuaries have to get involved and it’s more complex, it’s significantly more expensive than a solo 401(k) you can open with basically no cost. But you can’t put $150,000 into a solo 401(k) either. So, that’s really the benefit.

Recommended Reading:

Is a Cash Balance Plan Right for Your Medical Practice?

 

How Much Money Can You Put into a Cash Balance Plan?

If you’re in your 50s and 60s, the amount you can put into these things is pretty impressively high. You can get $200,000 plus into a cash balance plan in the right situation. But despite the fact that maximum contributions to plans can be surprisingly high, why do so many plans have such low contribution amounts?

Like at my practice the old plan we had was $30,000 across the board. That was the most anyone could put in. The new one is kind of age based from when the plan started. So, I’m locked in at just $17,500. That’s all I can put into our cash balance plan right now. I’m in my mid-40s. I should be able to put in $100,000, but I’m stuck at $17,500. Why is that?

“When I had to go shop around for different administrators and different actuaries, when we were getting it together for our company, you can talk to 10 different actuaries and get 30 different plans in terms of how it’s designed.

And so, it’s really important to know how much people want to put in first a priori and then design it around that. But people don’t want to say how much they’re going to put in until they know what the plan is going to be and how it’s going to work.

So, you get into this circuitous route of not actually accomplishing anything. But at the end of the day, it’s surprising how variable the setups can be. This is a defined benefit plan, not a contribution. So, it’s the benefit that technically has to be decided upon. That is in the IRS guidelines. But how you calculate that benefit is a lot of actuarial magic.

You can take different presumptions and different things and make the plan look differently. For example, we set a threshold that we could not credit any account by more than 5% in any given year. By doing that, it increased the total amount that the account could grow to over time, which allowed us to contribute more money.

Now you also have to consider the demographics of your group because of the way cross testing works, and all the other employees. And so, based on your age and how much it can grow to, based on the age of the other employees and how much their benefit can grow to, it can be limited.

Then further, a lot of times groups don’t want to allow contributions to go so high because anytime you have a pension, it is a liability to the company on paper. It is an employer liability, if there’s a shortage. So, they could limit the amount that goes in because they want to limit the risk to the business.

Shop around and see what other options there are available, see how different plans could be designed with market-based crediting, which allows you to credit amounts that are variable based on the returns of the investment. It can take a lot of that risk off from your company, and you can design your partnership agreement such that the risk to the company may be also mitigated by some personal liability to the person, if there’s a shortage.”

 

What are the Risks of a Cash Balance Plan

When we talk about a risk with these plans, it is if the value of the assets in the plan fall, a big bear market happens. But that’s not such a terrible thing in a partnership because in that situation you put more money into the plan.

It forces you, as a partner, to put more money in during a bear market and actually buy low. It’s a wonderful benefit, not so much a risk, of being able to put even more money into your retirement plan at exactly the time you want to put more money into the retirement plan.  I think that risk is overblown quite a bit. Obviously, some people are going to have cash flow problems doing that, but it’s not nearly as bad of a risk as some people make it out to be.

With my partnership, why the limits are so low in our plan is that only 8% of the doctors in my group maxed out their cash balance plan. This was the old plan of $30,000. Only 8% of the docs were doing it.

There just isn’t that much interest. The vast majority of people were contributing the minimum which I think in the old plan was $2,500. There is just not that much interest in doctors saving much more than they can put into their 401(k). I think that is the bigger issue.

But what happens if there is a loss in the cash balance plan?

“First of all, you might have an account that’s already overfunded. Our account fortunately is overfunded and we had over 10% return last year. Our cash balance pension caps the crediting at 5%. So, all of that extra 5% is just extra, it’s sitting in the account. This year we could have, let’s say a 2% loss and all of that surplus will help take care of the deficit. And we would still have extra cash to still credit people with a positive return. We could still maybe give them 2% or 3% for next year. And so, it really depends on the situation.

Now, if there is a loss and you’re underfunded where the total amount of the balances of the people in their hypothetical accounts is less than the total aggregate amount of the pool pension, then you’re underfunded. And so, you have to make this up over a period of time.

From my understanding, you have seven years of an amortization schedule to make it up. It’s highly unlikely that that balance over seven years, it’s not going to come back above zero. So, you have to potentially float it for a while, but it’s likely going to get back up there.

But one of the benefits, again, of having that cap on earnings is allowing people to contribute more, but it also allows us to have a surplus. And that’s something that was really important to our company. We’re a very big company and having a plan where you can have some padding and some cushion, it puts us in a position where we’re much more likely to keep that plan going. And a lot of people can just breathe a little bit more comfortably, knowing that we don’t owe millions of dollars to people, even though it would get taken care of.

But still if it went down 50% and we’re at probably 20 million plus in our fund, a 50% drop would be $10 million. That’s a lot of capital. So, we still don’t want to have that liability on our books, even though over time, it should correct itself. And the amount it takes to fix that over time is very minimal, relatively speaking. But yeah, technically you do have to come above water over a period of time. But in most practical scenarios, it’ll come back above water on its own anyhow.”

 

How to Get Your Practice to Adopt a Cash Balance Plan

Victor is a full-time private practice physician working for a private oncology group in Texas, a very big group, a 400+ doctors group of mostly older physicians. People say changing things in his group is like redirecting an aircraft carrier. It took years of prodding, but at the end of the day, he convinced enough people to make this happen. This is exactly the kind of group that should consider a cash balance plan.

When we discussed why doctors were not interested in saving more money beyond their 401(k), Victor thought it came down to misunderstanding and education.

“When it comes down to just saving more, a lot of people don’t realize how much they really need to be saving. A lot of people think that maxing out a 401(k), you check off that box in your financial to-do list box, and you think you’re accomplishing your long-term goals. But you really have to work backwards and say, “How much do I need to be saving?” not “Can I fill up this bucket?”

For example, if you’re making $500,000 a year, your 401(k) is $58,000, that’s like an 11% savings rate. That’s not going to get the job done if your spending habits are that high, that you’re spending all the rest of that money after taxes.

So, what I did when I first presented this to my group, I said we all have to be saving at least 20% to safely meet our retirement needs. And when the average person or the median person is in the top tax bracket, that 401(k) doesn’t even get them to a 10% savings rate. And so, most people, I think, who are earning that high of income are actually not saving as much as they need to be.

Here’s a vehicle that will really help you get there a lot faster than investing on the taxable side. It kind of takes away a lot of the decision-making. I think that’s why 401(k)s are so effective. Part of the reason why they are effective is because the pain points to participate are very minimal, that you can just participate in a target-based plan based on your age or whatever year you want to retire. And at least you’re investing, at least you’re getting something in there and your savings rate is really the strongest predictor of your financial security long-term.”

When Victor talked to one of the actuaries, he said that in a lot of physician’s groups, it ends up being about one-third are all for participating. One-third definitely won’t and about a third may. He got 174 participants in their first year. People were getting mostly between $50,000 to $100,000 per person. The following year, they added another 32 people so about 50% participation just after one full year cycle of it.

“If you’re in a situation where you’re in a high tax bracket, if you have the cash flow ability to do it, and you understand where you are financially, what goals you need to meet, I think a lot of people will participate.”

 

Tax Savings from Using Cash Balance Plan

This is tax deferred money, so you’re getting the same tax break as in your 401(k). But we talked about permanent tax savings for W2 employees using a cash balance plan.

“In our group, all partners are paid straight on W2. When you earn W2 income, you get paid on a W2 paycheck, you pay social security until you hit that wage base limit. And you also pay Medicare tax on all of your money. So, as an employee, you pay 1.45% Medicare tax on all of your earnings. You pay an additional 0.9% on all your earnings north of $250,000 if you’re married. That’s 2.35%. And the employer is paying 1.45% on all dollars that are paid to you on your paycheck. So, in total that’s 3.8%.

If you own the business, you are both the employer and the employee. If I’m putting $100,000 into my cash balance pension, I’m saving $3,800 in Medicare tax, for me and for my employer, because that money is bypassing payroll. That’s one of the benefits of bypassing payroll is you get away from those payroll taxes. That’s why a lot of people who are in an S-Corp structure, they designed it that way because it helps them avoid putting money on payroll. It shows up on their K-1 as opposed to on the W2.

You don’t have to pay payroll tax on K-1 income, but as a W2 employee, if you can save that 3.8%, that’s a guaranteed savings. So that money is never going to have to be paid back, at least based on all the data we have on tax deferred plans. I mean, who knows what’s going to happen 30 years from now, but there’s no plan, at least in the way we designed 401(k)s, to pull back Medicare payroll tax down the road. So that’s a huge benefit. That’s a guaranteed permanent return that you will never lose.”

 

How to Invest Assets in a Cash Balance Plan

You don’t get to control the asset allocation as a participant; the plan controls that. So how should a cash balance plan be invested?

