December 7, 2022

Does A Cash Balance Pension Plan Make Sense For You?

One of the most important decisions small business owners make is what type of retirement plan to adopt. There are many options, but one that is growing in popularity is the cash balance pension plan. This type of plan has several benefits that make it a great choice for small businesses that have owners in the highest tax bracket. In this blog post, we will discuss some of the key benefits of cash balance pension plans and why they could make sense for your financial plan.

To begin, a cash balance pension plan is a type of defined benefit pension plan that can be established and funded for a specific time before being terminated, allowing plan participants to roll their account balance upon termination into an IRA, for example. Cash balance pension plans contribution limits are actuarially determined, allowing a business owner to save additional funds outside of their typical retirement plan (401k or SEP IRA).

A cash balance pension plan is technically considered to be a “qualified plan.” So, all cash balance pension plan contributions are done on a pre-tax basis, allowing for an immediate income tax benefit in the year money is contributed. For those business owners in the highest marginal tax rate, this could result in a 37% tax savings on your annual contribution.

For example, let’s assume a 50-year-old business owner is fully completing the MegaBackdoor Roth IRA strategy for her 401k and contributing $61,000 in 2022. If cash flow allows and this individual wants to increase retirement savings, she could structure a cash balance pension plan for her and her employees. Actuarially, she could contribute an additional $173,000/year for herself into a cash balance plan. This contribution is entirely pre-tax, and assuming the highest marginal income tax bracket, she will see federal tax savings of $64,010 the year she makes this contribution. In this example, this business owner would be able to save $234,000 in 2022 on a tax-favored basis for their long-term financial independence goals. In order to satisfy nondiscrimination rules, she will have to contribute to her employees’ accounts as well– but the tax savings and additional funding for her retirement make those contributions worth considering.

Cash balance pension plans have a few aspects that need to be considered. A cash balance pension plan is typically invested more conservatively than a SEP IRA or 401k would be– this is due to the employer bearing responsibility for ensuring the benefits for its participants. Unlike a more traditional retirement plan, an actuary needs to be involved to determine contribution limits. Additionally, annual testing must be completed to ensure that the plan is on track and compliant. This requires additional administrative costs. However, if structured for the correct client situation, the potential tax savings from a cash balance pension plan generally more than outweigh these additional expenses. Ideally, a cash balance plan is funded for a certain time period (ten years), but contributions can be paused if business profits dip.

Does a cash balance pension plan make sense for you? If you are a business owner with a high income, a properly structured cash balance plan can be a fantastic way to save for retirement beyond the annual 415(c) limit (currently $61,000 in 2022). Additionally, it’s a great way to significantly lower your taxable income, as contributions are done on a pre-tax basis.

In order to determine if a cash balance pension plan is appropriate for your financial plan, please consult with a financial and tax professional.



Equilibrium Wealth Advisors is a registered investment advisor. The contents of this article are for educational purposes only and do not represent investment advice.

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This content has been prepared for general information purposes only and is intended to provide a summary of the subject matter covered. It does not purport to be comprehensive or to give advice. The views expressed are the views of the writer at the time of issue and may change over time. This is not an offer document, and does not constitute an offer, invitation, investment advice or inducement to distribute or purchase securities, shares, units or other interests or to enter into an investment agreement. No person should rely on the content and/or act on the basis of any matter contained in this document. The tax and estate planning information provided is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney.

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