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LF 401K BLOG

Cash Balance Plans

11/17/2017

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Are you a business owner who’s spent your life investing in your business rather than your retirement?

What if I told you that you can put away $200,000 plus in pre-tax dollars to catch up on retirement savings? And at the same time, lower your taxable income by that same amount in the current year?
 
If you’re an older business owner, you can do just that…
 
How does a Cash Balance Plan work?

A cash balance plan is a hybrid of a pension plan and 401(k). Like a pension plan, the cash balance plan is a defined-benefit. This means that unlike a 401(k), participants are guaranteed benefits using a computation that involves employment tenure and salary history among other factors- regardless of rates of return earned in the portfolio.
Contributions made to the plan are based on how much is needed to fund those benefits, which are defined using the previously described formula. Typically, cash balance plans are funded by a certain dollar amount or a percentage of an employee’s salary. Plus, an interest credit rate which is fixed or can be tied to the 30-Year Treasury rate.
Participants in cash balance plans have “hypothetical” account balances and projections as to what their defined benefit will be at retirement. Once retired, plan participants can cash out their vested portions via a life annuity or a lump sum payment.
For any employer who employs at least one other individual, offering a 401(k) plan as well is necessary to ensure non-discrimination testing meets IRS requirements.
 
How do business owners benefit from the Cash Balance Plan?
​
1) Catching Up on Retirement Savings
Business owners/partners/highly compensated employees can realize contributions higher than $55,000/$61,000 per year 401(k) plan limits.

Because maximum annual contributions are based on age, the older a participant is, the higher contribution limits are because they have less time to meet the required “hypothetical” account balance needed to fund the defined benefit at retirement.

Some owners can contribute AND deduct over $220,000 in 2018

PLUS, an employer should offer a 401(k) plan at the same time. For older business owners, this means another $60,000 of retirement savings contributions and reduced taxable income!
 
2) HUGE Tax Savings
Contributions directly reduce an employer’s ordinary income, dollar-for-dollar. Investment income is tax deferred until funds are distributed by the plan.

If you’re an older business owner and you contribute $100,000 into your plan, you will not be taxed on that $100,000 in the current year. As you can imagine, this can lower your tax bracket today, while also lowering future taxes as you withdraw during retirement at a lower income level.
 
Disadvantages

1) Owner Liability
Owners take all responsibility for plan performance and adequacy. However, cash balance plans are covered under the Pension Benefit Guarantee Corporation

2) Cost
Cash balance plans are costlier than a 401(k) plan or SIMPLE plan, but the ability to put away hundreds of thousands into retirement while seeing bracket lowering tax savings at the same time far outweigh any extra setup, administration, or management costs.

3) Business Income Stream
A steady stream of business profit is necessary to afford to maintain a cash balance plan. So those who cannot rely on certain levels of profit should avoid these plan types.

4) Number of Employees
The more employees your business has the more expensive it will be for you to run a cash balance plan, but remember, your taxable income is reduced by the contribution amounts.
 
Who Should Implement a Cash Balance Plan?
Small business owners who:
  • Make over $200,000/ year
  • Have few employees OR
  • Employ low wage earners
  • Have steady, predictable profit
  • Are older and need major catching up in retirement savings
  • Are straddling tax brackets
 
 
If you share these characteristics and want to hear more about how a cash balance plan can help you catch up on retirement and lower your taxable income, contact us for more information
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  • Home
  • About Low Fee 401k
  • Physician Retirement Plan Services
    • Starting a 401k
    • Review Your Current 401k Plan
    • Help Me Decide What Kind of Plan to Use
  • Blog
  • Contact