“First of all, you want to maximize your tax savings. You want to limit the liability to other people in your company, and you want something that will work with everybody’s portfolio. So, we designed something that could work for the people who want to have the most stock heavy or the most bond heavy portfolio overall. We designed ours to be 40/60. That’s 40% stocks and 60% bonds. And we have our money set up at Vanguard. It’s almost all index funds. There’s a little bit of active management on the bond side.

But at 40/60, the downside risk, the risk of losing more than 10% a year is very low. So, this very much limits the liability to other people and the company. And people who are putting money in here already are putting $58,000 into their 401(k) and probably investing more otherwise.

So, your cash balance pension is just a portion of your portfolio in aggregate. If you want to be 80% stocks, or if you want to be 80% bonds, you can still likely get there. And even if you’re not, you can have a wide range of asset allocation with very similar outcomes.

The driving force here is that tax savings will drive up your overall compound annual growth rate to favor maximizing the cash balance plan contribution more so than just what’s your overall asset allocation.”

A lot of people would say 40/60 is actually pretty aggressive in a cash balance plan. A lot of cash balance plans are even less aggressive than that, like 30/70.

 

Asset Protection for Cash Balance Plans

These are ERISA accounts. They get the same asset protection as 401(k)s. That is one of the big benefits, that it is ERISA protected, and it’s a qualified plan. So, it’s not subject to the risk of creditors. You can actually keep this, and no one can come after it. It is a lot safer than putting money, for example, in just a regular IRA, which doesn’t have that ERISA protection. IRAs are variable based on the state and different things.

What Happens When You Close a Cash Balance Plan?

Victor said this is where you get different answers from different people, but 10 years is a very comfortable number to work with. Once that 10 years is up, you can close it down and roll it over into your 401(k) or into an IRA.

“Now seven years is also probably a good number. I know a lot of people use seven years as their plan for how long to keep this open. And I’ve heard some people go down to as low as five years, although I’ve definitely gotten more hesitation from actuaries about planning to close a plan in five years.

But seven years seems to be pretty reasonable. That’s maybe where we’re going to aim for. And once you close it down, you could open up another one. So, once it’s closed down that money just stays pre-tax if you roll it over to another pre-tax account. So, it really is, like I referred to earlier, a mega backdoor 401(k).”

The point is not to leave it in the defined benefit plan for 30 years and then annuitize it and live on it as a pension in retirement. The goal is to get it into your 401(k) or your IRA. So, closing it is not necessarily a bad thing. The only downside to it is you have some additional legal and actuarial expenses when you close it down. But the IRS doesn’t want you to close it very often, or it looks like you’re not actually trying to set up a defined benefit plan in the first place.

I’ve been in my group for 11 years, we’re on our third cash balance plan. The reason is that we keep expanding the partnership. When you add twice as many partners as you already have in the partnership, it’s basically a new business. So, we got rid of the old cash balance plan, and started a new one. Each time we did that, I was able to roll that cash balance plan into another plan.

 

Cash Balance Benefits for Older Doctors

If you get to be 62 and a half, there is a unique provision in a cash balance plan that allows you to immediately roll the money out of the plan.

“This is how it really is a back door/side door 401(k). Because if you are of age, as soon as that money is invested into your account, you can roll it out. So, for example, the way ours works is they withhold it from your income over the course of a year. So, let’s pretend I put in about $100,000 a year. $100,000 gets withheld gradually from my income, let’s say $8,000 a month. And then at the end of the year, that money has already been all reduced from my W2. And then usually what we do is in March or April, after we’ve done all the processing, they do the profit-sharing contributions for the 401(k) and they put the money vested in your accounts on the cash balance pension side.

That includes your new contributions, but it also includes the crediting of the prior balance. So, if the balance was zero last year and I put $100,000 this year, once that $100,000 vests into my account, if I were of age, I get to roll that out immediately. It’s like doing a backdoor Roth. It goes into one account then it goes out of that account into the place where you want it to be. It maintains the same tax-deferred status.

With the CARES Act, they actually changed it now from 62 to 59. So, if you’re 59 and a half, you can put in your $19,500 into your 401(k). And as long as your plan documents allow this, this is permitted by the IRS rules, if you put your $19,500 in, you can roll that out immediately. The profit sharing 401(k) and the cash balance pension, we could roll all of that money into an IRA immediately.

And so, it’s really an incredible vehicle for the older doctors, because then they don’t have to worry about this pooled asset. They don’t have to worry about the downsides as much. They will be able to have control of their money basically immediately or within about a year or so. And so, it’s really a great vehicle.

If you have a group with a lot of older doctors, this takes a lot of risks off the table for the company, and it just allows them to basically add more to the 401(k). There’s not really much downside for those people at all.”

 

Do All Employees Have to Participate in the Cash Balance Plan?

Do all the employees and partners have to contribute? Do they have to contribute the same amount? How is that determined?

“Yeah, so this was actually one of the sticking points that I found out about why our company had not started the plan previously because they had presentations from Fidelity and people were hesitant to open one up because we do have a wide range of income across our partners. But you actually only need to have 50 participants or 40% of your employees.

So, we have over 400 doctors. It only takes 50 of them to say that they’re going to participate in order for us to be able to keep this open. And if you’re in a small group, like 10 people, you only need 40% of them or 4 of them to participate to keep it open.

And then the amounts that they contribute, the maximum amount that each person in our group is allowed to contribute is based on their age. And our plan is designed between $50,000 up to $100,000 as their maximum amount. They don’t have to contribute that amount, but they have to make an election of how much they do want to put in. And they’re kind of locked into that for three years and that’s just to make it look like a pension, as opposed to a defined contribution plan. You have to have a steady amount you’re putting in. You can also design it so that it’s a steady percentage of your income.  There is a lot of variability. Not everyone needs to participate and not everyone needs to get the same amount, which gives this opportunity for the people who want to participate, to participate and makes it a lot easier to get a plan open in a private group.”

What about the non-highly compensated employees and the 5% rule and non-discrimination testing?

“This is where it gets complicated. So, if you’re a 1099 doc, part of the real benefit of this is you have no other employees that you have to worry about. It’s just you. Now you could work in a group where you’re doctors, all highly compensated individuals. Those are people who earn more than $130,000 per year. And it’s kind of similar to the social security wage base.

But if you’re a physician and you have employees like nursing and other staff who earned less than $130,000, then the IRS says, if you’re going to have this extra retirement plan, you have to do it fairly. And that is you have to make sure that you’re giving enough money to the other non-highly compensated employees. This is the same thing that you have to do with a 401(k), especially if you have a profit sharing 401(k), where you’re adding on beyond that $19,500 and adding another $36,000. You have to make sure that the employees who are earning less than $130,000 are earning enough.

That’s why in our 401(k), we don’t do any of the profit-sharing contributions to people’s accounts until after the year’s over, until like March or April, when we’ve done all that cross testing. So, that cross testing is one of the tests, non-discrimination tests that have to be done, where you look at what percentage of a person’s income is going into their retirement contributions from the employer, across the participants in the cash balance plan, as well as people who are non-participants and the people who are earning less than $130,000.

To make it simple for most people and most plans, you’re going to have to give 5% of a contribution to those non highly compensated employees. We call it the 5% gateway. That’s the minimum they need to get. So, if you have an employee making $100,000, that employee will need to get $5,000 into their 401(k) as an employer contribution. Now that’s for basically all of your non-highly compensated employees. There are some people you can leave out. For example, people who are new and haven’t put in enough hours yet, they can be excluded from that. But everybody else has to get at least 5%.

Now, if they get 5%, then yes, you can have a cash balance pension and give allotments of contributions to participants. The amount of that allotment is going to change based on how much you’re getting to those other non-highly compensated employees. So, it could be 5%. It could be 6%, 7% or 7.5% percent. “

When you talk to an actuary and get a plan design made, they will often make a design of how much people can put in based at those different levels. This gets complicated but that is why you pay an actuary to figure it out.

“And it really depends on a lot of the assumptions that are made and how it was designed. I saw multiple plans where one of the plans that was offered to us literally excluded everybody under the age of 40. They can’t contribute at all. And then you could give more to the older people. And then same people, different option. Yes, you could give to people who are younger, but then it affects people who are older. You have to be giving them 5% as a minimum.”

 

Investing in a Cash Balance Plan vs Alternative Investments

A lot of people want to invest more aggressively than their cash balance plan is going to invest. Maybe they want to invest in real estate or Bitcoin or whatever, and they can’t do that, at least not easily, in a retirement account. How would someone decide whether to fund their cash balance plan versus going and buying a property or a syndication?

“This was actually the biggest bone of contention I had with the individuals, trying to sell them on participating. If you’re at a high tax bracket, you’re paying 40%-50% marginal tax. That money is gone immediately. You’re not going to have that money back.

