The ERISA consultants at the Retirement Learning Center Resource regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.
A recent call with an advisor in New Mexico is representative of a common question related to maximizing retirement plan contributions. The advisor asked:
“How can I determine if a cash balance plan might be a good fit for a business owner?”
Highlights of Discussion
As a type of defined benefit plan, a cash balance plan requires an adopting employer to fund the plan to provide participants with a promised retirement benefit. Cash balance plans are most popular among smaller, well-established firms that have significant and consistent cash flow (e.g., law firms, medical groups, and professional firms such as CPAs, architects and consultants). They also work well for older small business owners who are no longer making heavy investments in their businesses, and have significant amounts of pass-through income, resulting in high tax bills.
To determine an employer’s suitability for a cash balance plan, consider the following questions. The more “yes” responses the greater the possibility a business could benefit from having a cash balance plan.
Question |
Yes |
No |
Why it Matters |
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The potential to contribute more income to a cash balance plan increases with age. |
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If the owner has put money into the business in prior years, the business is now, likely, well established, freeing up capital. |
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This can lead to discussions on how to reduce a large tax bill. |
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Cash balance plans allow for higher contribution and deduction limits than defined contribution plans. |
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NQDC plans do not reduce taxable income for business owners of pass-through entities. |
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Cash balance plans are less complicated to maintain than traditional defined benefit plans, and design features allow owners to maximize contributions for themselves. |
As the table below illustrates, cash balance plans can allow much higher levels of contributions than a profit sharing or 401(k) plan. That equates to higher tax deductions for business owners. For some businesses, having both a defined contribution and cash balance plan may be appealing.
Conclusion
There are some key characteristics to look for in a business owner when evaluating whether a cash balance plan might be a good fit. For the right candidate, a cash balance plan—or even a combination cash balance and defined contribution plan—can provide significant benefits.
Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Consumers should consult with their tax advisor or attorney regarding their specific situation.
©2022, Retirement Learning Center, LLC. Used with permission.