Cash Balance Pension Plans Can Benefit Doctors, Lawyers and Small Business Owners
Five Reasons to Consider this Defined-Benefit Plan for Your Business
Many small business owners, including doctors and lawyers in private practice, can benefit from a cash balance pension plan. These plans offer significant tax deductions and accelerated retirement savings, making them especially beneficial for those with retirement looming in the near future. What’s more, this defined-benefit plan with a 401(k) twist can help you meet the needs of your employees, too. Many high-earning professionals are unaware of this option, though it offers benefits from both the retirement planning and tax avoidance standpoints.
How a Cash Balance Pension Plan Works
A cash balance pension plan is a defined-benefit plan, though it acts similarly to a defined-contribution plan. Made popular by the Pension Protection Act of 2006, it is a pension plan with the option of a lifetime annuity. With a cash balance plan, the employer credits each participant’s account with a set percentage of their yearly compensation plus a crediting rate.
As a defined-benefit plan, changes in the portfolio do not impact the final benefits a participant receives upon retirement or termination. The company bears ownership of all profits and losses in the portfolio. Similar to a defined benefit plan, the assets are all managed in a single account, but participants are provided statements with their account balance. Changes in the value of a participant’s portfolio will not affect the yearly contribution. At retirement, employees can opt to take their money in a lump sum, or choose a monthly payment based on their balance and years of service.
Benefits for Doctors, Lawyers, and Small Business Owners
Cash balance plans have been growing in popularity and now account for about one-quarter of all defined-benefit plans, according to Kravitz Inc. Much of this growth is due to high-earning professionals and solo business owners because they offer the following five benefits:
High Contribution Limits
One reason that cash balance pension plans can be attractive options for small business owners or doctors and lawyers in private practice is that it’s a plan that offers high contribution limits. Since the limits increase with age, those nearing retirement can use a cash balance plan to optimize their savings quickly. In 2021, for example, the IRS allows a 65-year-old to contribute up to $276,000to their cash balance plan, while still maintaining the ability to contribute $26,000 to a 401(k) plan, and $38,500 to their profit-sharing plan, too, for a total of $340,500 in tax-advantaged savings.
Not only do the high contribution limits mentioned above super-charge a retirement nest-egg, but they also allow for a greater degree of income tax avoidance for high earners. Since cash balance plans are IRS-qualified plans, all contributions are tax-deductible.
Protection from Creditors and Lawsuits
Cash balance plans also offer security in that they are protected from lawsuits and from most creditors (the U.S. government not included). This is another reason so many private practice professionals utilize this pension plan option.
In many cash balance plans, retiring participants or those leaving the company have the option to take a lump-sum distribution and roll it over to an IRA.
Because cash balance pension plans are invested very conservatively, there is less risk of a plan becoming underfunded – which is a concern with other types of defined-benefit plans.
Costs to Employers
While cash balance plans still have to meet certain testing requirements for the Department of Labor, the requirements are less stringent than one might think. Only 40% of all eligible employees or 50 employees, whichever is less, must be included in the plan. Depending on the makeup of your company, a significant portion of the contribution may be able to go to owners. An advisor can help you run an analysis to determine what percentage of total contributions are able to go to the owners.
Final Thoughts on the Benefits of a Cash Balance Plan
If you’re a small business owner or partner in professional practice, the retirement savings benefits and tax advantages of a cash balance pension plan are worth taking a look at. If you have the cash flow to fund a cash balance plan on a consistent basis, and you’re willing to make contributions for your employees, you can enjoy a ramped-up strategy for retirement savings and a higher tax deduction than most of the alternatives offer.
At Paces Ferry, we use our significant knowledge and experience to offer retirement plan consulting, including in the area of cash balance pension plans. If you’d like to discuss whether this may be the right option for your business, email firstname.lastname@example.org or use this link to schedule a call.
Paces Ferry Wealth Advisors, LLC is a registered investment advisor with the U.S. Securities and Exchange Commission (“SEC”). This material is intended for informational purposes only. It should not be construed as legal or tax advice and is not intended to replace the advice of a qualified attorney or tax advisor.
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