Cash Balance Plans- -- Profit Sharing on Steroids?
Cash balance plans are receiving a lot of press these days as business owners, professionals and their advisors seek safe and deductible exit strategies and strategic retirement planning.
A Bit of Background and an Example
Cash Balance Plans are IRS approved,safe and secure Profit-sharing-like plans that permit substantial deductions to businesses with a high degree of tax and benefit cost efficiency. Efficiency translates into what percentage of the cost of the plan actually makes its way back to the principals.
We know from studies that business owners and sponsors/adopters of qualified pension profit sharing and 401K plans, usually do so out of a combination of paternalistic care for their workers and the need to efficiently provide for their own retirement.
In the traditional 401K plan, an owner can defer up to $22,500 if he/she is age 50 or over. If they add a profit sharing component or institute a match, then for the individual owner, the max they can ‘salt’ away is $55,500 for their own account.
In the case of a match, getting that much into the owners account can bear a steep price, where, for example out of a $100,000 contribution to a 401k+match arrangement, the owner may only get 40 to 60% of the cost of the plan.
Generally, 401k plans cannot be designed for owners because of the very tight non discrimination laws
So advisors usually add a profit-sharing feature to such arrangements.
Adding a cash balance plan as a companion plan only makes it better…here’s an example:
| Who | Pay | 401k | Match Alone | Profit Sharing | Cash Balance |
| Owner | $250,000 | $22,500 | $15,000 | $50,000 | $160,000 |
| Employee 1 | $50,000 | $12,000 | $3,000 | $2,500 | $1,250 |
| Employee 2 | $40,000 | $6,000 | $2,400 | $2,000 | $1,200 |
| Total | $340,000 | $40,500 | $20,400 | $54,500 | $162,450 |
So under the 401k Match the owner receives 73.5% of the plan, under profit sharing he/she receives 91.74% and Under Cash Balance he/she receives 98.49%...staggering.
What to do next
Cash Balance Plans are “hybrid” plans under the Internal Revenue Code a s they take many of the best features of both Defined Contribution Plans [like 401K and Profit-sharing], and Defined Benefit Plans. They are, however, not your daddy’s pension plan. The Pension Protection Act passed in 2006 set new rules for Cash Balance Plans that make them quite flexible and VERY owner friendly.
Call your advisor. RIA provides actuarial studies without charge…takes only a few days.