Cash Balance Plans Offer Tax Advantages for Professional Services Firms

Roadmap to Retirement: Cash Balance Plans Offer Tax Advantages for Professional Services Firms

Maximizing savings and minimizing taxes are the universal goals when planning for retirement. However, the roadmap for achieving these goals depends on a wide range of variables, such as age, income level, individual preferences and how you intend to spend your retirement years. For high-income earners in the professional services sector, a cash balance plan can significantly accelerate retirement savings while offering additional opportunities for tax deferral.

Cash balance plans are IRS-approved defined benefit plans that look and behave like defined contribution plans. Sometimes called a “hybrid plan,” a cash balance plan combines higher annual contribution amounts and interest credits with the higher maximum benefit and deduction limits available to defined benefit plans. This means you’re able to accumulate a significantly higher retirement nest egg and defer taxation on much higher levels of your income compared to a 401(k) plan.

Today, cash balance plans represent the fastest-growing segment of the retirement plan market, with much of the growth fueled by small business owners and professional services firms that value the plan’s increased financial flexibility and opportunity to reduce taxable income.

How Cash Balance Plans Work

Cash balance plans are an especially good fit for professional services firms with a small number of high-income earners who are contributing at or near the defined contribution limits and looking for additional options to defer more income in retirement. While only business entities can sponsor a cash balance plan, the option is available to companies of all sizes, including those with a business owner as the entity’s only employee. In addition, cash balance plans can be sponsored as a standalone plan or alongside 401(k) and profit-sharing plans.

A cash balance plan provides “theoretical accounts” for each participant, which are maintained by the plan administrator. The accounts are credited with contributions, called pay credits, that are typically a percentage of pay, a flat-dollar amount or a combination of the two. In addition, the account is credited with interest based on a rate defined in the plan. The interest rate can be a flat percentage or based on the yield of an index, such as the 30-year treasury yield, but it’s generally unrelated to the actual return on assets under the plan.

When setting up a cash balance plan, the sponsor identifies a contribution amount for each owner, partner and participant, up to the maximum amount permitted by law. These plans are subject to minimum funding requirements and need an actuary’s annual certification that the plan met the minimum funding obligations. As a defined benefit plan, the investment risk falls upon the plan sponsor. That means investment returns may impact the required contributions from year to year but not the ultimate benefit that is payable to a participant.

The amounts that can be contributed to a cash balance plan are subject to nondiscrimination testing to ensure the contributions for highly compensated participants bear a reasonable relationship to the amounts contributed on behalf of non-highly compensated participants.

Many firms elect to take a “combo plan” approach, which enables them to treat their cash balance and profit-sharing plans as a single plan for nondiscrimination purposes. With a combo plan, an employee benefits by earning a pay credit in the cash balance plan or receiving an employer contribution in the profit-sharing plan, or both. In many cases, firms can implement a cash balance combo plan with little to no increase in contributions.

How Cash Balance Plans Reduce Tax Liabilities

Cash balance plans offer distinct tax advantages for plan sponsors and participants alike. For businesses, the tax deductions go beyond what’s available with a 401(k) plan. The funds contributed to a cash balance plan are tax deductible in the first year the plan is implemented and are considered an “above the line” deduction that reduces the business’ taxable income dollar for dollar. Company-paid plan administration fees may also be tax deductible.

For participants, contributions to the plan are made pre-tax, and the higher contribution limits compared to 401(k) plans or IRAs give high-earning individuals a way to greatly accelerate their tax-deferred retirement savings. Participants over age 60 are eligible to make $200,000 or more in tax-deductible contributions to a cash balance plan.

The professional services industry experts at CBIZ can help you explore whether a cash balance plan fits your specific business and retirement goals.

Gain access to more resources here.

Roadmap to Retirement: Cash Balance Plans Offer Tax Advantages for Professional Services Firmshttps://www.cbiz.com/Portals/0/Images/PSIndustryArticleSept2022.jpg?ver=OpCiEkzeMrnYk9nXPsclLQ%3d%3dMaximizing savings and minimizing taxes are the universal goals when planning for retirement.2022-09-28T16:00:00-05:00Maximizing savings and minimizing taxes are the universal goals when planning for retirement. Planning & Tax MinimizationRetirement Plan ServicesYes