Beyond the 401(k): Cash Balance Plans for High-Earning Small Business Owners
If you are a small business owner, you are probably aware of how setting up a 401(k) can help you defer portions of your income as a tax-efficient strategy for building wealth.
In 2020, employees/owners are generally permitted to contribute up to $19,500 each year into a 401(k), while those over 50 are allowed to make an additional catch-up contribution of $6,500. There may also be a company match in place, as well as a Profit Sharing component, which can carry total contribution limits of up to $57,000 not counting the catch-up contribution1. Of course, 401(k) plans are subject to certain non-discrimination plan testing, so it is important to coordinate your plan with a CFP® professional for help with oversight and compliance.
After You Max Out Your 401(k)
For high-income business owners, typically making over $250,000 a year and who already maxing out their 401(k) and profit sharing contributions, there is an additional powerful strategy called a Cash Balance Plan which has potentially even higher contribution limits. The following is a table of the 2020 IRS Contribution limits for Cash Balance Plans, when used alongside a 401(k) with Profit Sharing Plan2. As the table indicates, contributions to a Cash Balance Plan can be significant and allow for the potential of massive tax deferral/savings each year. Since high-income earners can be in much higher tax brackets, the combination of current year tax savings and tax deferred growth can be powerful.
2020 IRS CASH BALANCE PLAN LIMITS
Key Advantages of Cash Balance Plans
- Higher contributions limits than a 401(k) Plan
- Ability to capture tax-deferred growth on a larger pool of assets
- Increased asset protection from creditors on assets in the plan.
- Accelerated retirement plan timeline
- Flexible Investment Options
- Ability to rollover the Cash Balance proceeds into and IRA upon terminating the Plan
Our Partnership With Kravitz- A Leading Third Party Administrator
We have partnered with Kravitz, a Third Party Administrator who specializes in Cash Balance Plans to deliver Cash Balance Plan solutions to our clients. Kravitz is a subsidiary of Ascensus, a highly respected leader in the space. Please see the following video for more details.
Cash Balance 101:
A Cash Balance plan is a type of retirement plan that belongs to the same general class of plans known as “Qualified Plans.” A 401(k) is a qualified plan. These plans “qualify” for tax deferral and creditor protection under ERISA.
Participant accounts grow annually in two ways:
- The company contribution – a percentage of pay or a flat dollar amount – is determined by a formula specified in the plan document, and;
- An annual interest credit. The rate of return is guaranteed and is independent of the plan’s investment performance. That rate changes each year but usually is equal to the yield on 30-year Treasury bonds, which has hovered around 5 percent in recent years.
When participants terminate employment, they are eligible to receive the vested portion of their account balances, which can be rolled over into an IRA account.
Who is a good candidate for Cash Balance Plans?
- Higher-income partners or owners who desire to contribute more than $50,000 a year to their retirement accounts.
Many professionals and entrepreneurs neglect their personal retirement savings while they’re building their practice or their company. They often have a need to catch up on years of retirement savings. Adding a Cash Balance Plan allows them to rapidly accelerate savings with pre-tax contributions as high as $100,000 to $260,000, depending on their age. - Companies already contributing 3-4% to employees, or at least willing to do so. While Cash Balance Plans are often established for the benefit of key executives and other highly compensated employees, other employees benefit as well. The plan normally provides a minimum contribution between 5% and 7.5% of pay for staff in the Cash Balance Plan or a separate Profit Sharing 401(k) plan.
- Companies that have demonstrated consistent profit patterns. Because a Cash Balance Plan is a pension plan with required annual contributions, consistent cash flow and profit is very important.
- Partners or owners over 40 years of age who desire to “catch up” or accelerate their pension savings.
Maximum amounts allowed in Cash Balance Plans are age-dependent. The older the participant, the faster they can accelerate their savings3.
1 hour CPE credit offered for CPAs
As part of our partnership with Kravitz, we offer a 1 hour Continuing Professional Education (CPE) presentation for CPAs seeking to learn more about Cash Balance Plans. Feel free to contact us to schedule the presentation.
Interested in Learning More? Let's Talk
Footnotes/References
- https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits
- https://www.cashbalancedesign.com/resources/calculators-tools/maximum-contribution-calculator/
- https://www.cashbalancedesign.com/resources/cash-balance-101/
- https://www.irs.gov/retirement-plans/retirement-plans-for-self-employed-people