Cash Balance Plans: Are They Right for Your Business?
Cash Balance Plans: Are They Right for Your Business?
September 25, 2020
We know the Coronavirus has impacted everyone in ways that were unimaginable at the beginning of the year. This post is the 13th in a series designed to help you make the most of this challenging time. You can read prior posts in the Coronavirus Resources section of the SWP Blog.
When most people think of retirement plan options, they often focus on the two big ones: 401(k)s and IRAs. However, there are other options, and the rising popularity of those other options suggests they could play a more central role in retirement planning in the future.
One such option is a cash balance plan. This type of retirement plan is quickly gaining in popularity, especially among smaller businesses. Organizations with fewer than 100 employees comprise 92% of cash balance plan holders, and 57% of all cash balance plans come from companies with 10 or fewer employees.1
This article will explore how cash balance plans work, why they’re attractive to both business owners and individuals with 1099 income, as well as how to determine if one is right for your business.
How Do Cash Balance Plans Work?
Like 401(k)s, cash balance plans are “qualified” plans, meaning they qualify for tax deferral and creditor protection under the Employee Retirement Income Security Act (ERISA), which is a federal law that sets minimum standards for most retirement plans. Unlike 401(k)s, however, the value of cash balance plans increases through an assumed earnings rate, rather than from the performance of the plan’s investments. Cash balance plans are considered “defined benefit” plans since the value is calculated according to a set annual earnings rate. In other words, the “benefit” is determined based on the contribution, the assumed earnings, and time, which means the account balance is clearly defined for participants.
In 2020, cash balance plans allow participants who are 60 and older to set aside up to $329,500 per year for retirement: $26,000 in individual contributions, $63,500 from the profit-sharing part of the plan, and $266,000 from the cash balance portion (typically a flat dollar value or a percentage of the individual’s pay).2 When a plan participant retires, funds can be withdrawn in a lump sum or taken as annuity payments. Because payouts can be annuitized, cash balance plans can work like pensions for companies that don’t offer pension plans.
Why Do Companies Create Cash Balance Plans?
There are a number of reasons why companies create cash balance plans, but the most significant reason is the tax benefits they offer for business owners. The ability to put away significant amounts annually in tax-deferred assets means business owners (many of whom delay saving for retirement in order to fund their business) can catch up on their retirement savings.
Due to the high contribution limits of cash balance plans, companies that offer these plans can also gain an advantage when it comes to attracting and retaining top talent.
Should You Start a Cash Balance Plan for Your Business During COVID-19?
If you’re a business owner considering a cash balance plan, one key factor at the moment is how your business has been affected by the COVID-19 pandemic.
If your company has remained highly profitable, cash flow is not an issue, and setting up a cash balance plan would likely make sense for you. If, like many other organizations, your company is doing “just OK” during COVID, you may not want to commit to a cash balance plan just yet. However, if you think your organization’s cash flow is sufficient to support an additional layer of retirement planning, then it’s certainly worth exploring further.
If your company has been significantly financially impacted by COVID, starting a cash balance plan is not recommended at this time. Part of the reason cash balance plans are so attractive for employees is that the employer assumes the risk. To ensure employers can take that risk, they are obligated to fund the plan for roughly three years in the future. If cash flow is a challenge for your company right now, it is likely best to wait and revisit a cash balance plan option in the future.
What About the 2020 Election and Tax Law Uncertainty?
If you’re concerned that your tax burden will increase in the years to come, a cash balance plan can help reduce your tax burden today and defer taxes into the future.
Assuming a 37% tax rate, your maximum tax savings from a cash balance plan is $121,915 for 2020. And with a cash balance plan, you can save up to $3 million towards retirement, per current IRS lifetime contribution limits.
You’ve worked hard to build your business and make it profitable. If you’re concerned that your investments in your business could leave your retirement underfunded, a cash balance plan is a great way to tap into your business’ profitability and fund your retirement years. If you have questions about cash balance plans or whether they’re a good fit for you, we can help. Reach out to your advisor at Strategic Wealth Partners to discuss your options.
1. Kravitz, National Cash Balance Report 2018
2. Kravitz, Contribution Limits Table
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