It is very hard on a net return risk adjusted basis to get ahead of that tax savings with any return out there.  $100,000 into a cash balance plan would be like $60,000 or $50,000 in your pocket to invest. Now certainly you could invest it somewhere and make huge returns, but those are not risk adjusted compared to the 60/40 or 40/60. So, the risk adjusted return is still going to be way higher if you can save that 40% tax. And so that’s what I tell them.

And ultimately, again, this is a small portion of your total portfolio. There’s room in your portfolio for even the most conservative assets. If you wanted to have 70% of your money in more aggressive things then that’s fine, and this is still a small portion and is pre-tax. So, it’s good to have that diversification.”

 

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Milestones to Millionaire Episode

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Full Transcription

Transcription – WCI – 223

Intro:
This is the White Coat Investor podcast where we help those who wear the white coat get a fair shake on Wall Street. We’ve been helping doctors and other high-income professionals stop doing dumb things with their money since 2011. Here’s your host, Dr. Jim Dahle.
Dr. Jim Dahle:

This is White Coat Investor podcast number 223 – Cash balance plans.
Dr. Jim Dahle:
It’s story time, brought to you by Locumstory.com. Today, we’ll be reading “One job, two jobs.”

One job, two jobs. Red blob, no job.

Elective doc, emergency doc. Some in overstock, some in out of stock.

This doc is too abused. This doc is underused. This doc can’t get sick. Say, let’s try a brand-new trick!

For all the docs about to cry, here’s an idea you can try!
Look into a locum tenens assignment. A really great option, you might find it.

With all this new info, trapped up in your thinker,
Go to locumstory.com and use your mouse to tinker.

It’s here you’ll find the unbiased answers you are after,
So you can decide if locum tenens is your next chapter.

Dr. Jim Dahle:
That’s a fun ad. We need more ads like that.
Dr. Jim Dahle:
Thanks for what you do out there. I know you’re a high-income professional, or you soon will be, because you’re a trainee. and there’s a reason you get paid high income. It’s because your job’s hard, but it provides an important service to our society. So, thanks for what you do.

Dr. Jim Dahle:
If you’re not aware of this, we have a conference once a year. We call it a WCI con. We don’t call it that when we go to the people that we’re trying to get CME for it though. We call it The Physician Wellness and Financial Literacy conference. Our next one is going to be February 9th through 12th, 2022 at the JW Marriott in Phoenix, Arizona.
Dr. Jim Dahle:
Now, if you haven’t been to Phoenix in February, it’s absolutely delightful. Those of you coming from Alaska and Minnesota and Maine might particularly enjoy it that time of the year.
Dr. Jim Dahle:
But our registration is going to open in fall 2021, probably about mid-September. So, watch the monthly newsletter for announcements. You can sign up for that at whitecoatinvestor.com/free-monthly-newsletter. Watch the blog as well. We’ll try to make announcements on the podcast as best we can, but bear in mind, these things fill up and they fill up pretty fast.
Dr. Jim Dahle:
When we were doing sign ups for our event in Las Vegas. Well, our first one was in Park City and we sold that one out in six days. When we went to register for Las Vegas, it was one third full after seven minutes. And it was completely full after 23 hours. So, when the signup comes, you need to sign up if you want to come to this event.
Dr. Jim Dahle:
It’s going to be a lot of fun. We have some awesome speakers coming. It’s going to be great. And it’s great to meet all these people you know in the WCI community online to meet them in person, it’s just a really fantastic event.
Dr. Jim Dahle:
But if you want to come in person, you got to sign up right away. I’m just giving you the warning. It’s still a month out, but we’ll give you the time that we’re going to open up to sign up and we’re going to give you the date that we’re going to open up to sign up and we’ll be there to help you if you have any problems, but it’s going to fill fast. So, keep that in mind.
Dr. Jim Dahle:
We are going to have a virtual component. We really enjoy doing the virtual component as the only thing we had for 2021 due to the pandemic. And of course, that’s not going to have a limit on how many people can come, but if you want to come in person, you’re going to need to get signed up during that signup period. We always offer early bird kind of pricing, but pretty much everybody gets it because it fills during the early bird pricing period.

Dr. Jim Dahle:
Let’s do an interview today. We’re going to have an awesome interview and this is going to come from a doc by the name of Victor Mangona, who you may know. He’s been a part of the WCI community for a long time. But let’s get him on the line here.
Dr. Jim Dahle:
All right. Our guest today is Dr. Victor Mangona. Welcome to the podcast, Victor.
Dr. Victor Mangona:
Thanks, Jim. Huge pleasure of mine to be here. Thanks for inviting me.
Dr. Jim Dahle:
Yeah, it’s awesome to have you. Let’s just start with a little bit about you. Tell us a little bit about your upbringing and how it affected your views on money.
Dr. Victor Mangona:
I was born to immigrant Filipino parents. Middle-class income. They worked, they put us into school and also had two rental properties that my parents acquired during my childhood. And that kind of helped guide me toward the idea of investing. They weren’t high earners, but they did put in sweat equity and some capital into two rental properties. My dad’s an accountant and he understood the numbers.
Dr. Victor Mangona:
And so, that’s how I kind of got started in the world of investing. We didn’t really have a lot of income. I never went on luxurious vacations. I think I can only remember like two vacations, my whole childhood. I didn’t go on an airplane until I was 10 years old, but that set me up for my future, where I had every opportunity educationally to attain whatever I really aspire to.
Dr. Jim Dahle:
Let’s talk about that education. Tell us about your education and career so far and what you do.

Dr. Victor Mangona:
I went to Montessori school from PK through 6th. Jesuit Catholic Boys school until 12th grade. I went to Duke for undergrad, Wayne State back in Michigan, my hometown for medical school. I actually did two years of high school science and math teaching before I went back to medical school. And then I did residency in radiation and oncology at Beaumont hospital, suburban Michigan. And I did a fellowship at MD Anderson and I worked in private practice.
Dr. Victor Mangona:
So interestingly, my experience as an educator started off in Montessori school, which is the reason I bring it up because that’s part of the curriculum is learn and teach. And so, I learned through school teaching my classmates ever since I can literally remember since kindergarten. And I’ve always thought of myself as an educator, as one of my core traits and part of how I got into doing what I do now.

Dr. Jim Dahle:
Awesome. And are you practicing full-time right now?
Dr. Victor Mangona:
Yes, I definitely am a full-time private practice physician. I work for a private oncology group in Texas, a very big group, 400 plus doctors. And this is my first job out of training. We’ve finished fellowships, my wife and I, in 2015. And I’m about to hit my six-year anniversary from starting my practice. I became a partner after about two years. And the job has overall been financially very, very fortunate. And I ended up at this job. We’ve done very, very well.

Dr. Jim Dahle:
It’s a good specialty. It’s good practice. You’re in a good place. It all comes together, doesn’t it sometimes?

Dr. Victor Mangona:
Yeah, absolutely. I thought it was by accident, but getting two specialist’s jobs in the same city was very, very, very challenging, it happened a little bit by luck, probably a lot by luck. And it just happened to be that we were in Texas, which is probably the best state in the country for two specialist physicians, at least from a financial perspective.
Dr. Jim Dahle:
So, tell us about your family.
Dr. Victor Mangona:
I’m married to my wife, Kate. She’s a pediatric radiologist, academic at UT Southwestern. We got married right before we finished residency. We went to residency at the same institution. And since we finished training, we’ve now had our third child as of eight days ago.

Dr. Jim Dahle:
Oh, congratulations. I understand there’s a fur baby in there too. Is that right?
Dr. Victor Mangona:
Yeah, our first child was our fur baby. Our nine-pound poodle. That was soon after we finished training. And then, about a year and a half later, came the first child. And now we’re on our third girl in just under four years.

Dr. Jim Dahle:
Oh, it sounds like you guys are going to get really busy. You’ve just switched from man to man to zone coverage.

