Your Guide to Cash Balance Plans

If you’re like most business owners, you’ve been investing all your company’s excess cash back into its operations, watching those dollars expand product lines, build bigger customer bases, and open new markets. But how much time and effort have you put into your personal product line or customer base? Too many corporate executives (from solo contractors to CEOs) neglect their individual financial situation in favor of that of their enterprise. Then they realize too late that they’ve not put enough money aside to provide for their personal lives after retirement. 

Fortunately, a Cash Balance Plan (CBP) gives business owners the opportunity to make up for lost time. These IRS-qualified accounts permit pre-tax contributions that are significantly higher than those allowed by traditional 401(k)s or IRAs. If you are concerned about how much cash you’ll have available after you retire, read on. 

What is a Cash Balance Plan?

The short answer: It’s a financial retirement vehicle that allows account holders to save significantly more annual pre-tax dollars (up to $350,000) in a tax-deductible account.

The more detailed answer: A CBP is an investment ‘pension’ type of account that provides business owners and their qualified employees an option for retirement savings that factors in their age and the financial sacrifices they made over the course of their careers. The closer you are to the age of 62 (the earliest you can begin drawing on your IRAs), the more money you can contribute each year to your CBP. 

The CBP combines the typical ‘defined benefit plan’ and the ‘defined contribution plan.’ 

  • Defined benefit plans calculate pension values based on length of service and salary levels, and they typically allow for a much higher annual contribution level than other types of tax-deferred retirement accounts.
  • Defined contribution plans, in contrast, require either or both the employer and the employee to make retirement account contributions up to a specified value on an annual basis. The consequent balance will reflect both those contributions as well as any investment growth they may experience over time.    

The CBP caters especially well to smaller companies and sole proprietorships that seek to provide a reasonable retirement income for their aging worker population. They also offer a privately funded retirement option that operates outside the usual 401(k) and IRA retirement strategies. 

The tax savings opportunity may be the biggest reason to set up a CBP plan. Diverting sometimes tens of thousands of dollars into a federally protected retirement savings plan can reduce personal taxes significantly, including state, federal, Medicare, and qualified business income taxes. Not least significant, CBP contributions are business expenses, and your company can deduct them from its income to reduce its tax exposure. 

Ultimately, a CBP offers every qualified person the opportunity to continue building their tax-deferred retirement saving activities even after maxing out their 401(k) and IRA annual contributions. At the same time, it allows organizations to lower their tax burden by reducing their taxable income.

How Does a CBP Work?

The business sets CBPs up on behalf of its principles and qualified employees. On an annual basis, the organization deposits into each participant’s plan a fixed pay credit, which represents a percentage of their yearly compensation. It also contributes an interest credit into that account, which represents the interest that stakeholder will receive upon payout. 

The company then uses those funds to invest in assets covering future obligations. The account values – benefits – are presented like a typical investment balance, with principle and interest designations. This reporting process contrasts with that of a standard retirement account, which, instead, calculates the actuarial retirement income that is anticipated several years in the future.     

For the recipient, the CBP also offers more flexibility as they get closer to retiring. Unlike other forms of retirement savings accounts, CBP funds can be rolled into traditional IRAs post-retirement, where they will continue to hold tax-deferred status. If the CBP is paired with a 401(k) account, those funds can also be rolled into the IRA. There’s no penalty for making the transfer, either. Standard 401(k)s do not allow this feature. 

What Are the Benefits of a CBP?

Especially for a small business, a CBP offers excellent advantages. 

  • The plan allows business owners to contribute as much as four times the dollar amount over what they would usually add to a traditional 401(k) account.  
  • The principals and eligible workers who receive CBP benefits also appreciate the higher rate of return on their CBP-directed investments. In fact, offering a CBP as part of a compensation package can attract and secure higher-quality talent to your enterprise.  
  • These contributions are also deductible business expenses, so they reduce tax exposure. 
  • They are flexible in their design. Recipients can receive differing contribution values, and business owners can establish ‘classes’ of contribution levels as they determine how to allocate these funds.

CBPs are also easier to manage than other forms of retirement funds: 

  • Company officers and recipients can both understand and track their accounts with ease. 
  • The aggregated corporate CBP portfolio can be managed as a single account, similar to typical pension plans, making it easier to maintain.
  • As a federally protected financial asset, the CBP is also protected from creditors in case of bankruptcy or lawsuit.

Are There Drawbacks to CBPs?

There are a few details to keep in mind when considering establishing CBPs for your organization:

  • Because the end benefits are guaranteed, but the returns from the investment vehicles they are deposited in are not, the business assumes the risk of loss if those outside accounts don’t cover the guaranteed funding. 
  • Also, maintaining a roster of CBPs requires a steady and reliable cash flow throughout the year to ensure there are sufficient funds for annual allotments. 

 You’ve built your business into a strong, successful, and financially sound enterprise. Now, it’s time to put the same resources and energy into your retirement plan. Kelly Insurance & Investments, Inc., helps employers establish CBPs for all qualified workers, as well as manage the actuaries who set them up. As part of the Chesapeake Growth Network, they stand ready to assist you with your business and personal financial needs. Call them today to learn how a Cash Balance Plan can open the door to your happy retirement.

And keep your eye on this blog. Next, we’ll be chatting about how to build a consistent link between estate and business planning.

 

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