How to Hack A 6 Figure Tax Deduction Using A Cash Balance Plan

Did you know that there’s a simple secret business owners like you are using to cut their taxes by up to 6 figures? And they’re doing that while accelerating their retirement savings up to twice the speed at the same time. That’s thousands and thousands of extra dollars in your pocket at the end of each year — all entirely legal!

A 2013 survey showed that 60{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439} of small business owners were not saving the money they needed for retirement. And there’s a simple reason behind that: business owners and employers everywhere are simple too busy.

If you’re an employer, you likely have a never-ending list of things to do in the back of your mind. From hiring the right people, to targeting the right audience and hitting your financial goals, there’s a dozen things you’re constantly juggling on your plate to make sure every little thing in your company is running as smoothly as possible. And if you’re a small business owner, you know just how much more stressful it is running a tight ship daily.

Let’s keep it simple.

2 Types of Cash balance plan tax deductions:

These two types are defined contribution plans and defined benefit plans, where both types of contributions provide tax deductions to the business.

In defined contribution plans, employees decide what percentage of their salary they want to save, and that amount is automatically deducted from their payroll. You know these as the run-of-the-mill 401(k) or 403(b) accounts.

In defined benefit plans, employers contribute a fixed amount of money to their employees’ retirement accounts. That’s your usual pension plan.

But What Is A Cash Balance Plan?

A cash balance plan is a type of hybrid retirement plan:  it’s a defined benefit plan with a twist. It’s a financial secret few financial planners and employers are aware of. But here’s why you need to know about them.

A cash balance plan provides employees with the option of a lifetime annuity, just like a traditional pension. But they also create an individual account for each covered employee with a specified fixed sum. So you’ll be getting the best of both worlds- in savings, that is.

What that means is employees are guaranteed a fixed sum by the time they reach retirement. Once they retire, they can take the fixed amount through a one-time lump sum, or as an annuity that pays out over regular checks. Sounds good, right?

So How Do Cash Balance Plans Work?

Taking advantage of this knowledge on cash balance plans for tax deductions is no longer a secret, and entirely legal. Each time an employee signs up for a cash balance plan, the employer creates an individual account with predetermined annual contributions calculated according to a simple formula:

annual benefit = (benefit credit) + (interest credit)

It’s all pretty mathematical, so you know what you’re committing to beforehand: kind of like a pre-nup, but for retirement. But let’s break this down even more. As the employer, you will contribute a “benefit credit”, which is a specified, fixed percentage of the employee’s salary (commonly 5{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439}).

The “interest credit” is a specified, guaranteed rate of return. It can be a fixed rate (ex. 6{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439}) or a variable rate fixed to an index, commonly a federal long-term rate (e.g. 30-year Treasury rate). It’s like that end-of-year bonus you’re always hoping for, except you’re guaranteed to get it.

Now, for example, let’s say an employee makes an annual salary of $60,000, with a predetermined benefit credit rate of 5{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439}, and with the Treasury rate (2.98{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439}) as the interest rate.

Here’s what the calculations would look like:

annual benefit = (0.05 x 60,000) + (2.98 x 60,000)

The annual benefit would be $4,788. That’s almost 8{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439} of the employee’s annual salary.

But don’t get your calculator out yet. This is just a simple explanation to give you an idea of how things work. Once you choose a cash balance plan, a professional financial advisor will do all the math for you, and help you maximize your benefits and savings. And an actuary will maintain the individual accounts and generate annual participant statements. So if you can’t remember grade school Algebra, no worries.

A study from Vanguard shows that on average, employees between the ages of 25 to 34 save 5.3{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439} of their annual salary with their retirement plan, while those ages 55 to 64 save 7.8{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439}.

So no matter what figure you use as the employee annual salary, the average cash balance formula will always come out close to 8{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439}. That’s because the structure of a cash balance plan revolves around benefit and interest credit to give you the most savings possible.

Why Choose A Cash Balance Plan?

• FLEXIBILITY: Plans can be designed to be age-based, or service-based, to provide larger benefits to older or longer-service employees participating in this plan. Benefit credits are most commonly class-based, which rewards higher benefits to owners/shareholders and partners, with lower amounts to employees. The “benefit credit” gives you maximum freedom to design plans as you please.
• PORTABILITY: Not only do cash balance plans provide employers with more design flexibility, they also offer more flexibility through a “portability feature.” If an employee leaves a company before retirement age, they don’t have to cash out. He or she can just take the accumulated cash balance with them. And that balance can be used to fund another retirement account. This makes cash balance plans highly attractive to younger employees who are more likely to move from one career to another every few years.

But no worries: the law has your back, and so do we. There’s something called a “vesting period” to protect employers. This is the minimum amount of time a plan participant must be employed to earn a legal right to the benefits. Each year of employment adds up to a percentage of accessible money, so if an employee quits after 3 years of working, they cannot take the entire sum of money with them.