Dr. Victor Mangona:
It is, though, as I said, we do have nanny coverage now, which has helped keep it one-on-one at least for the most part. And her mom is helping us at the moment while we just have the child. Actually, during the maternity leave period, it doesn’t tend to be so bad on me because my wife does exclusive breastfeeding mostly, but it’s once she gets back to work, that’s when I think the real challenge happens for all of us.
Dr. Jim Dahle:
Yeah. I think you’ve got plenty of challenges in your lap with two practices and three kids under four. You got a lot of work ahead of you for sure. All right. Well, let’s talk a little bit about finances. We’re supposed to be here on a finance blog. You start a finance podcast. You started a finance blog a few years ago. You titled at 39.6 after the highest tax bracket at the time. And the first time I saw that, I wondered if you would regret it when the tax bracket is inevitably changed. Well, they changed. Do you regret that name?
Dr. Victor Mangona:
When starting a business, I think the most important thing is to get started. You can look back and say, did I make the best decision? Maybe not. I don’t regret it because it was the first thing that I had to do to get started. And it got me started. It’s also a brand. I had considered more strongly changing it in the past two years. But then the past year I was like, “Well, at this point, I’m just going to ride it out because it might come back within the next seven months or so”.
Dr. Jim Dahle:
Then you’ll look like a genius as soon as it comes back to 39.6, right?
Dr. Victor Mangona:
Yeah. I think it might get a lot more press, that percentage might be out there and then somebody will stumble upon some of my content.
Dr. Jim Dahle:
Now, are you done blogging? What are you doing now? I understand you’re on YouTube. What are you doing exactly?
Dr. Victor Mangona:
I gave up the written format as my primary modality to share and educate. I do basically all live broadcasts on my Facebook community, 39.6 community and on YouTube. I’m the type of person who’s going to start writing something and if it doesn’t have a due date, I’m going to continue rewriting that same thing. It will never finish.
Dr. Victor Mangona:
At the end of the day, I was like I can’t spend this much time to produce so little content. So, I switched media and I’m much better at verbally presenting and teaching the dynamic than writing out.
Dr. Victor Mangona:
And what’s nice about doing a live broadcast is I start the live broadcast and I end the live broadcast and it’s done. I don’t do any post production. I’ve strongly considered repurposing and having some editing done, but at least this way I can sit down half an hour and get something out there. And they say B minus work gets the job done. And I’d rather have a whole bunch of B minus work out there that people can enjoy and use however they want to then get a tiny fraction of A minus or A work.
Dr. Jim Dahle:
Now I owe you a debt of gratitude. When the world was collapsing around us during WCICON20, and about a quarter of the conference faculty wasn’t able to make it, you stepped in and gave a talk with about 12 hours’ notice, as I recall. And it was very well received. I think your wife Kate spoke this year at our virtual WCICON21, and also did really well. But how’d you get to be such a talented public speaker?
Dr. Victor Mangona:
Well, I appreciate that. Thank you very much. I actually did not know about the deadline last year for the applications. And I was like, “Oh, I missed the deadline”. So, I was bummed I didn’t apply, but I was there and I love giving public presentations. Now, it’s interesting. I didn’t do debate or forensics or any of those things in school. And even when we had plays, I didn’t like to do plays in high school.
Dr. Victor Mangona:
So, I attribute it to two things. One, again, I love teaching and I’ve always been a teacher. But two, my parents started me in violin when I was like six years old. And one of my teachers, when I was in middle school, high school, actually had us do a recital every single month. So, I had to prepare and perform something new every month for probably years. And that repetitive nature of performing got me past the stage fright. I still have some stage fright.
Dr. Victor Mangona:
But I really started to enjoy that opportunity and being able to perform. And I spent two years teaching and I became very comfortable teaching, talking to crowds and often actually doing things with very little preparation. I think that’s actually one of my strongest skills is being able to not just do improv, but be able to be ready to speak on a moment’s notice, which is basically what we did last year. And it was a great time. I had an excellent time being able to give my lecture and talk to everybody afterwards. Thank you for the opportunity.

Dr. Jim Dahle:
Yeah. Your talk there was about cash balance plans. And somewhere along the way, you’ve developed an expertise on these somewhat unusual and surprisingly physicians’ specific retirement accounts. How come you know so much about cash balance plans?
Dr. Victor Mangona:
I’m in a very large group by 400 plus people, maybe similar to your group size. And people say changing things in our group is like redirecting an aircraft carrier. So, it took years of prodding, but at the end of the day, I had to convince enough people to make this happen. And I was not going to get there without having basically expert knowledge in this area in order to convey enough information, to get enough people on board, to instill a change in a group that’s a larger group of mostly older physicians.

Dr. Jim Dahle:
Which is exactly the kind of group that should consider a cash balance plan. So, you had a pretty easy sale, once they got the information about them, at least. But for the sake of our listeners, can you explain what a defined benefit cash balance plan is?
Dr. Victor Mangona:
Okay, excellent. That is actually the right term. Defined benefit cash balance plan is a type of a defined benefit plan. When we look at retirement accounts, we basically have our defined contribution plans, like a 401(k) where you define how much you’re putting in at $19,500.
Dr. Victor Mangona:
And you have the other end, which are the defined benefit plans or pension plans. And a lot of people think of the old school pensions, like what people would have gotten a say, if they worked for IBM or Chrysler, Ford, GM, where you get a certain amount of money per year after you retire. And a lot of people in academia have those types of pensions.
Dr. Victor Mangona:
A cash balance pension, a subtype of defined benefit plan lies as kind of a hybrid between the two. It still falls in the category as a defined benefit plan, but it’s purpose is designed not so that you have an annual income distribution after you retire or an annuity per se, but that you take the lump sum.

Dr. Victor Mangona:
And that lump sum is a lump sum at any point, during the entire time you hold onto this every single year, when your account gets credited, there’ll be a certain amount of dollars, cash balance that you have assigned to you that you know that your balance is worth.

Dr. Victor Mangona:
As opposed to other traditional annuities, where it’s kind of a black box where you don’t really quite know how much your pension is worth. For example, social security. You know kind of how much we put into it, but there’s no lump sum option to social security. I don’t think it would really work if that were an option. And you don’t know at any point in the process, what it is really worth. A cash balance defined benefit plan has a clear balance directly associated to each individual person who is participating in the plan.

Dr. Jim Dahle:
So, essentially, it’s another 401(k) masquerading as a pension.
Dr. Victor Mangona:
Yeah. A wolf in sheep’s clothing, or I like to call it the mega side door, mega backdoor 401(k). So much extra capital that ends up in your 401(k).

Dr. Jim Dahle:
Yeah. That’s a good way to think of it. So, who should consider a cash balance plan?
Dr. Victor Mangona:
Anybody who has extra money to invest beyond their 401(k), that’s basically a prerequisite. Because if your 401(k) is all you can put in anyhow, then that’s all you need. And this is for people who are able to save extra, preferably people who are at a high tax bracket, like 30% federal, or have a high state tax rate. 20% federal tax rate, maybe, and depending on your total financial situation.
Dr. Victor Mangona:
But these are really more for people who are at the higher tax bracket in trying to save more in tax. If you’re trying to seek early financial independence, this is also an excellent vehicle to stash money away tax free on the way in or pre-tax and have that growth, and then allow you to reach a net worth number sooner based on a saving on that tax.
Dr. Jim Dahle:
All right. You mentioned your practice, right? It’s a pretty profitable practice. Doctors are making quite a bit of money in the practice. A lot of them are older, and this worked out really well for them. Lots of them are putting lots of money away. What about younger doctors? Is this worthwhile if you’re still in your 30s, you think? Even assuming you want to save more than your 401(k) can put in, is it worth it if you’re only 35 or is this really something only people at 45, 50, 55 plus should be thinking about?
Dr. Victor Mangona:
Absolutely. If you’re in a high tax bracket and you’re not able to take a lot of other deductions like businesses deductions, if you’re paying a high marginal tax rate, it is very difficult to beat the savings of a pre-tax investment, no matter how you invest, especially when you look at it from a risk adjusted net return perspective.
Dr. Victor Mangona:
So yeah, even at the age of 35, potentially you could get $77,000 into a cash balance pension based on last year’s numbers. And that’s still a lot of money. Is that as much money as some of the older docs? Certainly not.
Dr. Victor Mangona:
But if you’re able to put that money in and the cost to you as a participant is zero or negligible in comparison to their tax savings, definitely is something to look into. And I’ve seen a lot of people who are younger, who have written off these plans because they’ve heard that they shouldn’t because they’re too young. But really you just have to run the math. And if you have a cash balance pension that’s offered to you without any cost to you and you can participate in it and take advantage of pre-tax investing, then absolutely. I would do that way over doing a backdoor Roth.
Dr. Jim Dahle:
Okay. So, pretty much any doc that’s making decent money and saving a lot of money it’s going to work out for. I typically see them in physician partnerships. Private practice partnerships are where I typically see them. Have you ever seen anybody in a university and academic doc with a cash balance plan?
Dr. Victor Mangona:
I have not yet, because from my experience and looking at those at those big academic institutions, they often already have some sort of a pension plan already in place that is more on the traditional benefits side, which is what we often see in government organizations.
Dr. Victor Mangona:
Now, certainly there could be a transition to a cash balance type of defined benefit plan. And I know a lot of for-profit institutions have tried to convert because it decreases the liability risk to the company of having to pay out an annuity at the time somebody retires, but that’s much more difficult in general. Once you have a plan in place, this is a lot easier for places that don’t have something in place already. You can just start it up and set it up this way.
Dr. Victor Mangona:
Cash balance pension plans did not really become clearly documented until 2015 with what we call market-based crediting. It was about a decade before that when the pension protection happened, basically legitimizing past balance pension. So, these are relative newcomers to investment vehicles. And so, a lot of older institutions, academic institutions have been in place a long time before this and couldn’t really have passed down before this 2006 ruling.

