For some business owners, cash balance plans can offer tax benefits beyond other retirement plans. They can be an excellent way for business owners to build retirement funds quickly while offering tax benefits for their business.
What is a Cash Balance Plan?
A cash balance plan is a type of defined benefit pension plan. With a cash balance plan, employees will receive a predetermined amount of benefits at retirement. It is similar to a traditional defined benefit plan in that it provides a guaranteed benefit to employees upon retirement, but a cash balance plan differs in the way that the benefit is funded and calculated.
How is a Cash Balance Plan Different from Traditional Defined Benefit Plans?
In a traditional defined benefit plan, the employer makes contributions to a fund that is used to pay out retirement benefits to employees. The amount of the benefit is typically based on the employee’s salary and years of service, and it is paid out as a monthly pension.
In a cash balance plan, the employer also makes contributions to a fund, but the benefit is calculated differently. Instead of being based on salary and years of service, the benefit is typically based on a fixed percentage of the employee’s salary. Employers contribute a pay credit (a percentage of the employee’s salary) as well as an interest credit, which could be a fixed rate or variable rate.
The employer’s contributions are credited to the employee’s account, and the account balance grows over time through the investment of those contributions. Unlike a 401(k) plan, the employer bears the investment risk. Additionally, the employer is responsible for ensuring the employee receives the promised benefit amount, so an actuary is required to annually certify that account balances are properly funded.
When the employee retires, they can choose to receive a lump sum payment equal to the balance in their account or a monthly annuity payment.
Cash Balance Plans for Business Owners
Cash balance plans can offer tax benefits to some business owners. Good candidates for cash balance plans are established business owners and partners who want to make substantial retirement contributions each year while also offering tax benefits to their business.
As a business owner, you can use a cash balance plan to reduce your tax expenses by contributing a portion of your income to the plan on a tax-deductible basis. Contributions that you make to the cash balance plan on behalf of yourself and your employees are deductible as an above-the-line deduction and reduce a business’s taxable income.
It is important to note that there are limits on the amount of contributions that you can make to a cash balance plan on a tax-deductible basis. These limits are set by the IRS and are based on the age of the participants in the plan and the value of the plan’s assets. It’s advisable to consult with a tax professional to determine the maximum amount of contributions that you can make to the plan on a tax-deductible basis.
In addition to reducing your tax liability through tax-deductible contributions, you may also be able to use a cash balance plan to save on taxes in other ways. For example, the investment earnings on the contributions made to the plan will generally be tax deferred, which means that you will not have to pay taxes on those earnings until they are withdrawn. This can help to reduce your overall tax burden and allow you to save more for retirement.
Overall, a cash balance plan can be a useful tool for business owners who are looking to reduce their tax expenses and save for retirement. By making tax-deductible contributions to the plan and taking advantage of tax-deferred investment earnings, you can potentially save on taxes and build a secure retirement nest egg.
Delap Wealth Advisory’s advisors work to help our clients determine the right tax-advantaged retirement strategies based on their goals. Contact our team to get started today.
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