• TAX-DEDUCTIONS: Cash balance plans can be combined with 401(k) profit sharing plans to maximize tax-deductible contributions for employers. Tax deductions range from an additional $50,000 to $250,000 a year, depending on the age and income level of plan participants. We’ll touch more on this in a second.
• TAX-FREE: And just when you think this can’t get any better, it does. All contributions to cash balance plans made by employers who maintain corporate entities are free of Social Security and Medicare taxes (7.65{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439} for both the employer and the employee). That’s more money in your pocket! At least until money is withdrawn at retirement. But by then, the money in your cash balance plan will likely have accumulated enough interest to make up for that. That’s why choosing cash balance plans is more strategic than being taxed upfront.

How Do Tax-Deductions In Cash Balance Plans Work?

All contributions made to cash balance plans are tax deductible, meaning all contributions reduce the employer’s taxable income dollar for dollar. And all plan assets are tax-deferred until distributions are made; including the costs of administrating a cash balance plan. While your business pays for the services to implement the plan, the costs for maintaining a cash balance plan are also tax-deductible. That’s savings on savings!

Tax deductions are made through either a company tax deduction or a personal tax deduction, depending on whether the plan sponsor is a corporation. Contributions from a non-owner will always count as a company tax deduction.

A cash balance plan typically guarantees an annual return of 4{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439} on mandatory annual contributions. And if that doesn’t sound like much, just remember that Federal and State income tax rates combine to be as high as 45{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439}, meaning that tax savings from plan contributions and investment earnings can easily add up to 6 figures, especially when it’s across all cash balance plans within your company. You don’t want all your hard-earned cash to get taken by the government, do you?

Advantages to a Cash Balance Plan:

• Major tax savings and tax-deductible contributions
• Supercharge your retirement savings with high contribution limits
• Portable feature attracts younger talent
• Flexible plan designs customizable to your business
• Benefits are clear outlined and guaranteed – easy for employees to understand
• Clearly defined liability so you know what you’re signing up for

Disadvantages to a Cash Balance Plan:

• Costs more upfront to implement than traditional 401k’s
• Plan funding limits may restrict lump sum payments
• Employers bear the investment risk
• Require Pension Benefit Guaranty Corporation (PBGC) premiums

How To Start A Cash Balance Plan:

Easy As One, Two, Three!

Starting a corporate-wide cash balance plan may sound like a daunting vacuum of endless paperwork and calculations, but it’s actually really plain and simple.

Let’s walk through the process.

Step 1: Select a retirement service firm. The firm will provide tax and financial advisors to collect a census outlining the employee demographics of a company. After that, a professional retirement plan designer will assess that information and calculate details of the plan for owners, executives, and employee. A professional tax and/or financial advisor will look over that plan to ensure that it treats all parties equally, and will pass IRS testing and non-discriminatory standards. This might sound boring, but it’ll save you from several paperwork headaches later on.

Step 2: File and legalize. A financial advisor will put together a legal document outlining the entire plan’s details, including key information such as the contributions for the participants, the benefit credit rate, and the annual interest credit. This document has to be signed within the fiscal year which your company wants to take the tax-deduction. So remember: just sign here on the dotted line for thousands of dollars in savings, no shipping and handling fees necessary.

Step 3: Fund your plan. This is another important step — contributions to the cash balance plan must be funded by the due date of your tax return (including tax extensions), and no later than eight and a half months after the year ends. All these due dates might bring back traumatizing high school memories, but no worries. Your financial advisor administering these plans will act like your mom and hound you to make these contributions in time. No need to panic though, they won’t send you to your room or take away your electronics.

Starting A Cash Balance Plan:

A Few Things To Keep In Mind

Any company offering cash balance plans should have a history of stable cash flow and profits. Cash balance plans require a stable contribution level for three years or more to establish and meet plan “permanency” requirements. You wouldn’t want the IRS hunting you down for tax evasion, of course. If you do… you’re on the wrong article.

The nature of cash balance plans means that part of it depends on an investment: the interest credit. Increases and decreases in the value of the benefit credit rate will not affect the benefit amounts promised to participants. And because the employer makes all investment decisions, they also assume the investment risks. But again, you’re not navigating these uncharted waters alone: you’ll have a professional financial advisor by your side.

If the assets perform better than the benchmark return this year, your annual benefit contribution will be smaller next year. Likewise, if the investments fall short this year, the employer has to make up the difference.

You might have hesitated a little, but that’s not something you should worry about. Just like other pension plans, assets are pooled and invested by a trustee or professional investment manager. That shortfall is a gap that generally makes up for itself over a few years, so you can rest assured that your investment is safe.

So, to quickly recap, a cash balance plan is a win-win for both employees and business owners. Both parties enjoy reliable savings, while business owners get huge tax savings on top of that.
And as always, we’re dedicated to helping you skyrocket your tax savings and your retirement savings so you can focus your full attention on your company’s growth.

If you have any questions about whether a cash balance plan is the right fit for you, contact one of our professional financial advisors for a free consultation, or go through our many retirement resources to take a look at your options.