Dr. Jim Dahle:
Now what about an independent contractor? I understand now you can go to Schwab or some other places and get a personal defined benefit plan, a personal cash balance plan. Do you think it’s worthwhile for them as well?
Dr. Victor Mangona:
If you are a 1099 contractor, you’re one of the best people to probably consider it because one of the biggest downsides of having a cash balance pension is that your money is pooled with other people. But if you are the entire pool, then this really becomes an extension of your 401(k).
Dr. Victor Mangona:
So, in a lot of ways, they are the best people to take advantage of them. Now, there are some other things that do come into play. The profit-sharing portion of your 401(k) may be decreased. You may not be able to get that full $58,000 between your 401(k) employer and employee contributions. You might have to decrease the employer contribution. But if you can open up that cash balance side, it can be well worth it.
Dr. Victor Mangona:
And at Schwab, I just looked it up. Recently, they had updated their pricing, but it was like $2,250 to set it up and only $1,750 a year going forward. So, that’s pretty cheap, $2,000 a year. And that’s an expense to the business. So that’s tax deductible. And if you’re putting in $50,000 and saving $20,000 on that, that’s an incredible benefit to you.

Dr. Jim Dahle:
Yeah, for sure. Unfortunately, due to the fact that actuaries have to get involved and it’s more complex, it’s significantly more expensive than a solo 401(k), but you can open with basically no costs. But you can’t put $150,000 into a solo 401(k) either. So, that’s really the benefit.
Dr. Jim Dahle:
If you’re in your 50s and 60s, the amounts you can put into these things are pretty impressively high. You can get $200,000 plus into a cash balance plan in the right situation. But you know what? Despite the maximum contributions to plans that can be surprisingly high, why do so many plans have such low contribution amounts?
Dr. Jim Dahle:
Like my practice has planned, for instance, the old plan we had was $30,000 across the board. That was the most anybody could put in. And the new one is kind of age based when the plan started. And so, I’m locked in at just $17,500. That’s all I can put into our cash balance plan right now, which is lame, right? Because I’m in my mid-40s. I should be able to put in $100,000, but I’m stuck at $17,500. Any idea why people set them up this way?

Dr. Victor Mangona:
Yeah. This is a really good question. When I had to go shop around for different administrators and different actuaries, when we were getting it together for our company. And it’s interesting, you can talk to 10 different actuaries and get 30 different plans in terms of how it’s designed.
Dr. Victor Mangona:
And so, it’s really important to know how much people want to put in first a priori and then design it around that. But people don’t want to say how much they’re going to put in until they know what the plan is going to be and how it’s going to work.
Dr. Victor Mangona:
So, you get into this circuitous route of not actually accomplishing anything. But at the end of the day, it’s surprising how variable the setups can be. This is a defined benefit plan, not a contribution. So, it’s the benefit that technically has to be decided upon. And that is in IRS guidelines. But how you calculate that benefit is a lot of actuarial magic, right?
Dr. Victor Mangona:
You can take different presumptions and different things and make the plan look differently. For example, we set a threshold that we could not credit any account by more than 5% in any given year. And by doing that, it increased the total amount that the account could grow to over time, which allowed us to contribute more money.
Dr. Victor Mangona:
Now you also have to consider the demographics of your group because of the way cross testing works and all the other employees. And so, based on your age and how much it can grow to, based on the age of the other employees and how much their benefit can grow to, it can be limited.
Dr. Victor Mangona:
And then further, a lot of times groups don’t want to allow contributions to go so high because anytime you have a pension, it is a liability to the company on paper. It is an employer liability, if there’s a shortage. So, they could limit the amount that goes in because they want to limit the risk to the business.
Dr. Victor Mangona:
And sometimes, different partners may not want to take on the risks of other partners. And they agree upon things that, for example, if you’ve told your group different people can get different numbers of vacation dates. And then people said, “Well, that’s not fair”. The only way to be fair is to give everybody the same. And then you all decided, well, that’s what we’re going to do is going to be the least number of vacation days of the range. And there you go, it’s fair. And that’s actually, unfortunately, what you often see in partnerships, right? Because it’s only fair if it’s equal.
Dr. Victor Mangona:
So, I don’t know what went on during the design of the plan. I would certainly shop around and see what other options there are available, see how different plans could be designed with market-based crediting, which allows you to credit amounts that are variable based on the returns of the investment. It can take a lot of that risk off from your company and you can design your partnership agreement, such that the risk to the company may be also mitigated by some personal liability to the person, if there’s a shortage.
Dr. Victor Mangona:
We have it designed so that our company can claw back any shortage that potentially is associated with somebody taking out money that is less than the actual amount of money they have in there. Or their hypothetical balance is more than their amount of invested capital in the fund.

Dr. Jim Dahle:
Yeah. When we’re talking about this risk, what we’re talking about happening is that the value of the assets in the plan fall. A big bear market happens. But that’s not such a terrible thing in a partnership because what you do in that situation is you put more money into the plan.
Dr. Jim Dahle:
So basically, what that forces you to do as a partner is to put more money in during a bear market and actually buy low. It’s a wonderful benefit, not so much a risk of being able to put even more money into your retirement plan at exactly the time you want to put more money into the retirement plan. So, I think that risk is overblown quite a bit. Obviously, some people are going to have cash flow problems doing that, but it’s not nearly as bad of a risk I think as some people make it out to be.
Dr. Jim Dahle:
But what’s interesting is we actually surveyed, and this is probably the reason why our limits are so low in our plan. Only 8% of the doctors in my group max out their cash balance plan. This was the old plan. The old plan was $30,000. Everybody put in $30,000 a year. But only 8% of the docs were doing it.

Dr. Jim Dahle:
And so, there’s just isn’t that much interest. The vast majority of people were contributing the minimum which I think in the old plan was $2,500. So, I guess there’s just not that much interest in doctors in saving much more than they can put into their 401(k). And I think that’s the issue. But why do you think so many doctors don’t want to save more?

Dr. Victor Mangona:
Well, ultimately, it’s interesting. I think a lot of this comes down to misunderstanding and it comes down to education. When it comes down to just saving more, a lot of people just don’t realize how much they really need to be saving. And a lot of people think that maxing out a 401(k), you check off that box in your to-do list, financial to-do list box, and you think you’re accomplishing your long-term goals. But you really have to work backward and say, “How much do I need to be saving?” not “Can I fill up this bucket?”
Dr. Victor Mangona:
For example, if you’re making $500,000 a year, your 401(k) is $58,000, that’s like an 11% savings rate. That’s not going to get the job done if your spending habits are that high, that you’re spending all the rest of that money after tax.
Dr. Victor Mangona:
So, what I did when I first presented this to my group, I said we all have to be saving at least 20% to safely meet our retirement needs. And when the average person or the median person is in the top tax bracket, that 401(k) doesn’t even get them to a 10% savings rate. And so, most people, I think who are earning that high of income are actually not saving as much as they need to be.
Dr. Victor Mangona:
So, the first step is, are you at least getting the job done or what needs to get done? If you’re not, well, here’s a vehicle that will really help you get there a lot faster than investing on the taxable side. It kind of takes away a lot of the decision-making. I think that’s why 401(k)s are so effective. Although there are a lot of people who can argue that they’re not effective.
Dr. Victor Mangona:
But part of the reason why they are effective is because the pain points to participate are very minimal, that you can just participate in a target-based plan and based on your age or whatever year you want to retire. And at least you’re investing, at least you’re getting something in there and your savings rate is really the strongest predictor of your financial security long-term.
Dr. Victor Mangona:
So, it ultimately comes down to really just understanding how these plans work, that the risks of the plans really are not as bad as people make them out to be, like you’re saying. Certainly, cash flow risk, I think, is something that people get scared of. They may be living paycheck to paycheck and they see the money was good this year, the past year. And sure, I could do it this year, but I don’t know what’s going to happen next year. And I may have a kid going to college in two years and I may have to spend that $50,000 for college tuition. And then the year after that, I might have another kid going to college. And so, that cashflow issue certainly becomes a risk. But I think that it’s the minority of people.

