What does your retirement financial planning include? If you’re like most, you have a 401(k) or perhaps an IRA. Maybe a supplemental investment account or a Health Savings Account to help fill in, when needed. However, as traditional pension plans subside, many retirees are finding that 401(k) and IRAs are simply not enough to cover living expenses, even with the extra contributions allowed as retirement comes within reach.
Enter the cash balance pension plan. This super tool for retirement financial planning helps build savings while greatly reducing taxable income. It’s something every small business owner should not only know about, but also consider employing.
Why Choose a Cash Balance Pension Plan
The cash balance pension plan is a defined-benefit plan that company owners can utilize to contribute a large amount to a retirement account while also providing a sizable contribution to the employees as well. One of the key benefits of the cash balance pension plan is the ability to contribute large amounts of money, pre-tax, as part of your retirement financial planning, and then save in tax deductions.
The plan can be used in combination with other popular retirement plans, such as a profit sharing plan or 401(k), particularly after you have reached the maximum contributions for those accounts. Contribution limits for a cash balance pension plan increase with the account holder’s age; those 60+ can contribute over $200,000 a year. That’s more than three times the combined employee and employer contribution limit for a 401(k)!
Small business owners stand to benefit most from cash balance pension plans. The plan works when you: a) have consistent profits, and b) make contributions to employee profit sharing accounts, including your own.
Increasing You and Your Employees Investment Potential
In fact, passing the savings opportunities on to your employees is a requirement for all cash balance pension plans. An employer credits an employee’s account with a set percentage of his or her salary, plus interest. The account is professionally managed and the employee is promised a certain benefit upon retirement.
The benefit is represented like a 401(k)-account balance – not a monthly stipend. When the employee retires, he or she takes an annuity or lump sum. But unlike a 401(k), changes in the market or the employee’s portfolio do not affect the contribution.
On average, the contribution to employees’ accounts is equal to about 7% of employees’ salaries (typically around 4% for the cash balance plan portion and 3% from the 401k match – if they have a 401k with the cash balance plan). That means that the cash balance pension plan tends to work best for businesses with fewer employees.
This plan does come with setup and administrative fees, like most retirement accounts. And the contributions to employee accounts will likely be higher than 401(k) plans. However, the ability to add significantly more to your wealth via this effective retirement financial planning strategy plus the potential savings in tax deductions more than make up for the fees.
The Plan of Choice for Small Business Owners
This secret weapon of retirement financial planning epitomizes one of Stableford Capital’s highest values: it’s not what you make, it’s what you keep. In fact, the potential tax savings is so high that it could hit six figures. The more you contribute to the plan, the more you save in taxes. Because of this, the plan is particularly attractive to higher earners.
Additional small business owner benefits:
- You can combine with a Profit Sharing 401(k) plan to play catch up with your retirement funds while reducing your tax liability. This could literally translate to putting tens of thousands of additional retirement dollars away and getting a tax deduction for every dollar you contribute.
- If you are a partner or owner in a professional firm with multiple owners or partners, such as law firms or dental and medical firms, all the owners/partners can potentially defer more than $300,000 per year into a retirement account.
- The cash balance pension plan could be a work-around for the pass-through entity income limits recently set in the 2018 tax law changes. This is for small business owners who report their business income on their individual tax returns (LLCs, S Corps, partnership, etc.). The Treasury Department is still working out details of the tax changes, but recently proposed a 20% deduction and is pushing for other limits to what it terms “abusive” retirement financial planning practices.
- You can roll cash balance pension plan balances into an IRA to manage the funds yourself. You then pay taxes when you pull money out, usually when you are in retirement and taxed a lower bracket than when you were working.
- Bonus benefit to employees. Since traditional 401(k) contributions hover around 3% for employees, the cash balance pension plan average rate can double that contribution.
Retirement Financial Planning in Action
At Stableford Capital, we have several small business owners who have taken advantage of all the benefits that cash balance pension plans can offer. And because these plans can be used in different ways dependent upon each individual investor and business owner’s unique situation, here are a few examples to consider.
Client A is in his 60s and owns a small business that provides large tools and services for oil companies. The company employs 14 people, does not have a retirement plan for those employees, but does have extra cash at the close of each year. By combining a 401(k) and profit sharing/cash balance plan, the owner would be able to contribute an annual $325,000 into a retirement account for himself.
Client B, a husband and wife team, owns a small business that provides construction, service and equipment sales for a specific niche market. The company employees 50 people and was already matching 10% for their current 401(k). The company could continue matching at its current level AND add the cash balance plan, allowing the owners to defer over $600,000 each year.
Client C are small business owners in their 40s with a niche in home automation, security and networking for high-end homes. The company employs 15 people and does not have a retirement plan. Adding a 401(k) and profit sharing/cash balance plan combination would allow the owners to defer over $150,000 each.
While each small business and owner is different, the consensus is clear that a cash balance pension plan could be a significant boost to retirement financial planning. And because Stableford takes an integrated advisory approach, we are focused on not just how to grow your wealth, but also how to keep it. To learn more about creative and innovative retirement financial planning strategies, contact a Stableford advisor today at 480.493.2300.