Cash Balance Plans for the Small Business
As many small business owners get closer to retirement, they may have concerns about whether their savings are sufficient for retirement, especially given the current economic state.
One way in which business owners can maximize their nest egg is to establish a Cash Balance Plan. Cash Balance plans offer higher contribution limits in line with a Defined Benefit plan, but with a twist that incorporates some elements of a 401(k) plan such as providing an individual balance each year.
Cash Balance plans are not the right fit for every company, but there are three key features of the Cash Balance plan that make them very appealing to small businesses.
In professional industries such as doctor’s offices, legal firms, or companies with high income earners as compared to the staff, Cash Balance plans have strong appeal. In a small business with older, higher-income owners who have a tax problem and a need for retirement savings. The cash balance allows the owners to make a large contribution to themselves, while keeping the contributions to the employees at a minimum and deferring taxes to a time when hopefully they are in a lower tax bracket. Because a cash balance plan is a type of pension plan, the contributions are mandatory. Contributions are a promised benefit and must be made on an annual basis. For a highly profitable business, this could be a great solution to minimize taxes each year.
Whether Sole Proprietors, Partnerships, or S-Corps, all must take the company earnings and claim taxes on those earnings for the year in which that money was earned. In Indiana, a successful company will pay up to 43% income taxes on these earnings if the earnings are taken as income. Therefore, if a company has one million dollars in earnings they may pay as much as $430,000 in taxes. That hard-earned money is gone forever. Instead, business owners can take that same $430,000 (or something less), and put up to $350,000 in their retirement account, and give their employees around $80,000 based on the ages and wages of their staff. This way, the owner keeps most of the money, uses a small portion to incentivize employees to stay with the company through a vesting schedule, and promotes happy employees, which leads to higher employee retention. The owner must spend that $430,000 either way. One way, he gives it to the government and loses it forever. In the other scenario, he gives some to his employees and a large portion to his future self.
Financial Security for Business Owners
Often, successful business owners often face improper planning for their retirement. Sometimes, it is as simple as the busyness of building a business that can cause an owner to forget to save for retirement. Other times, the owner is counting on selling their business to create their retirement fund, but they over-estimate what their business will be worth. The Cash Balance plan allows an older, successful business owner to make up for lost years of saving for retirement by putting in large contributions over a short period of time. It may also allow him to pass a business on to family rather than having to sell it. The Cash Balance plan also promotes a promised retirement benefit at a stated retirement age. An owner will know exactly what he is getting financially, unlike a 401(k) that can fluctuate in value. Lastly, a retirement benefit is free from creditors (even the IRS), so if you are in a business that could easily get sued, such as a medical practice, the Cash Balance plan guarantees your money will be there for you and cannot be taken by creditors.
Cash balance plans offer a list of significant benefits while also allowing for cost savings and flexibility along the way, all of which can prove very beneficial for small businesses. However, with great benefits come complicated rules and regulations that both employers and participants should be informed of. When deciding on your retirement plan, it is important to understand every aspect of the plan. Should you have any questions about choosing the right retirement plan, our team at RPCSI is here to help.