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5 Signs a Cash Balance Plan is a Good Fit for Your Small Business
Bottom Line Up Front
- Most business owners who adopt a Cash Balance plan are looking to accelerate their retirement savings and take advantage of the huge tax deduction benefits
- But not every business is a good fit for a cash balance plan
- The top 5 signs that a CB plan is right for your business include having fewer than 10 employees, high & predictable/growing income, high pass-through income, neglected personal retirement savings, and maximum contributions to your current 401(k) type plan.
As a small business owner, you are responsible for setting up a qualified retirement plan to support you and your employees. One possibility is a Cash Balance (CB) plan. A CB plan is a type of Defined Benefit Pension Plan that’s often used by small business owners. Most business owners who adopt a CB plan are looking to accelerate their retirement savings and take advantage of the tax deduction benefits.
The following 5 signs could determine if implementing a cash balance plan for your small business would be beneficial:
- Your company has fewer than 10 employees
- You have high & predictable/growing income
- You have high pass-through income
- You’ve neglected your personal retirement savings
- You’re contributing the maximum amount in your current plan
1. Your company has fewer than 10 employees
While CB Plans can work for companies of any size, they are well suited for small companies with fewer than 10 employees. These plans require annual contributions by the employer on behalf of the owner and employees. As the number of employees increases above 10, the liability for these employees begins to become unmanageable, suggesting that a different retirement plan may be a better fit.
Another benefit of the Cash Balance plan is that when it is paired with a profit-sharing plan, it allows a large percentage of the benefits to be steered to the target group (e.g., owners). This benefit fades as the number of employees enrolled in the plan increases.
2. You have high & predictable/growing income
CB plans are a better fit for small businesses that are well established. These older businesses typically have more capital available to take advantage of the increased contribution limits under Cash Balance plans. Young companies trying to make ends meet most likely lack the excess capital to truly take advantage of the higher contribution limits. Businesses with more capital and steady income streams are better equipped to make the required contributions in good years and bad.
3. You have high pass-through income
Small business owners can face greater taxes as a result of income from their business being taxed on their personal tax returns, also known as pass-through income. Implementing a Cash Balance plan can greatly reduce these taxes. Due to the fact that CB plans allow larger contributions, business owners can contribute more of their income to the plan, therefore, reducing their taxable income (both State & Federal) and the amount of taxes they owe. Contributing to a CB plan reduces the taxable income while the contributions grow on a tax-deferred basis in the plan.
4. You have neglected your own retirement savings
If you’ve neglected your own retirement savings in the past, that makes you a prime candidate for a Cash Balance plan.
It’s also one of the main reasons most small business owners decide to open a CB plan. The contribution limits for CB plans are determined by age and salary, which is advantageous for older business owners who are looking to contribute large sums. The higher contribution limits would allow you to catch up on your retirement savings quicker than a 401(k) plan. The contribution limits increase with age allowing for the opportunity to contribute more each year as you near retirement.
5. You are already contributing the maximum amount in your current 401(k) type plan
Installing a cash balance plan can be very advantageous for small business owners who are already contributing the maximum amount in their current plan. As seen in the table below, Cash Balance plans have much higher contribution limits than a 401(k) plan, especially for older contributors. As mentioned above, this is good for older business owners that are looking to catch up on their retirement savings. Beware that the use of a CB Plan may reduce the amount that can be contributed to the 401(k) type plan but the increased CB Plan contributions are far higher than that reduction.
Higher contribution limits can also reduce the amount of taxes that you would need to pay each year since a portion of the income is now being allocated towards the CB plan.
There are a lot of factors to consider when adding a new retirement plan as a business owner. If you are an owner with stable or accelerating income, and you want to significantly increase your retirement contribution then a cash balance plan may be a good fit for you.
Whenever you’re ready, here are three ways we can help:
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