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The Cash Balance Plan: A Pension Plan for High Earners

If you’re a business owner, physician or self-employed individual, you likely face higher taxes than the majority of Americans. However, there are strategies you can use to keep more of your hard-earned money by reducing your tax liability and increasing your asset protection. One of these strategies is through a particular type of Defined Benefit Plan called the Cash Balance Plan.

Understanding Defined Benefit Plans

The Cash Balance Plan may be right for you if you find yourself in the same boat as many high-earners – maxing out your 401(k) contributions, adding employees into a profit-sharing plan, amortizing depreciation of your equipment and still earning a salary of more than $250,000. Despite your best efforts, your tax liability is still greater than you would like. However, you may be able to avoid additional taxes by utilizing a Defined Benefit Plan.

Defined Benefit Plans are regulated by the Employee Retirement Income Security Act (ERISA) under the U.S. Department of Labor. ERISA controls various retirement plans, including pensions, 401(k)s and 403(b)s. Defined Benefit Plans and pensions are not nearly as popular as they used to be because they require funding by the employer, which the employee then draws down at a defined annual rate in retirement. Recent economic volatility and increased life expectancies of workers have led to funding shortfalls in both government and private Defined Benefit Plans, and they have largely fallen out of favor. However, these plans could be incredibly valuable for high-income earners.

The Cash Balance Plan

One particular type of Defined Benefit Plan – the Cash Balance Plan – actually offers some elements of Defined Contribution Plans, too, such as 401(k)s. Using the Cash Balance Plan, you may be able to significantly offset any tax liabilities that remain after you’ve maxed out your own 401(k) or other tax-advantaged plan.

Additionally, the Cash Balance Plan offers other benefits. Your assets will grow tax-deferred, and they are protected from creditors and bankruptcy.

By the Numbers

Let’s take a look at how using the Cash Balance Plan might play out. Contribution limits vary based upon age, so let’s say you are 45 years old. In 2020, your maximum contribution permitted to a Cash Balance Plan is $126,000 – a far cry from your 401(k) max of $19,500. So, as a business owner, physician or self-employed individual this year, you could combine your Cash Balance contribution and your 401(k) contribution for a total of $145,000 in tax-deferred retirement money. It’s easy to see how using the combination of a Cash Balance Plan and your 401(k) can considerably offset the tax liability that typically comes with your high income.

A Few Notes on Risk

If you choose to use the Cash Balance Plan strategy, you will likely be a plan fiduciary. As such, you must follow all ERISA guidelines to the letter. This includes strict standards that protect your plan participants, and you will bear responsibility for plan performance.

Performance can be measured in multiple ways:

  • Setting an assumed rate of return, typically known as the “interest-credentialing rate”
  • Benchmarking against something like Treasury Yields
  • Setting an agreed-upon rate with plan participants

Regardless of how you choose to measure performance, if the Cash Balance Plan fails to perform, then you as fiduciary are responsible for making up any cash shortfalls.

Final Thoughts

High-income earners have often reached that status because they have maintained focus on growing their business. This means you may not be spending as much time as you should be in mitigating your tax liabilities. If you think utilizing the Cash Balance Plan strategy may be valuable for you, speak with a financial professional to learn more.

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.

Zachary Morris

Zachary Morris, CFP®

Having traveled to over 35 countries, Zach is a believer in Ralph Waldo Emerson’s statement that Life is about the journey, not the destination. Being a CERTIFIED FINANCIAL PLANNER™ provides Zach the opportunity to help clients define and realize their journey, and co-founding Paces Ferry Wealth Advisors, an independent firm, allows the freedom to define the client experience along the way.