Over the past decade, cash balance pension plans have skyrocketed in popularity among small business owners, state governments, and large corporations, alike. According to the 2018 Kravitz Cash Balance Research Report, cash balance plans now make up 37% of all defined benefit plans, compared with only 2.9% in 2001. But while the state governments and larger corporations were the first to gain attention for switching to this retirement option, it is in fact the small and mid-size businesses that are fueling this growth with 92% of cash balance plans being in place at firms with fewer than 100 employees such as medical practices, law firms, CPA firms, and high-income family businesses.
What Are They and Why Are They So Popular Amongst Small Businesses?
A cash balance plan is a “Defined Benefit” plan whereas a 401(k) is a “Defined Contribution” plan. With a 401(k) an employee makes contributions to a retirement plan which may or may not be matched by the employer. An employee’s retirement benefits depend on the performance of the market, the success of the funds that hold the 401(k) contributions, and the amount of contributions the employee makes.
With a cash balance plan, an employee’s benefits are “defined” and will not change. The employer, not the employee, bears the risk of market fluctuations with this option as the employer is the one providing the cash funding for each employee’s plan. Each participant in the plan has his or her own designated benefit amount that is guaranteed and insured by the Pension Benefit Guaranty Corporation. Unlike with traditional pension plans, the benefits an employee accrues can be transferred as a rollover or taken as an annuity if the employee leaves the company or retires.
The Benefits for Small Business Owners
Research has shown that many small business owners of the baby boomer generation have spent years and years continuously directing their assets into the growth of their business, but have neglected to prepare a retirement plan that will actually support their lifestyle after they discontinue working. This means that more business owners are nearing retirement and are fiscally underprepared for it.
Cash balance plans offer a way to supercharge lagging retirement savings because they boast higher annual contribution limits and allow for an increased number of tax deductions. The 2019 total 401(k) contribution limit with profit sharing is only $62,000 which is grossly insufficient for retirement accounts that are already behind.
However, the annual limit for a cash balance pension plan at age 55 is $203,000. These higher contributions allow for a considerable increase in savings over a shorter period of time allowing business owners to retire with lots of life left to live.
Furthermore, cash balance plans afford business owners hefty tax breaks. Plan contributions reduce adjusted growth income, which helps to counteract taxes on both net investment income and payroll.
Not only does implementing cash benefit plans allow you to invest more in your business and your own retirement, but also in your employees. Funding your employees’ cash balance plans reduces your business’s taxable income and allows you to offer those savings back to them—benefits such as this help businesses retain key individuals as well as attract qualified, prospective candidates.
So, Is This Right for Me?
If you are a thriving small business with the cash flow to fund yours and your employees’ pensions, then this might be a great way to drastically save on income taxes while rapidly reviving your retirement account. Some business owners are dismayed with the higher initial setup costs of cash balance plans as they can range anywhere from $2,000 to $8,000. However, the initial costs will be offset by the annual tax savings these plans afford.
Cash balance plans are designed to truly benefit the business owner as well as key employees. If funding each of your employees’ individual plans is feasible for your business, you have the potential to take the money you would normally have to pay the IRS and distribute it back into the growth of your business, into the care of your employees, and into your own retirement account.
Investment Advisory Services offered through Resolute Wealth Advisor, Inc., a Registered Investment Advisor.
Resolute Wealth Advisor does not provide tax or legal advice. This material was not intended or written to be used or presented to any entity as tax advice or tax information. Tax laws vary based on the client’s individual circumstances and can change at any time without notice. Clients are urged to consult their tax or legal advisor before establishing a retirement plan.