Dr. Victor Mangona:
Now, when I talked to one of the actuaries, he said that in a lot of physician’s groups, it ends up being about one-third, one-third, one-third. One-third are all for participating. One-third definitely won’t. And about a third may. And I probably work harder on this one thing that I had done on many other things my entire life was getting this plan going. But we got 174 participants in our first year. People were getting mostly between $50,000 to $100,000 per person. And that’s a group of about 400 people. So, we were almost at half. And then the following year, we added another 32 people. So, I think we’re at about 50% participation just after one full year cycle of it.
Dr. Victor Mangona:
I think that when the new tax rules go into place, oh, I know there’s going to be something different about them. We can all comfortably say there’s going to be some sort of increased tax for the highest earners of which most of my partners are. I think there’ll be a much stronger impetus to participate because now we’ll be on the higher end of the scale of where tax brackets have been. Whereas during this past administration, we’ve actually been on the lower side.
Dr. Victor Mangona:
So, bumping up to 39.6% marginal tax rate and for people who are like in California, where you could easily be adding another 10%, 11%, 12% on top as a state tax rate. I mean, you’re looking at marginal tax rates of 50%, and that’s before accounting for Medicare tax.
Dr. Victor Mangona:
So, I think that once people really understand, if you’re in a situation where you’re in a high tax bracket, if you have the cash flow ability to do it, and you understand that where you are financially, what goals you need to meet, I think a lot of people will participate.

Dr. Jim Dahle:
Now, obviously it’s tax deferred money, so you’re getting the same tax break yard in your 401(k). But do you like to talk about permanent tax savings for W2 employees using a cash balance plan? Explain what the permanent tax saving is?
Dr. Victor Mangona:
Yeah. In our group, all partners are paid straight on W2. When you earn W2 income, you get paid on a W2 paycheck, you pay social security until you hit that wage base limit. And you also pay Medicare tax on all of your money. So, as an employee, you pay 1.45% Medicare tax on all of your earnings. You pay an additional 0.9% on all your earnings north of $250,000 if you’re married. That’s 2.35%. And the employer is paying 1.45% on all dollars that are paid to you on your paycheck. So, in total that’s 3.8%.

Dr. Victor Mangona:
If you own the business, you are both the employer and the employee. If I’m putting $100,000 into my cash balance pension, I’m saving $3,800 in Medicare tax, for me and for my employer, because that money is bypassing payroll. That’s one of the benefits of bypassing payroll is you get away from those payroll taxes. That’s why a lot of people who are in an S-Corp structure, they designed it that way because it helps them avoid putting money on payroll. It shows up on their K-1 as opposed to on the W2.
Dr. Victor Mangona:
You don’t have to pay payroll tax on K-1 income, but as a W2 employee, if you can save that 3.8%, that’s a guaranteed savings. So that money is never going to have to be paid back at least based on all the data we have on tax deferred plans. I mean, who knows what’s going to happen 30 years from now, but there’s no plan, at least in the way we designed 401(k)s to pull back Medicare payroll tax down the road. So that’s a huge benefit. That’s a guaranteed permanent return that you will never lose.

Dr. Jim Dahle:
Awesome. Great. I like how you put that. All right. So, inside this plan, you got to invest the money. The money’s got to be invested and you don’t get to control that as a participant, the company controls that, or the plan controls that. How do you think a cash balance plan should be invested? How does your group do it for instance?
Dr. Victor Mangona:
First of all, you want to maximize your tax savings. You want to limit the liability to other people in your company, and you want something that will work with everybody’s portfolio. So, we designed something that could work for the people who want to have the most stock-heavy or the most bond-heavy portfolio overall.
Dr. Victor Mangona:
We designed ours to be 40/60. That’s 40% stocks and 60% bonds. And we have our money set up at Vanguard. It’s almost all index funds. There’s a little bit of active management on the bond side.
Dr. Victor Mangona:
But at 40/60, the downside risk, the risk of losing more than 10% a year is very low. So, this very much limits the liability to other people and the company. And people who are putting money in here already are putting $58,000 into their 401(k) and probably investing more otherwise.
Dr. Victor Mangona:
So, your cash balance pension is just a portion of your portfolio in aggregate. If you want to be 80% stocks, or if you want to be 80% bonds, you can still likely get there. And even if you’re not, you can have a wide range of asset allocation with very similar outcomes.
Dr. Victor Mangona:
The driving force here is that tax savings will drive up your overall compound annual growth rate to favor maximizing the cash balance plan contribution more so than just what’s your overall asset allocation.

Dr. Jim Dahle:
All right. So, let’s talk about that loss. What happens in your plan if there’s a loss in the account?
Dr. Victor Mangona:
First of all, you might have an account that’s already overfunded. Our account, fortunately, is overfunded and we had over 10% return last year. Our cash balance pension caps the crediting at 5%. So, all of that extra 5% is just extra, it’s sitting in the account. This year we could have, let’s say a 2% loss and all of that surplus will help take care of the deficit. And we would still have extra cash to still credit people with a positive return. We could still maybe give them 2% or 3% for next year. And so, it really depends on the situation.
Dr. Victor Mangona:
Now, if there is a loss and you’re underfunded where the total amount of the balances of the people in their hypothetical accounts is less than the total aggregate amount of the pool pension, then you’re underfunded. And so, you have to make this up over a period of time.
Dr. Victor Mangona:
From my understanding, you have seven years of an amortization schedule to make it up. It’s highly unlikely that that balance over seven years, it’s not going to come back above zero. So, you have to potentially float it for a while, but it’s likely going to get back up there.
Dr. Victor Mangona:
But one of the benefits, again, of having that cap on earnings is allowing people to contribute more, but it also allows us to have a surplus. And that’s something that was really important to our company. We’re a very big company and having a plan where you can have some padding and some cushion, it puts us in a position where we’re much more likely to keep that plan going. And a lot of people can just breathe a little bit more comfortably, not knowing that we don’t owe millions of dollars to people, even though it would get taken care of.
Dr. Victor Mangona:
But still if it went down 50% and we’re at probably 20 million plus in our fund, a 50% drop would be $10 million. That’s a lot of capital. So, we still don’t want to have that liability on our books, even though over time, it should correct itself. And the amount it takes to fix that over time is very minimal, relatively speaking. But yeah, technically you do have to come above water over a period of time. But in most practical scenarios, it’ll come back above water on its own anyhow.

Dr. Jim Dahle:
And a lot of people would say 60/40 is actually pretty aggressive in a cash balance plan. A lot of cash balance plans are even less aggressive than that.

Dr. Victor Mangona:
Yes, absolutely. Some are like 30/70.
Dr. Jim Dahle:
Yeah. Okay. So, let’s talk a little bit about asset protection. These are ERISA accounts. They get the same asset protection as 401(k)s. They get that federal asset protection. Correct?
Dr. Victor Mangona:
Absolutely. And that’s one of the big benefits of this is that it is ERISA protected, and it’s a qualified plan. So, it’s not subject to the risk of creditors. And so, you can actually keep this and no one can come after us. And it’s a lot safer than putting money, for example, in just a regular IRA, which doesn’t have that ERISA protection. And IRAs are variable based on the state and different things. But absolutely this is ERISA protected.

Dr. Jim Dahle:
All right. So how often can you close the cash balance plan and what happens when you do?

Dr. Victor Mangona:
This is where you get different answers from different people, but 10 years is a very comfortable number to work with. I had somebody I know talk directly to Schwab about their plan and they basically have an off the shelf plan design for 10 years. So, 10 years is super safe. Once that 10 years is up, you can close it down and you can roll it over into your 401(k) or into an IRA. At least that’s based on what we know now in 2021. There could be changes tomorrow.
Dr. Victor Mangona:
Now seven years is also probably a good number. I know a lot of people use seven years as their plan for how long to keep this open. And I’ve heard some people go down to as low as five years, although I’ve definitely gotten more hesitation from actuaries about planning to close a plan in five years.
Dr. Victor Mangona:
But seven years seems to be pretty reasonable. That’s maybe where we’re going to aim for. And once you close it down, you could open up another one. So, once it’s closed down that money just stays pre-tax if you roll it over to another pre-tax account. So, it really is like I referred to earlier a mega backdoor 401(k).

