The Self-Employed Cash Balance Plan

Small Business Owners Can Benefit from These Plans in More Ways Than One

Within many companies, employees enjoy a plethora of benefits that come along with their salary. Typically, there’s paid time off, health insurance, and for some, access to retirement savings accounts through the employer. One way a company may offer to help their employees save for retirement is through a cash balance plan, which works almost like a traditional pension plan but with some differences that make it attractive to small business owners. In essence, a cash balance plan provides self-employed individuals the opportunity to make sizable contributions to a retirement savings account while also enjoying tax benefits for their businesses.

This is an important option to consider because, oftentimes, self-employed individuals end up robbing themselves of the benefits that others get because they’re focused on putting all their money and resources into their business. However, cash balance plans come with tax benefits that significantly help any self-employed individual in the present, while offering a valuable way to save for retirement, too.

What is a Cash Balance Plan?

There are an abundance of retirement benefit plans out there that varying companies choose to offer their employees. A cash balance plan is one of these retirement benefit plans that clearly delineate a percentage of your yearly salary plus interest charges that your employer will contribute to an account designated for retirement. Currently, the interest charged to cash balance plans is between 4% and 5% but varies depending on the employer.

While a cash balance plan is similar to a traditional pension plan, there are some key differences that set it apart. The main difference is that, unlike pensions, cash balance plans create an individual account for each employee that is complete with a specified lump sum.

SEE ALSO: Small Business Financial Health Checklist

How Does a Cash Balance Plan Work?

A cash balance plan is a type of retirement structure where an employee is told that they will have access to a specific sum of money upon reaching retirement. Once the employee retires, they have the option of taking all the money out of their account or committing to an annuity that pays a portion of the total amount in regular checks. With this kind of plan, the money is pooled together in one account for all employees with each employee being entitled to a designated amount. Most cash balance plans are protected from any filed bankruptcy claims, as well, and they come with different rollover options.

Traditionally, the account is funded by the employer, who deposits a specific agreed-upon percentage of the employee’s salary, combined with interest credit that gets added to the account. As mentioned above, the interest charges vary depending on the employer, but currently hover around the 4%-5% range.

Making a Cash Balance Plan Work for You

It’s not just large companies that can benefit from using a cash balance plan. By establishing cash balance plans for yourself and your employees, small business owners are provided with much higher contribution limits than one could find with a basic 401(k). For self-employed workers, the contribution limit is age-dependent, so the amount you’re allowed to contribute annually depends on how old you are. Thus, older business owners who may be feeling the pressure to begin making sizable catch-up contributions to prepare for retirement have the opportunity of saving more in a shorter amount of time with higher limits when using a cash balance plan.

SEE ALSO: Choosing the Best Retirement Plan for Your Employees

What’s more, cash balance plans are considered a qualified plan by the IRS, meaning that they have designated tax benefits, grow tax-free, and any contributions made aren’t taxed until retirement or withdrawal. Additionally, self-employed workers aren’t required to pay the same contribution to each employee. Rather, they can pay different credits for different groups of employees based on things such as age, years of service, or area of operation within the company.

Bottom Line

When it comes to saving for retirement, a cash balance plan is a valuable option for a self-employed individual. These plans are becoming increasingly popular since they offer significant tax deductions and tax savings, asset protection, and a higher contribution limit than other types of plans.

If you are self-employed and thinking about setting up a cash balance plan for your business, be sure that you take the time to fully understand all the plan requirements and have the financial stability to fund this plan for an extended period of time. At Paces Ferry, we strive to help our clients identify their goals, create an operational plan, and provide support along the way. If you’d like to talk with one of our professionals about implementing a cash balance plan for your business, contact us today.

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.