Cash-balance plans offer break to small-business owners

Are you a small, highly profitable business owner looking for ways to reduce your current taxes and/or dramatically step up your tax-sheltered retirement savings?  If so, a cash-balance plan may be worth looking into for your company.

A cash-balance plan is a retirement savings vehicle, crafted with the small-business owner in mind. When combined with a safe harbor 401(k) or profit-sharing plan, it can allow you to make significant, tax-deductible contributions to your own and partners’ retirement savings, while controlling the costs of your contributions to employee retirement accounts. “Significant” may be up to $200,000 or more annually, depending on your age, income, years in business and other Internal Revenue Service limits.

In addition to accompanying it with a 401(k) or profit-sharing plan as required, your cash-balance plan usually works best when all of these conditions are met:

• You are a small-business owner, age 40 or older, with 1 to 10 employees.

• Your expected income is relatively predictable for at least the next five years.

• You can contribute up to $200,000 or more annually for the next five years.

To establish your cash-balance plan, you open one trust investment account for the plan, where investments are pooled for participants — you and any partners or key employees. Each participant has a hypothetical “account” that earns a set interest credit annually, regardless of the plan’s actual investment performance. Contributions are then adjusted annually as needed, to fill any underperformance gap that may occur. When investing your pooled assets, we’d typically suggest something in the range of a 3 percent performance target, generated by a conservative, low-cost portfolio.

Here are two cash-balance plans in action, reprinted with permission from Dedicated Defined Benefit Services. They assume combined federal and state tax rate of 38 percent and are based on specific assumptions and used for illustration only.

Case 1: a medical practice with 1 to 10 employees

Dr. Curtis, age 53, is a successful internal-medicine practitioner with four employees. During the next decade, she wants to maximize her own retirement savings while contributing to her staff’s retirement accounts. Chart 1 shows how that might look. Dr. Curtis’ estimated annual tax savings is approximately $78,500, with 93 percent of her contributions funding her own retirement.

Case 2: four business partners with no employees

Four partners in a successful law firm have varying preferences for funding their retirement accounts during the next five years. A cash-balance plan can help the senior partners save at accelerated levels, while junior partners can contribute more modestly. Chart 2 shows what that might look like. The partners’ combined annual estimated tax savings is approximately $145,000.

As you might expect, even if a cash-balance plan sounds right for you, there are plenty of caveats to consider, including ensuring that you and your plan remain compliant with IRS tax regulations as well as the Department of Labor’s fiduciary rules. We recommend consulting with professional tax and financial specialists to determine how the details apply to you.

Robert J. Pyle is president of Diversified Asset Management, Inc. This column reflects the writer’s views, is not a recommendation to buy or sell any investment and does not constitute investment or tax advice. Contact him at 303-440-2906 or info@diversifiedassetmanagement.com .

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