Dr. Jim Dahle:
Yeah, exactly. That’s the point of these things. The point is not to leave it in the defined benefit plan for 30 years and then annuitize it and live on it as a pension in retirement. The goal is to get it into your 401(k) or your IRA. And so, closing it is not necessarily a bad thing. The only downside to it is you have some additional legal and actuarial expenses when you close it down. So, that’s a good thing to close it. But the IRS doesn’t want you to close it very often, or it looks like you’re not actually trying to set up a defined benefit plan in the first place.
Dr. Jim Dahle:
7 to 10 years sounds like 5 to 10 years or a change in the business. For example, that’s what happened in my group. I’ve been in this group for 11 years, we’re on our third cash balance plan. And the reason why is because we keep expanding the partnership. When you add twice as many partners you already have in the partnership, it’s basically a new business. We joined a new business.
Dr. Jim Dahle:
And so, we got rid of the old cash balance plan, and started a new one. I’m not sure I like the new one better than the old one, but here we are. And the nice benefit is each time I did that, I was able to roll that cash balance plan into another plan. So, I put mine in TSP, it’s invested in the G fund.
Dr. Jim Dahle:
The only downside to that TSP for me right now is I can’t do Roth conversions in the plan, which I’d like to do. And I haven’t figured out a way to do that. But who knows, maybe the TSP will allow that in a couple of years. You never know.
Dr. Jim Dahle:
All right, well, let’s talk about another aspect of these, which is for older docs. If you get to be 62 and a half, I understand there’s the kind of unique provision in a cash balance plan that allows you to immediately roll the money out of the plan. Can you tell us about that?
Dr. Victor Mangona:
Yeah. So, this is how it really is a back door side door 401(k). Because if you are of age, as soon as that money is invested into your account, you can roll it out. So, for example, the way ours works is they withhold it from your income over the course of a year. So, let’s pretend I put in about $100,000 a year. $100,000 gets withheld gradually from my income, let’s say $8,000 a month. And then at the end of the year, that money has already been all reduced from my W2. And then usually what we do is in March or April, after we’ve done all the processing, they do the profit-sharing contributions for the 401(k) and they put the money vest in your accounts on the cash balance pension side.

Dr. Victor Mangona:
That includes your new contributions, but it also includes the crediting of the prior balance. So, if the balance was zero last year and I put $100,000 this year, once that $100,000 vest into my account, if I were of age, I get to roll that out immediately over. It’s just like doing a backdoor Roth. It goes into one account. It goes out of that account into the place where you want it to be. And it maintains the same tax-deferred status. In a backdoor Roth it maintains the post- deferred status.
Dr. Victor Mangona:
However, one of my listeners fortunately told me about this earlier this year, but with the Cares Act, they actually changed it now from 62 to 59. So, if you’re 59 and a half, you can put in your $19,500 into your 401(k). And as long as your plan documents allow this, this is permitted by the IRS rules, but your plan documents have to still have whatever provisions.
Dr. Victor Mangona:
So, if you put your $19,500 in, you can roll that out immediately. The profit sharing 401(k) and the task balance pension that we get all vested in like April. We could roll all of that money into an IRA immediately.
Dr. Victor Mangona:
And so, it’s really an incredible vehicle for the older doctors, because then they don’t have to worry about this pooled asset. They don’t have to worry about the downsides as much. They will be able to have control of their money basically immediately or within about a year or so. And so, it’s really a great vehicle.
Dr. Victor Mangona:
If you have a group with a lot of older doctors, this takes a lot of risks off the table for the company, and it just allows them to basically add more to the 401(k). There’s not really much downside for those people at all.

Dr. Jim Dahle:
Yeah. It’s even bigger than catch-up contributions on 401(k)’s and HSAs and Roth IRAs. All right. So, does everybody have to contribute? Do all the employees and partners have to contribute? Do they have to contribute the same amount? How is that determined?
Dr. Victor Mangona:
Yeah, so this was actually one of the sticking points that I found out about why our company had not started the plan previously because they had presentations from Fidelity and people were hesitant to open one up because we do have a wide range of income across our partners. But you actually only need to have 50 participants or 40% of your employees.

Dr. Victor Mangona:
So, we have over 400 doctors. It only takes 50 of them to say that they’re going to participate in order for us to be able to keep this open. And if you’re in a small group, like 10 people, you only need 40% of them or 4 of them to participate to keep it open.
Dr. Victor Mangona:
Now, even if you have like 3 doctors and 10 employees, you can still include one of your other employees in the plan just to meet your numbers. And they would have this cash balance pension as one of their benefits. And often you may have to do that just to hit the minimum threshold to get the plan going. And it can be well worth it for the tax savings. But absolutely 50 people or 40%.
Dr. Victor Mangona:
And then the amounts that they contribute, the maximum amount that each person in our group is allowed to contribute is based on their age. And our plan is designed between $50,000 up to $100,000 as their maximum amount. They don’t have to contribute that amount, but they have to make an election of how much they do want to put in. And they’re kind of locked into that for three years and that’s just to make it look like a pension, as opposed to a defined contribution plan. You have to have a steady amount you’re putting in.
Dr. Victor Mangona:
Now you can also design it so that it’s a steady percentage of your income. And for example, if you’re a 1099 person and you really don’t know where your income may be from year to year, you can have a lot more safety, potentially if you could do it on a percentage basis as opposed to a flat dollar amount. So, you don’t have to worry about earning as much. You just have to make that percentage.
Dr. Victor Mangona:
But yeah, there’s a lot of variability. Not everybody needs to participate and not everybody needs to get the same amount, which gives this opportunity for the people who want to participate, to participate and makes it a lot easier to get a plan open in a private group.

Dr. Jim Dahle:
What about the non-highly compensated employees and the 5% rule and non-discrimination testing? Can you tell us about that?

Dr. Victor Mangona:
This is where it gets complicated. So, if you’re a 1099 doc, the part of the real benefit of this is you have no other employees that you have to worry about. It’s just you. Now you could work in a group where you’re doctors, all highly compensated individuals. Those are people who earn more than $130,000 per year. And it’s kind of similar to the social security wage base.
Dr. Victor Mangona:
But if you’re a physician and you have employees like nursing and other staff who earned less than $130,000, then the IRS says, if you’re going to have this extra retirement plan, you have to do it fairly. And that is you have to make sure that you’re giving enough money to the other non-highly constant complaints. This is the same thing that you have to do with a 401(k), especially if you have a profit sharing 401(k), where you’re adding on beyond that $19,500 and adding another $36,000. You have to make sure that the employees who are earning less than $130,000 are earning enough.
Dr. Victor Mangona:
That’s why in our 401(k), we don’t do any of the profit-sharing contributions to people’s accounts until after the year’s over, until like March or April, when we’ve done all that cross testing. So, that cross testing is one of the tests, non-discrimination tests that have to be done, where you look at what percentage of a person’s income is going into their retirement contributions from the employer, across the participants in the cash balance plan, and as well as people who are non-participants and the people who are earning less than $130,000.

Dr. Victor Mangona:
To make it simple for most people and most plans, you’re going to have to give 5% of a contribution to those non highly compensated employees. We call it the 5% gateway. That’s the minimum they need to get. So, if you have an employee making $100,000, that employee will need to get $5,000 into their 401(k) as an employer contribution.
Dr. Victor Mangona:
Now that’s for basically all of your non-highly compensated employees. There are some people you can leave out. For example, people who are new and haven’t put in enough hours yet, they can be excluded from that. But everybody else has to get at least 5%.
Dr. Victor Mangona:
Now, if they get 5%, then yes, you can have a cash balance pension and give allotments of contributions to participants. The amount of that allotment is going to change based on how much you’re getting to those other non-highly compensated employees. So, it could be 5%. It could be 6%, 7% or 7.5% percent.
Dr. Victor Mangona:
And basically, when you talk to an actuary and get a plan design made, they will often make a design of how much people can put in based at those different levels. And if you get to the 7.5% level, then you can get the skyrocket high numbers where you can get almost $300,000 for people who are 62 years old into their cash balance pension, in addition to their 401(k). But that’s at 7.5% percent.

