Understanding Cash Balance Plans

Business owners need to understand what cash balance plans are and how they work.  These types of plans are becoming increasingly popular among business owners who want to provide both themselves and their employees with a steady stream of income in retirement and provide the business with a significant tax deduction today.  There are many types of plans available to small businesses and we have a few outlined in our Retirement Plans for Small Business: Comparison Chart.

Cash balance plans are a type of defined benefit plan that combines the features of a traditional pension plan with those of a defined contribution plan. Unlike traditional pension plans, cash balance plans provide participants with individual account balances that are more easily understood and managed.  This plan works by having the employer set aside a certain amount of money each year for each participant. This amount is usually based on a percentage of the participant’s salary, and it is credited to the participant’s account with interest. The interest rate is usually based on a fixed rate or a rate tied to an index, such as the 10-year Treasury rate. The account balance grows over time, and the participant is guaranteed a certain benefit at retirement, regardless of the investment performance of the plan.

A big advantage of cash balance plans is that they can provide significant tax benefits for employers. Contributions to cash balance plans are tax-deductible, and the interest earned on the plan’s investments is tax-free. Additionally, cash balance plans can be used to help business owners save for retirement. Because the contribution limits for cash balance plans are higher than those for other types of retirement plans, business owners can use them to save more for retirement and reduce their tax liability.

Real Example from a Family We Serve:

We had a family we work with that has been consistently showing a net profit of $1MM per year.  At tax time this profit is all taxable to the two owners, 50% each.  With the use of a cash balance plan, we were able to have them defer about $300,000 of their profit into the cash balance plan (about $150,000 per owner).  This allowed the business to deduct this contribution reducing their tax liability by approximately $120,000 in total and reducing the taxable profit down to $700,000.  This is a powerful tool when used properly.

Some key considerations for a cash balance plan are that they can be more attractive to younger employees who may not be as interested in traditional pension plans which can help employers attract and retain talent.  They also can be more expensive to set up and administer than other types of retirement plans. Additionally, they may not be appropriate for businesses that have a high turnover rate or that are in industries with a volatile workforce. Lastly, these plans tend to not be as flexible as other plans may be.  It is important to weigh the pros and cons for your business and consult with a fiduciary advisor to determine what may be right for your company.

We would be happy to schedule a time to discuss how we can help your business review your current retirement plan or options that may be available.  Feel free to schedule a 30 Minute Zoom Meeting for us to discuss this.

The hypothetical investment results are for illustrative purposes only and should not be deemed a representation of past or future results. Actual investment results may be more or less than those shown. This article represents the opinion of Mitlin Financial Inc. It should not be construed as providing investment, legal and/or tax advice. Investing involves risk, including possible loss of principal. No strategy assures success or protects against loss. To determine what may be appropriate for you, consult your financial advisor.

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