Cash balance retirement plans

Are you a successful business owner or professional service provider who has the problem of paying a lot in taxes because you are strong earner?  Do you feel like your 401(k) plan contributions are not enough and would like to do more?  Perhaps a cash balance plan might be a viable solution for you, either as a sole business owner or a business owner that has employees. 

A cash balance plan is a qualified retirement plan that can be adopted as a stand-alone retirement savings solution or complement or supplement an existing retirement plan like your typical group 401(k) or solo 401(k) plan.  A cash balance plan can be described as a “hybrid” between a defined contribution plan, where the employee bears investment risk, and a defined benefit plan, where the employer bears investment risk, in that cash balance plan participants' account balances will grow annually based on the employer's actual contribution as well as a guaranteed interest credit.    

Cash balance plans consist of pooled investments and the scope of the underlying investment options can extend beyond ordinary 401(k) plan investments.  The primary objective of a cash balance plan is to allow participants to save for retirement while achieving a potential maximum tax deduction. See the chart below for potencial contribution limits for 2022:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

*401(k) Maximum contribution limits for 2022: $20,500 Salary-deferral; $6,500 Catch-up for 50+; $40,500 profit sharing.

As shown above, the amount of potential total pre-tax deduction may be significant.  The overall tax deferral that results is dependent upon the account owner’s effective federal and state income tax rate, as applicable.  Please consult with your professional tax advisor to determine the tax benefits that might be achieved with adopting this or any other qualified retirement plan. 

If compensation is lower than the IRS maximum compensation limit, the 401(k) contribution amounts will be reduced. Other deduction limits may impact contribution amounts as well. Maximum cash balance amounts assume a 3-year average compensation of at least $245,000 annually. Lower averages may reduce contribution and tax-savings amounts shown.

The pooled investment performance of a cash balance plan must be assessed annually as it determines future employer contributions.  If the plan's investment earnings exceed the guaranteed rate, the excess will be used to reduce future employer contributions but will not affect the amount credited to participants' accounts.  The opposite or inverse fact pattern or scenario holds true as well. 

Based on the chart above and the fact that this type of retirement plan is geared towards those who generate higher incomes and have sufficient excess disposable income to be able to defer it, the best candidates for cash balance plans tend to be:

  1. Those seeking a tax deduction of $50,000 or more and earn $250,000 or more per year
  2. Highly profitable businesses of all types and sizes, including family owned or closely held
  3. Professional services, including CPA and law firms, medical and dental practices, engineering, and consulting firms, etc.
  4. Business owners closer to retirement who want or need to condense and accelerate their retirement savings into a very short period.

If you believe you and your business fit the criteria above and you want to emphasize and concentrate on tax efficient savings, please contact us for more information as we would like the opportunity to answer any questions and help you design and implement a plan.