Dr. Victor Mangona:
If you’re at 5%, it’s interesting. Numbers will A) be lower, but instead of the numbers increasing, as people get older, there can be another test that also gets in the way where you end up getting this bell curve shape contribution limit, where in our plan is the people who are between 40 to 45, actually who are getting the most amount in. And the people who are older are getting less.
Dr. Victor Mangona:
At 45 years old, we’re able to get about $100,000 to our partners. And then the people who are 65, it’s only like $50,000. And so, it goes down to the demographics of your group. The age of the employees, non-highly compensated age of your partners. And sometimes you might have some people that throw it out of whack. You might just have to give some employees a little bit extra into their 401(k) to meet the cross testing.
Dr. Victor Mangona:
But this is really where the actuaries get paid. This is super complicated. I’m explaining it at basically the level I understand it. And that’s basically the limit. These calculations are so much more complicated. I’ve talked to multiple actuaries. And I’m like, “Can you just please teach it to me so I can understand it? Because I’m an engineer. I can figure this stuff out”. But this is actuarial math. This is really complicated.
Dr. Victor Mangona:
And it really depends on a lot of the assumptions that are made and how it was designed. I saw multiple plans where one of the plans that was offered to us literally excluded everybody under the age of 40. They can’t contribute at all. And then you could give more to the older people. And then same people, different option. Yes, you could give to people who are younger, but then it affects people who are older.
Dr. Victor Mangona:
I don’t understand how this all works, but you have to be giving them 5% as a minimum. And fortunately, this is probably the only reason why we were able to get open in our group. It was because we were already giving them 5% as a 401(k) contribution to all of the non-highly compensated employees, because we had to do that to make sure we hit our profit sharing numbers. So, we could get $36,500 or $37,000 or whatever it is in a given year.
Dr. Victor Mangona:
In order to max out the profit sharing to all the shareholders, we had to give 5% across the board. Now I wanted to juice the plan up. I wanted to get up to 6% or 7% or 7.5% and really increase the numbers. It wouldn’t have helped me as much as it would have helped the older docs who wanted to put in $200,000 plus.
Dr. Victor Mangona:
But for every percent we were going to add to the employees, it was going to cost over a million dollars. And to get a plan started that people still have this real black box about how this is going to work. And then you tell them it’s going to cost the business a million plus you’re not going to get a lot of people who are going to raise their hands. And that cost, that additional cost was going to be ultimately divided across all the participants. So, the fewer the participants, the more it was going to cost each of us. And if it’s going to cost a one person $10,000 to make up that extra percent, because you don’t have enough participants, then it becomes really not necessarily cost-effective unless you’re getting a really high number.
Dr. Victor Mangona:
So again, it goes down to the demographics of your group and how many people are participating. We have like a 10 to 1 proportion of non-highly compensated to the highly compensated people. And so, that’s like an average number of maybe. Some people work in groups where it’s like 5 to 1 or 3 to 1, and it can make it a lot easier. For us, for every percent costing us seven figures that was going to shut the plan down. It was never going to get off the ground.
Dr. Victor Mangona:
Now I aspire to bump it up to 6%, 7%, 7.5% with a change in the plan as we get more people involved. If we’re at 200 this year and next year, if we get to 300 and the tax brackets go up, this will be like, if the tax brackets go up, I’m going to be paying a lot more taxes. That’s fine.
Dr. Victor Mangona:
But the silver lining is it’ll be a lot easier to get A) more participants and B) people more willing to pay a little bit out of their pocket to their own employees who are own staff. It’s not like we’re paying the government. But pay a little bit more out of their pocket to really crank up that tax savings. If someone’s being able to save an extra hundred thousand dollars, and that could be worth $40,000 federal plus the 4% on Medicare, $44,000 even if you pay a few thousand dollars to your employees. That is well, well, well worth it. So that’s what I’m hoping to happen this year, at least by 2022.

Dr. Jim Dahle:
Yeah. The key with employees is getting them to appreciate what’s coming. If people are realizing how valuable that benefit is, well, maybe you don’t have to give them a raise. And so, it’s not a complete loss for instance.
Dr. Jim Dahle:
All right, let’s see. We’re starting to run short on time, but I wanted to talk about one more topic about these cash balance plans. A lot of people want to invest more aggressively than their cash balance plan is going to invest. Maybe they want to invest in real estate or Bitcoin or whatever, and they can’t do that, at least not easily in a retirement account. How would someone decide whether to fund their cash balance plan versus going and buying a property or a syndication or something like that?

Dr. Victor Mangona:
Yeah. This was actually the biggest bone of contention I had with the individuals, trying to sell them on participating. If you’re at a high tax bracket, you’re paying 40%, 50% marginal tax. That money is gone immediately. That is gone. You’re not going to have that money back.
Dr. Victor Mangona:
It is very hard on a net return risk adjusted basis to get ahead of that tax savings with any return out there. If I’m running against, let’s say Michael Johnson. He is the fastest man in the world, running a hundred meters and I’m running a 50-meter dash. Now I used to run and the 50 meter was like my event. This is like in middle school because they don’t have it in high school. But there’s no way the fastest man in the world will beat me running a hundred meters compared to me running 50 meters. Because I have such a large head start and that’s basically what you’re doing here.
Dr. Victor Mangona:
$100,000 into a cash balance plan would be like $60,000 or $50,000 in your pocket to invest. Now certainly you could invest it somewhere and make huge returns, but those are not risk adjusted compared to the 60/40 or 40/60. So, the risk adjusted return is still going to be way higher if you can save that 40% tax. And so that’s what I tell them.

Dr. Victor Mangona:
And ultimately, again, this is a small portion of your total portfolio. There’s a room in your portfolio for even the most conservative assets. If you wanted to have 70% of your money in more aggressive things then that’s fine, and this is still a small portion and is pre-tax. So, it’s good to have that diversification.
Dr. Victor Mangona:
And that tax savings, it’s just so hard to get ahead of it. And I invest a lot in real estate and I expect to get great returns in real estate, but on a risk adjusted basis, it’s still not going to get there in my tax bracket. And definitely not next year or at least I wouldn’t expect to. Certainly, it can over-perform. That’s based on volatility, right? That’s not necessarily expected.

Dr. Jim Dahle:
All right, we need to wrap up, but you’ve got the ear of 30,000 or 40,000 high-income professionals who are going to listen to this podcast eventually. What have we not talked about today that they should know?
Dr. Victor Mangona:
There are three things I want to bring up. One is on the offense side financially. A lot of people worry about the return of their investment of their investment capital. But what we don’t often talk about, which I think is far more appropriate or far more meaningful is the return on investment of yourself.
Dr. Victor Mangona:
You invested so many years in college, med school, residency, fellowship, et cetera. And how often do people negotiate their salaries? How much more could you be earning doing the same exact job in a different place?
Dr. Victor Mangona:
Your earning potential, you’ve already invested all that time and effort. If you put in as much focus into maximizing that ROI, you’re going to get a lot more gains than you will spending time trying to bump your ROI 1% or 2% here and there on a portfolio.
Dr. Victor Mangona:
Now on the defense side, we often talk about life insurance, disability insurance, but really the biggest financial impact potential catastrophe over your life, not included in those is your marriage.
Dr. Victor Mangona:
And this is what my wife talks about a lot. This is what she talked about at your conference last year, it is investing in your marriage. And it’s something that we often don’t prioritize and put a focus on, but that’s the easiest way for a doctor to have much more difficulty long-term is to go through a divorce. Investing in your marriage is so unbelievably important and often not talked about.
Dr. Victor Mangona:
The last thing about avoiding catastrophes is I highly recommend anybody buying a new car, buying any car. The first prerequisite for a vehicle is to get automatic emergency braking. There’s now enough data out there about the improvement in mortality and morbidity of accidents and avoiding accidents that helps you out financially, but also just the catastrophe of an accident from your personal health, but also your financial liability.
Dr. Victor Mangona:
Because there’s very few things on a day-to-day basis outside of being a doctor that either A) you could die from or B) you could be sued for and lose a lot of money. It’s a car accident.
Dr. Victor Mangona:
So, I think for any higher owner, any physician it’s of very high importance, and if you have kids keeping them rear facing as long as possible is highly recommended. I am a medical engineer and did my research on cervical spine flection and extension injuries. For children, the highest risk of death between one to five is an accident. These are things that you can do to save lives and it really does save lives.

Dr. Jim Dahle:
2018 and newer, right? For automatic emergency braking, that’s when it came out?
Dr. Victor Mangona:
In 2015 it started to come out, but only on the top trim level vehicles. So, it was really expensive to get them. Now you can get base model cars like Kia’s Toyota’s who have AEB on even the base models. So, if we have an easy way to decrease car traumas that money can pay for, and not necessarily a lot of money when it comes down to it, then absolutely we should.
Dr. Jim Dahle:
All right. Well, thank you Dr. Victor Mangona for coming on the podcast today. It’s been wonderful to have you here. And I suspect a lot of people are going to be a lot more interested in cash balance plans after listening to you.
Dr. Victor Mangona:
Thank you, Jim.
Dr. Jim Dahle:
All right. I hope you enjoyed that interview. Cash balance plans. I’ve used them for years. They’re a great retirement account. They’re great asset protected accounts. It’s really worth looking into those.
Dr. Jim Dahle:
For doctors, the story has changed. Visit locumstory.com to see if a locum tenens assignment is right for you. It’s here where you’ll find the unbiased answers you are after so you can decide if locum tenens is your next chapter.
Dr. Jim Dahle:
Don’t forget as well about WCI con 22. It’s February 9th through 12th, 2022. Save the date. We’re going to be in Phoenix. Registration is going to open in September. Watch the monthly newsletter for announcements.
Dr. Jim Dahle:
You can sign up for that free monthly newsletter, which includes a blog post essentially that doesn’t go out on the blog. It only goes out in the newsletter at whitecoatinvestor.com/free-monthly-newsletter.
Dr. Jim Dahle:
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Dr. Jim Dahle:
Keep your head up, shoulders back. You’ve got this and we can help you. We’ll see you next time on the White Coat Investor.

Disclaimer:
My dad, your host, Dr. Dahle, is a practicing emergency physician, blogger, author, and podcaster. He’s not a licensed accountant, attorney or financial advisor. So, this podcast is for your entertainment and information only and should not be considered official personalized financial advice.

The post Understanding Cash Balance Plans – Podcast #223 appeared first on The White Coat Investor – Investing & Personal Finance for Doctors.

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