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Cash Balance Plans: What You Need to Know about Tax Savings

Published by Tom Wadelton on 14 Feb 2024

As tax time nears, there’s one question every small business owner is asking themselves (and their financial advisor): “Why am I writing such a big check to the IRS?”

No one is on the edge of their seats when the topic of taxes comes up. (Except for our Tax Director, but that’s a different story.) But the concept of tax savings is top-of-mind for business owners, especially as filing deadlines approach.

As CFOs, we work more in tax forecasting rather than tax planning: We make sure our clients are setting aside estimated payments so there are no awkward cash flow surprises come April.

But another part of our job involves connecting our clients to experts who work — all day every day — on specialized areas, for example, tax deferred retirement plans that can help slim down that check and boost overall retirement savings.

That’s why we wanted to sit down and talk with David Podell, founder of Business Benefit Consultants, who specializes in cash balance plans, a way to boost retirement accounts at a faster pace than traditional qualified retirement plans, like a 401k or SEP IRA whose annual contribution limits are below the six-figure threshold.

That’s where the cash balance plan comes in.

What Is a Cash Balance Plan?

For business owners looking to put away $100,000 or more in tax-deferred plans, the cash balance plan — also known as a cash balance pension plan — is growing in popularity. It combines elements of defined benefit plans and defined contribution plans: the account balance at retirement determines the benefit amount. However, while it could be paid as an annuity, it also could be a lump-sum payment (which could be rolled over into an IRA or another plan).Blog Post Template (12)

As the Department of Labor explains, “A cash balance plan is a defined benefit plan that defines the benefit in terms that are more characteristic of a defined contribution plan. In other words, a cash balance plan defines the promised benefit in terms of a stated account balance.”

Governed by federal pension laws — including the Employee Retirement Income Security Act (ERISA), the Age Discrimination in Employment Act (ADEA), and the Internal Revenue Code (IRC) — a cash balance plan can boost the owner’s and (to a lesser extent) the employee’s benefits.

The cash balance plan isn’t meant to replace all others; generally, it is combined with a profit sharing ‘bucket’ as well as a 401k ‘bucket.’ Adding a cash balance plan to the mix doesn’t usually disrupt what is in place, but everything needs to get tested together to ensure the best plan design to fit the businesses’ objectives.

Who Can Benefit from a Cash Balance Plan?

Most small business owners have the majority of their net worth in the business. Maybe they have a 401k, maybe they have a profit sharing plan, a SEP or some other plan.

For owners who are behind where they want to be in their retirement savings, a cash balance plan is a way for them to put a significant amount of money away on a pre-tax basis and take a big tax deduction. While employees can receive some of the benefit, most cash balance plans are geared towards providing most benefit to the owner and partners (generally between 85-100%) who also bear the risks.

It should go without saying, but to participate, a business needs profits and cash, usually $100,000 or more. Any less, and David recommends an on-the-shelf plan. Plans can go well into the half-to-one million range and beyond.

Like traditional retirement accounts, a cash balance plan requires that money be left untouched until 60. You can’t access it or take a loan against it, let alone spend it. That’s why these plans tend to be more popular with owners in their 50s who are looking to catch up on retirement planning.

“They've gotten a business to a point where the business is seasoned,” says David. “They're comfortable with profits. They're comfortable with what they're taking. It's grown and they want to be able to pay less in taxes and put away more for themselves on a pre-tax basis.”

How Does the Investment Work?

Beyond those big-picture requirements, there’s a lot of flexibility.

Any entity type — LLC, S Corp, C Corp, etc. — works, as long as the income is pensionable. For example, if you only have passive real estate income, you’d need to have a management company that pays the owner. The amount of the contribution will depend, in part, on wages, so if an owner is taking a low wage, they might have to increase that to enable a higher contribution. It will mean higher income tax and FICA but also a bigger social security check — in addition to the deferred tax benefits.

In terms of contribution amounts, cash balance plans are designed to accommodate swings in profitability: because each plan is unique, it is possible to put in large sums one year and then nothing at all the following year.

“We only work with actuarial designs that are flexible in terms of annual contributions,” David says. “That's going to be the biggest question: ‘Can I put $100,000 away this year, but next year go to 0 or 300,000?’ The answer is yes — we just need throughout the year to be in touch with how that client is doing and what they might want to do for a target funding of the next year.”

That said, you don’t want to open one of these plans for less than 3-5 years. David explains, “The IRS does not want these big deductions and plans put in place and then shut down a year later. It doesn't mean you need to fund at the same dollar amounts, but that plan should be open and kept open for around those 3 to 5 years. The plan could be in place longer, even passed down to someone else in the business.”

There’s also freedom in terms of type of plan investments. Plan assets can go into private equity, real estate, other things outside of the traditional market, but the investment philosophy should be moderately conservative. Higher returns can come from a 401k.

“Anything that gets a 10-15% rate of return can lose 10-15% and that can mess with the funding,” David explains. “That's why we're in touch with the advisors on where those assets should be from an investment risk standpoint. You don't want to go and make 30% every year for a few years, which overfunds the plan. The actuary will have to say, ‘Hey, you can't put money in again. I know you want a deduction, but you're stuck, because you put assets in the plan that were high flying.’”

How Much Does It Cost to Set Up and Maintain?

A cash balance plan consultant works with a third-party administrator (an enrolled actuary). In addition to packaging all the resources for the client and their advisors to understand, there is continual behind the scenes work: coordination, compliance, filing, etc.

Rather than being paid as investment advisors, there is a design and administration fee that can range from $4,000 for a solo plan to $6,000-$8,000 for a complex plan with multiple employees.

How to Get Started

With all the potential upside, why isn’t this a more widely adopted tax-savings approach? David suggests it’s because, “There are a lot of resources involved. There’s complexity. Because of that, people don’t know where to go for it, or they’ll go directly to a third-party administrator or an actuary — and that might work out, but clients don’t know what they don’t know. There may be a better plan out there for them.”

That’s where a CFO can reach out, on behalf of a client, to a consultant like David. The advisor has deep insight into the businesses’ finances — particularly cash flow — as well as the owner’s goals and their retirement savings. By working with a cash balance plan consultant, they can find the perfect match.

David works with about 15 different actuarial designs around the country, so he sees firsthand vast differences, depending on the objective. In one scenario, he worked with three different designs, that ranged from $100,000 in maximum contribution all the way up to $250,000.

Typically, the process, which takes around 4-6 weeks to get up and running, works like this:

  1. A financial advisor identifies a client with additional money they want — and are able — to put away.

  2. The financial advisor contacts a consultant and provides intake information (client goals, etc.)

  3. The consultant looks into designs to figure out what fits best, in conversation with the client and financial advisor

  4. The consultant and advisor work together throughout the plan’s life to make necessary adjustments.

Cash Balance Plan Take-Aways

  • A cash balance plan is a good option when the business has excess cash that the owner is willing put away until age 60 ($100,000-$1 million+)

  • Annual contributions are flexible, can vary, or even go down to zero.

  • Plans can work with existing 401ks

  • Plans should be active 3-5 years

  • Assets can go in different areas: private equity, real estate, the market

  • A moderately conservative investment approach is recommended

  • A consultant can shop around for the plan design that best meets the owner’s objectives, and set up and maintain the plan in close coordination with any financial or tax advisors, CFOs, etc.

  • Plan administration costs can range from $4,000 for a simple, solo plan, to $6,000-$8,000 for more complex plans

  • Setup generally takes 4-6 weeks

  • Funding for the previous calendar year is permitted until the current year filing deadline

To learn more about how a Virtual CFO can help your business, schedule a free consultation below. 

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