It doesn't happen to every business owner, but there are occasions when a firm generates more profit for the owner than a standard 401(k) retirement plan can accommodate.
A cash balance plan may be an excellent method for you to save more money for retirement and protect more of your income. These programs are extremely beneficial to business owners who have high-profit businesses.
Unlike a 401(k), which has a combined individual and employer annual contribution limit of $54,000 in 2017, a cash balance plan, which is a form of defined benefit plan, may allow you to save four, five, or even six times that amount. It, too, defers taxes until the money is disbursed in retirement, much like a 401(k) plan. The fact that the corporation, not the individual, makes the deductible contribution is a tax benefit for the employer. This might result in a tax savings of more than 40% for the company.
However, despite its benefits, assessing if a cash balance plan is the best option for you and your financial circumstances is not straightforward. Smith and Howard Wealth Management can assist you in determining if the plan's benefits exceed its drawbacks, how much you might or should contribute, and how this plan can benefit your retirement planning.
A formula considers numerous parameters, including current age, retirement age, and how much of a retirement payout is needed, to decide how much to deposit into the plan. The following are some critical questions to consider as you begin the process of creating your cash balance strategy.
The starting point for evaluating how much time is available to develop the benefit is your current age. This plan is ideal for company owners who are in their late 40s or older and have prioritized expanding their firm over investing for retirement. It helps company owners who are older than their employees grow their nest egg faster since it enables larger contributions than a 401(k). Because they have more time to save for a predefined benefit amount, younger business owners may not benefit from a defined benefit plan, diluting the tax benefits of the cash balance plan.
These programs have greater expenses than a 401(k), but the benefits of being able to save $300,000 each year for retirement might outweigh the expenditures. And if you're able to save this much, you're probably in a higher tax rate. If you defer taxes on this amount of money, you could be able to go into a lower tax rate. This is dependent on a number of things and should be discussed with your tax expert.
The end goal for deciding how long and how much you need to save is the age you want to retire and the amount of retirement benefit you want (within IRS restrictions). Another factor to consider is your retirement age in comparison to that of your staff. All eligible employees must be included in the plan; the younger they are, the less you'll have to contribute because they're closer to retirement. As a result, the cash balance plan is an excellent choice for business owners who may have a shorter retirement timeline than their employees.
Owners of a well-established firm with significant cash flow and a positive prospect for future earnings are often good candidates for a cash balance plan. Businesses whose revenues fluctuate year to year are not well suited to a defined benefit plan since they must commit to making the same contribution every year (or suffer fines).
Because this plan is defined by the benefit – the amount of money you'll need to finance your retirement income stream – those consistent gains are critical for another reason. Actuaries assist in determining the appropriate amount to put into the plan based on numerous assumptions, including an interest rate for asset growth.
We discovered his living expenditures were significantly lower than his level of income when conducting some planning for a customer, "John," the owner of a professional services organization. He had a good salary and the opportunity to spend significantly less than he earned because he was the sole employee in his firm. Because of these two factors, he was classified as a client who may benefit from a cash balance plan. Rather than having the surplus money taxed (as a company or personal income), a scheme like this may allow John to postpone the tax and build his savings (also tax-deferred).