- High-earning owners of business and professional practices may be able to sock away several hundred thousand dollars per year toward retirement—after maxing out their 401(k)s.
- Cash balance pension plans work especially well for owners in their peak earning years who have primarily young employees.
- Any size business can set up a cash balance plan, including sole proprietors. But if you have employees, you must make contributions on their behalf as well.
If you are a high-earning owner of a business or professional practice, you most likely are being taxed at the highest marginal rate of 37%. With Uncle Sam potentially taking more than one-third of your hard-earned income, you owe it to yourself and your family to maximize retirement plan contributions during your peak income years. By expanding these contributions, you receive a 37% tax deduction on the contribution if you are in the highest bracket and the investment assets grow tax deferred. Even better, the distributions are taxed at potentially lower tax rates during retirement.
It may sound too good to be true, but it’s not.
Maximize Your Retirement Contributions
The most common way to maximize retirement contributions tax advantageously is through a 401(k) profit-sharing plan. In this plan, the maximum allowable contribution is based on meeting certain income levels - $58,000 per year if you are under the age of 50 and $64,500 per year if you are age 50 or older. Before you proceed, remember you also need to make contributions to each of your employees—you are not allowed to contribute only to yourself and family members who work for the business.
Cash Balance Pension Plan (CBPP)
There is another retirement option to consider that could substantially increase your retirement plan contributions, depending on your income, your cash flow available for savings, and your employee demographics.
A CBPP may be combined with a 401(k) and a profit-sharing plan or used alone. Depending upon the ages of you and your co-owners/partners and your staff demographics, you may be allowed to increase contributions by several hundred thousand dollars per year based on your age—on top of your 401(k).
Real World Scenario
In conjunction with an actuary, we recently prepared a proposal for a physician group. In one option, the group’s oldest physician could contribute approximately $300,000 per year to a combined 401(k) profit-sharing plan AND cash balance pension plan, along with a contribution to the staff amounting to 11% of the staff’s compensation. In a second option, the proposal reduced the oldest physician’s contribution to $183,000, but also lowered the staff’s contribution to 8.73% of their compensation.
How CBPPs Differ From 401(k) Profit-Sharing Plans
With a 401(k) profit-sharing plan, contributions are usually made to self-directed accounts in which participants make their investment selection and the benefits are based on the value of the assets at a given date in time.
With a CBPP, the benefit is based on a monthly annuity at the future retirement age of the participants. These investments are managed in a single account to meet the future calculated benefit. Things to keep in mind if considering a CBPP:
- CBPPs work best if you are over the age of 50 and you have primarily younger employees.
- Any size of business can set up a CBPP, including sole proprietors.
- Contributions can be substantial and you need to maintain the plan for several years. Make sure you understand your long-term financial commitment to a CBPP. As with a 401(k) profit-sharing plan, assets contributed to a CBPP are generally protected from a seizure by creditors. It’s a great vehicle for shielding your assets.
- You will need an actuary to calculate benefits. There are accounting and reporting requirements (both to participants and the government) and you need to factor in the administration costs of a CBPP as you evaluate the benefits.
- Employees must also be included in the benefit calculation. Don’t forget the overall employee cost of a CBPP when evaluating the benefits and tax savings for yourself and other owners.
- Though benefits are calculated based on an annuity payment, you can also take a lump-sum distribution and roll the assets over to an IRA when you retire.
- As with a pension plan, responsibility for investing CBPP assets falls to you, the employer and you bear the investment risk. Contrast this to self-directed defined contribution plans [such as 401(k) plans], in which participants generally choose their own investments and bear the risk.
We Can Help You Consider the Right Plan
I’ve shared just a few of the nuances to consider when evaluating a cash balance plan for your business. You don’t have to go at it alone; Soundmark has been helping high-earning clients sift through the advantages and disadvantages of CBPPs for many years. If you think a cash balance plan may be a great way for you to maximize retirement contributions during your peak earning years—and generously reward your employees, please feel free to contact us.
About the Author:
Todd Flynn, CPA, CFP® is a Principal at Soundmark Wealth Management, LLC. Todd works closely with physicians, business owners, and other high-net-worth individuals to help them define their financial goals and implement an ongoing financial planning process.