Cash Balance Plan at Your Biz?

If you own a business and want larger tax deductions and increased retirement contributions for yourself and your employees, think about a cash balance pension plan.

A cash balance plan acts as a kind of hybrid retirement plan specifying both the contribution credited to each participant and the investment earnings credited based on the contributions. This contrasts with other, more traditional retirement plans and pensions based on how long you or your employee worked on the job and the average salary in the last few years of employment.

The interest crediting rate matches the rate of the 30-year U.S. Treasury bond; target return for 2014 is approximately 3.75%. Federal insurance through the Pension Benefit Guaranty Corp. protects the benefits in most cash balance plans.

Let’s say you are a 51-year-old business owner with annual income of approximately $1 million. You already max out your 401(k) and profit-share contributions of $57,500, leaving you with earned income of $942,500. How do you reduce taxes on that income?

A cash balance plan offers you the business owner a legal avenue to defer taxes on large sums of income. You will pay taxes on the money later – perhaps in a lower tax bracket. Typically, a participant’s account receives an annual pay credit (such as 5% of compensation from you, the employer) and an annual interest credit (either a fixed or a variable rate linked to an index such as the one-year Treasury bill rate).

In the example above, you may be able to contribute an additional $200,000 a year to your plan (your contribution rides on many factors, including your age and income and the ages and income of the other participants). In five years you contribute an additional $1 million to your retirement account.

Account balances define payouts. Your employee with an account balance of $100,000 at age 65 and who decides to retire receives an annuity based on that balance. In many plans, your participating employee can instead choose a lump-sum benefit equal to the balance.

(This employee, who’s presumably leaving your company, can generally roll the payout over into an individual retirement account or to another employer’s plan if possible.)

Another distinction for business owners: The employer (or an investment manager you appoint) manages investments of the plan.

Ideal businesses for cash balance plans: law firms, medical groups, family businesses, highly profitable companies, professional firms, companies with older owners who never saved for retirement and companies that want to retain key employees.

In recent years, companies using most cash balance plans employed fewer than 100 staffers (63% of plans had fewer than 36 participants) and most plans combined with a defined contribution (DC) plan (where a company sets aside money annually for employees). Here are the most common factors to determine if a cash balance plan fits your business:

  • Owners and employees want to contribute more than that $57,500 toward retirement. Adding a cash balance plan allows you to rapidly accelerate savings with pre-tax contributions as high as $100,000 to $220,000 depending on a participant’s age.
  • Business owners willing to contribute 5% to 7.5% to employees. Cash balance plans are designed to benefit owners and key employees and typically require this range of contributions. (I often find business owners using this additional contribution in lieu of a pay raise.)
  • Companies with consistent profit patterns. As the plan requires annual contributions, consistent cash flow is very important.

Some once called these plans age-discriminatory because younger participants accrue more interest credits than older participants. Internal Revenue Service rules for calculating lump-sum payments also sometimes produced distributions greater than account balances.

The Pension Protection Act of 2006 solved these problems, opening the door to a potentially powerful retirement tool for your business.

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Scott Thompson is the co-founder of Thompson Wealth Advisors (TWA), a Registered Investment Advisory firm with offices in Statesville and Mooresville, N.C. TWA specializes in helping business owners maximize the value of their business and preserve their personal wealth. Scott holds Series 7, 24, 63 and 65 licenses and is a Certified Specialist in Retirement Planning. Laura Thompson (co-founder) is a Certified Public Accountant and Certified Specialist in Estate Planning.

Securities offered through Geneos Wealth Management, Inc. Member FINRA/SIPC. Business Exit Planning Services are only offered through Thompson Wealth Advisors, RIA.

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