Cash Balance Plans: An Overlooked Tool for Year-End Tax Planning

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As we start the new year, many business owners are looking for ways to reduce their taxable income while also seeking the need to accelerate retirement savings. While the tax-deferral benefits of retirement vehicles such as SEPs, SIMPLEs, 401(k)s and Profit-Sharing plans are well-known, many are unfamiliar with the powerful benefits of the Cash Balance plan.

The Benefits Of A Cash Balance Plan

Here are some of the main features to consider when determining whether adopting a Cash Balance plan makes sense for your business.

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The Best Of Both Worlds

A Cash Balance plan is an IRS qualified retirement plan that operates as a hybrid between both a defined benefit and defined contribution plan. In other words, it defines the promised benefit in terms of a stated account balance.

As such, each participant has an account that grows annually with an employer contribution known as a “pay credit” (based on a participant’s compensation) and “interest credit” (that can be a fixed or variable rate) that is guaranteed. Increases and decreases in the value of the plan's investments do not directly affect the benefit amounts promised to participants.

Higher Contribution Limits

For a business owner who wishes to fund the maximum benefit limit to a Cash Balance plan, the business owner's annual tax-deductible contributions could reach $250,000 or more each year depending on the owner's age, annual income, and plan document provisions. 

Significant Tax Advantages

Cash Balance plans offer business owners distinct tax advantages and deductions. The funds contributed are tax deductible in the first year the plan is implemented and are considered an “above the line” deduction that reduces the business’ taxable income dollar for dollar.

For participants, contributions are made pre-tax, and with higher contribution limits compared to other retirement plan types, high-earning individuals can accelerate their retirement savings. Furthermore, plan set-up and administration fees may be tax deductible to the business owner.

Mandatory Contributions

It’s important to remember that once you set up a Cash Balance plan, the contribution is mandatory each year. Should you fail to do so, you may be subject to substantial penalties by the IRS. That is why Cash Balance plans are ideal for companies with consistent and predictable cash flow.  

Investment Risk

Under a Cash Balance plan, the annual interest credit required by the employer is guaranteed and usually tied to a conservative benchmark such as the 30 Year Treasury.

Since the responsibility of investing the plan assets rests with the employer who bears all the risks, it is prudent to seek out professional financial guidance who can help assist with the investments that target the returns of the benchmark. In the event the investment returns do not keep pace with the funding requirements, additional unanticipated contributions will need to be made.

There’s Still Time

Business owners still have plenty of time to establish a Cash Balance plan. The deadline for setting up these plans and making mandatory contributions comes on the date when the business files its annual tax return.

Contributions must be made by the deadline of the company's tax return including extensions but no later than September 15, 2023. Note: Annual contributions are due by the earlier of the due date of the business tax return, with extensions and 8 ½ months following the end of the plan year  (September 15 for a calendar year entity).

Finding The Right Cash Balance Partners

Due to the complexities associated with Cash Balance plans, they require the expertise of tax advisors and actuaries who will require information to calculate the amount to be contributed to the plan for both business owners and their employees.

Furthermore, as market volatility affects the predictability of annual ongoing contributions to the plan, partnering with a financial advisor will help to ensure the right investments are selected with returns consistent with the plan’s interest credit rate (ICR).

Cash Balance plans are terrific options for business owners who have delayed planning for retirement, due to their high contribution limits to build up retirement assets quickly.  They’re also powerful tools with several tax advantages and should be a part of any conversation regarding year-end tax planning for entrepreneurs. 

About the Author

Ross K. Brown is vice president of business development at Payden & Rygel, a global asset management firm. [email protected]