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Boosting Retirement Savings for Business Owners with a Cash Balance Pension Plan

Mike Metzger, Founder | CERTIFIED FINANCIAL PLANNER™
Salt Lake City, Utah
Business owners looking too supercharge retirement savings should consider a cash balance pension plan to maximize retirement wealth! This type of retirement plan offers unique advantages, including significant tax benefits, flexibility in contributions, and the ability to maximize retirement savings. In this blog post, we will delve into what a cash balance pension plan is, the rules around it, how to calculate maximum savings, potential tax advantages, and the flexibility in accessing funds at retirement.
What is a Cash Balance Pension Plan?
A cash balance pension plan is a type of defined benefit plan that combines features of both traditional pension plans and defined contribution plans. In a cash balance plan, participants receive annual contributions to their individual accounts, which are typically based on a percentage of their salary and age. These contributions grow at a predetermined interest rate, providing participants with a guaranteed benefit at retirement.
Rules Around Cash Balance Pension Plans:
1. Contribution Limits: The maximum annual contribution to a cash balance pension plan is determined by a combination of factors, including the participant’s age, salary, and years of service. The IRS sets limits on the annual contribution amount to ensure that the plan remains compliant with tax regulations.
2. Nondiscrimination Rules: While cash balance pension plans can be designed to favor business owners and highly compensated employees, they must still adhere to nondiscrimination rules to ensure that rank-and-file employees also benefit from the plan. Employers may need to make contributions on behalf of employees to meet these requirements.
Contribution Rules Expanded- Average of 3 Years of Gross Income Rules:
The average of three years of gross income rule is a method used to calculate the allowable contribution amount that a business owner can make to a cash balance pension plan. This rule takes into account the business owner’s gross income over the past three years and uses this average as the basis for determining the maximum contribution amount to the plan.
Calculating Maximum Contribution Amount:
To calculate the maximum contribution amount based on the average of three years of gross income, business owners typically follow these steps:
1. Determine Gross Income: Calculate the gross income earned by the business owner in each of the past three years. This includes all sources of income related to the business, such as salary, bonuses, dividends, and other forms of compensation.
2. Calculate Average Gross Income: Add together the gross income earned in each of the three years and divide by three to calculate the average gross income over the three-year period.
3. Determine Contribution Limit: The contribution limit to a cash balance pension plan is typically a percentage of the business owner’s average gross income. This percentage can vary based on factors such as age, years of service, and other plan-specific criteria.
4. Maximize Contributions: Business owners can maximize their contributions to the cash balance plan by contributing up to the allowable limit based on the average of three years of gross income. By contributing the maximum amount allowed, owners can take full advantage of the tax benefits and retirement savings potential of the plan.
Tax Advantages of Cash Balance Pension Plans:
One of the key benefits of a cash balance pension plan is the tax advantages it offers to business owners. Contributions made to the plan are tax-deductible for the employer, reducing the company’s taxable income. Additionally, participants in the plan can defer taxes on their contributions and investment earnings until they begin withdrawing funds in retirement, potentially allowing for tax-deferred growth over time.
Flexibility in Accessing Funds at Retirement:
When it comes time to retire, participants in a cash balance pension plan have several options for accessing their funds. They can choose to receive a lump sum distribution of their account balance, convert it into an annuity for a steady stream of income, or roll it over into an individual retirement account (IRA) for continued tax-deferred growth. The flexibility in how funds can be accessed allows retirees to tailor their retirement income strategy to their individual needs and preferences.

A cash balance pension plan can be a valuable retirement savings vehicle for business owners looking to maximize their savings potential while enjoying significant tax benefits. By understanding the rules around cash balance plans, calculating maximum savings, and exploring the flexibility in accessing funds at retirement, business owners can take advantage of this powerful retirement planning tool to secure their financial future. With careful planning and strategic contributions, a cash balance pension plan can help business owners build a robust retirement nest egg and enjoy a comfortable retirement lifestyle.

 

 

Disclosures:

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal.  Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.

Traditional IRA account owners should consider the tax ramifications, age and income restrictions in regards to executing a conversion from a Traditional IRA to a Roth IRA. The converted amount is generally subject to income taxation.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

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