Business owners in the Lehigh Valley such as sole proprietors, physician practice partnerships, law practice partnerships and entrepreneurs can reduce their personal and business tax burdens while substantially increasing retirement savings by offering a cash-balance plan to both owners/partners and employees. What distinguishes cash-balance plans from other retirement-savings vehicles is that they have significantly higher contribution limits than more traditional retirement plans – and those contribution limits increase with age.
For business owners who may have spent years investing in their own businesses and who, therefore, may be behind on retirement savings, the higher contribution limits permitted through cash-balance plans are appealing, allowing them to amass more pretax dollars each year than they would be permitted through a traditional 401(k) plan. For them, investing in a cash-balance plan can serve as a foundation for long-term wealth building.
The IRS’ annual contribution limit for employees under age 50 contributing to 401(k)s and other traditional retirement plans is $19,000 in 2019. For those over 50, that contribution limit is $25,000. For 2019, the contribution limits in total employer and employee contributions for cash-balance plans are $194,000 for a 55-year-old, $254,000 for a 60-year-old, and $266,000 for a 65-year-old. With such high contribution limits, business owners can certainly accelerate retirement savings.
Let’s say a business owner arrives at the age of 55 with no real retirement savings, having reinvested most of his earnings into his business. He need not fear – it’s not too late. If he invests up to the contribution limit of $25,000 per year in a 401(k) for 15 years, he will have $539,464 by the time he is 70 (assuming 5 percent annual investment return over 15 years). If, however, he were to contribute up to the much higher contribution limits of a cash balance plan over those same 15 years, he would have $5,007,222 – or nearly 10 times the savings. Of course, high business cash flow is required for such significant distributions to retirement savings, but this is what is possible and permissible. And since a business owner is permitted to contribute to both a 401(k) and a cash balance plan, the combined retirement savings in this scenario could be as much as $5,546,686.
Because cash-balance plans can be designed to reward employees at varying levels, the higher distributions offered can be a very attractive enticement for upper-management recruits. Also, the plans are qualified by the U.S. Internal Revenue Service, tax-deferred, secured under the Employee Retirement Income Security Act and protected from creditors.
Like in traditional defined-benefits pension plans business owners or partners coordinate with their plan manager to try to match assets (plan balances) and liabilities (future payouts). And once again, businesses or partnerships offering this type of retirement benefit must have stable profits and cash flow year over year since employers are required to make contributions to employees’ cash balance plans annually. Administrative fees for cash-balance plans are higher than those of 401(k)s , ranging from $2,000 to $10,000 annually – and investment management fees can be 0.25 percent to 1 percent of assets.
When they reach the age of retirement, plan participants can make a choice about how they wish to receive their cash-balance plan earnings; distributions can be taken as an annuity or as a lump-sum benefit that can be rolled over into an individual retirement account or another employer’s plan. The common practice — and the recommended one — is to take the distribution as a lump-sum benefit.
Business owners in the Lehigh Valley are well advised to consider offering a cash-balance plan as a powerful tool to build personal wealth and to reduce both personal and business taxable income.
Michael Joyce is founder and president of Agili in Bethlehem and Richmond, Virginia. He is responsible for overall investment strategy, management of investment portfolios and financial counseling services. He can be reached at email@example.com.