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If you are a small business owner, an entrepreneur or self-employed, there’s a good chance you keep a close watch on ways to manage time and money more efficiently, which of course extends to the subject of taxes. A helpful tool gaining traction this year is something called a cash balance plan. A cash balance plan is a powerful retirement option that combines the better parts of traditional pensions and 401(k)s for an attractive solution for maximizing tax deductions as a small business owner.
A cash balance plan is a defined benefit plan with a simplified process. Unlike a traditional pension, a cash balance plan is presented more like a 401(k), with each participant having an account with a pay credit – either a percentage of salary or a flat sum – and an interest credit that grows annually. The main difference is that the employer is responsible for guaranteeing the promised benefit instead of the market. Due to this structure, there can be much higher contribution limits than a typical 401(k), great for high-income earners or business owners trying to amplify their retirement savings.
For example, let’s consider a 52-year-old business owner who is generating $750,000 in annual income. After contributing to a 401(k), she has found that she has hit the contribution ceiling. After adding a cash balance plan, she contributes an additional $180,000 for the year, which not only significantly increases her retirement savings, it reduces her taxable income. If she repeats this over the next ten years, that would be over $1.8 million saved for retirement with the added benefit of tax savings.
If a small business is looking for a retirement plan offering the most tax deductions, a cash balance plan is going to be the one. Small business owners are able to save more to keep their retirement goals on track while paying less in taxes. Since contributions to the plan are tax deductible, this can allow for quite substantial contributions per year, also offering:
Some business owners might be rightfully concerned about the cost of a cash balance plan, considering there is more administrative oversight required than what one might find with a SEP IRA or solo 401(k). However, those costs are typically outweighed by the tax savings and retirement benefits, with additional ways to predict and manage associated costs, including:
Small business owners particularly love cash balance plans because they are structured in a way that benefits entrepreneurs who have spent so much time dedicated to the success of their business. It’s common that so much money has been invested into a small business that there isn’t much leftover for a retirement contribution, and this is a solution that helps remedy that. For older business owners, it’s a fantastic way to make up for limited retirement contributions, instilling a sense of control over your financial future. Some of the best benefits of a cash balance plan include:
More familiar retirement plan options include SEP IRAs or 401(k)/profit sharing plans. These are a great option, but have certain limits that aren’t conducive to high-level contributions or tax deductions. While alternative plans often cap out around $66,000 per year total, a cash balance plan offers the ability to contribute up to $100,000-$300,000+ per year, depending on age and income. This allows the chance to quickly increase retirement savings, a great advantage for business owners who have previously bypassed retirement savings to build their business. While admin requirements can be more extensive, the trade-off for most business owners is worth the extra effort.
If you’re reading this as a small business owner, you might be ready to learn more about cash balance plans, especially if you’ve been wondering about ways to maximize your retirement contributions and tax deductions. Most small businesses are eligible for a cash balance plan, whether you’re on your own or have employees. For the most flexibility, it’s best to start as early in the year as you can, designing the plan to fit your specific structure. To set up a cash balance plan:
Q: Is it a requirement for a small business to include their employees in a cash balance plan?
A: Yes, employees must be included in a cash balance plan. However, contributions are able to be designed in a way that is fair while remaining efficient. A cash balance plan is traditionally designed to provide a good benefit for staff while focusing on higher contributions for the owner(s).
Q: What are the risks of a cash balance plan?
A: The main risks with a cash balance plan revolve around funding and compliance requirements, much like any benefit plan. These are easily managed and worked through by having a good advisor by your side.
Q: What is the benefit to a cash balance plan over just maxing out a 401(k)?
A: Cash balance plans are highly beneficial to small business owners who earn a high-income or who are trying to quickly increase their retirement savings. If you have the desire and ability to save more than what a 401(k) limit allows, a cash balance plan is a great option.
If you are a high-earning small business owner or self-employed, a cash balance plan is a great opportunity to contribute a significant amount of money to your retirement account while maximizing deductions on your annual taxes.
Contact the retirement plan specialists at PlanPerfect for a free consultation to see if a cash balance plan sounds right for your business. If you’re interested in seeing an estimate of your potential tax savings, use our free online calculator.
