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For those business owners who are looking to supercharge their retirement savings and are already maxing out their 401(k) accounts, there is another way to put away even more money and save on taxes.
Many small business owners think SEP IRA or Solo 401(k) plans are the best option to make large retirement contributions. This may be great for some, but for those with higher incomes looking for more tax breaks, these plans may not be enough. A cash balance plan comes into play for people playing catch-up on retirement savings, or those needing a little more help getting on track toward financial freedom. This plan may someday make work an option, not a requirement.
What Is a Cash Balance Plan?
The premise of a cash balance pension plan is to provide a specifically defined income benefit at retirement. Think of it as a monthly payout similar to Social Security, or in terms of a pension that provides income for your lifetime.
To fund these future benefits, the entrepreneur is allowed to contribute substantial amounts of money to the plan to fund future benefits. To encourage people to save for retirement, contributions are tax deductible. Allowable contributions are based on age and compensation, unlike self-employed 401(k) plan contributions, which are limited to $55,000 in 2018, with an additional $6,000 in contributions allowed for those over age 50 (not to be confused with a regular employer-sponsored 401(k) plan that limits under-50 contributions to $18,000).
Candidates for a Cash Balance Plan
The tax benefits from these plans can be substantial for business owners in a wide range of professions, but these plans are not for everyone. Below are just some of the professions who stand to benefit from cash balance plans:
Business owners with steady profits
Entertainment industry professionals, such as producers, directors, or screenwriters with their own corporations
Professional service businesses (lawyers, physicians, CPAs, etc.)
Companies with small but important workforces (a pension plan is great for employee retention and morale)
Business owners looking to catch up their retirement accounts
Entrepreneurs who don’t want to pay too much in taxes
Spousal businesses with high incomes
Business owners with large amounts of money invested in taxable accounts (For more from this author, see: Which Retirement Plan Is Best for Your Small Biz?)
Some people shy away from cash balance plans because there are annual minimum contribution requirements. Keep in mind those requirements are generally tied to your net income. If you have a bad year or end up with a bunch of other tax write-offs, your expected contribution will drop.
You could also cut back further on the 401(k) portions of the plan, as those tax-deductible contributions are not required. The biggest benefit to setting up a defined benefit cash balance pension plan is the tax savings. When you combine the federal and state tax rates, it can make a cash balance plan a no brainer. The savings in California, which has the highest state taxes in the nation, are huge. They can approach 50% for the highest earners. (For related reading, see: Cash Balance Pensions: Pros, Cons for Small Biz.)
Funding a Cash Balance Plan
Many business owners who are maximizing contributions to their 401(k) and cash balance plan contributions make much more income or have accumulated substantial amounts of money in taxable investment accounts. As your business success grows, the typical contribution to a traditional 401(k) will leave you paying way too much in taxes. Cash balance plans can be designed specifically for your financial goals and income levels. It may take a bit of extra effort, but the tax savings make it more than worth it.
Remember, these plans are not for everyone. But if you feel you are paying too much in federal income taxes, or if you are playing catch-up for retirement, these plans can be a great way to get back on track toward financial freedom.
(For more from this author, see: A Defined Benefit Plan for Small Business Owners.)
Read more: Increase Retirement Savings With a Cash Balance Plan | Investopedia https://www.investopedia.com/advisor-network/articles/increase-retirement-savings-cash-balance-plan/#ixzz5PaBySD1m
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