POV: you’re a business owner who may need to play catch-up with your retirement plan. After years of putting money back into the business, you may have neglected to consider the impact of your own retirement income plan.
This is where a defined benefit plan, more specifically, a cash-balance plan comes into play for your business.
Here at Consolidated Planning, we have over four decades of experience guiding business owners through their critical financial decisions. The understanding that comes with honing our craft over this period of time helps us deliver a refined process to align your planning efforts with your financial goals.
In what follows, we’ll help you understand what a cash-balance plan is, five ways these plans can lower your taxes as a business owner, and if this defined benefit plan is right for you, your employees, and business goals.
What Is A Cash-Balance Plan?
A cash-balance plan is one of the three kinds of defined-benefit pension plans, the other two being a traditional or fully insured plan. While all forms of defined benefit plans are attractive in that they may be appropriate for any type of business entity as well as for a sole proprietor with no employees, for the purpose of this article we’ll focus on the cash-balance plan.
The plan must, of course, satisfy the Internal Revenue Code (IRC) rules for eligibility, participation, benefits, vesting, and funding. The cash-balance plan option does boast the flexibility to design the plan in a way that rewards certain groups of employees, such as owner-employees and key employees. The option to offer enhanced benefits to certain employees specifically is a great way to further retain key employees to grow your business.
A cash-balance plan is considered a hybrid defined-benefit plan that provides guaranteed benefits to employees. It resembles a profit-sharing account because it provides benefits to employees that they can review, which are referred to as the hypothetical account balance.
The hypothetical account is a great way to communicate the benefit in the plan. There is actually no individual account balance, as plan assets are commingled and generally directed by the plan’s fiduciary. Contributions to the hypothetical account are typically based on a percentage of compensation. This is a career average plan, as contributions credited are typically based on each year’s compensation, as defined in the plan document. The contributions to the hypothetical account are credited with interest each year based on some objective index or other amount defined in the plan.
Unlike other defined-benefit plans, a cash-balance plan may be designed to better control the cost of the retirement plan.
5 Ways A Cash-Balance Plan Lowers Taxes For Business Owners
Cash-balance plans can be an effective tool for business owners to lower their current tax liability, maximize retirement savings, and facilitate long-term wealth accumulation and estate planning strategies. Here’s five ways it can help your business goals:
#1 Tax Deductions for Contributions
The contributions made to your cash-balance plan can be deducted from your taxable income. Since these contributions are treated as a business expense, they reduce the taxable income of the business, resulting in significant tax savings for the business owner.
#2 Tax-Deferred Growth
Similar to other retirement plans, the investment earnings within a cash-balance plan grow on a tax-deferred basis. The contributions and any investment gains in the plan are not subject to current income tax, allowing the assets to grow more quickly than if they were taxed on an annual basis.
#3 Larger Tax-Deferred Contributions
Cash-balance plans allow for larger tax-deferred contributions compared to other retirement plans like 401(k)s or IRAs. This is particularly beneficial for business owners who have a higher income and want to contribute more towards their retirement savings all while reducing their current tax liability. And we’re guessing that’s something you’ll want to do.
#4 Wealth Accumulation and Estate Planning
As a business owner, you’re likely in your wealth accumulation and estate planning phase. A cash-balance plan can also serve as a tax-efficient vehicle for these planning purposes. By contributing your pre-tax dollars into the plan and allowing the assets to grow tax-deferred, you can potentially accumulate more wealth over time. Additionally, upon your retirement, the plan assets can be passed on to beneficiaries with favorable tax treatment, providing a tax-efficient way to transfer this wealth to future generations.
#5 Flexibility in Contribution Levels
In a perfect world, your business would make slightly (if not vastly) more year after year. But, we all know that being a business owner comes with its fair share of challenges.
Cash-balance plans offer flexibility in contribution levels, allowing business owners to adjust contributions based on their financial situation and business performance.
Is A Cash-Balance Plan Right For Your Business Goals?
Contributions made to defined-benefit plans are generally tax deductible, reducing ordinary income, while subsequent earnings on these contributions grow on a tax deferred basis. The federal and state income tax savings can be impressive here.
For more predictable, safe, and recurring tax deductions for business owners, a cash-balance plan may align with your overall financial goals.
To fully understand your tax situation and how large deductions are potentially possible for your business, start the conversation with an experienced planning professional at Consolidated Planning.
2024-171769 Exp. 3/2026
Material discussed is meant for general informational purposes only and is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice.
This material contains the current opinions of Ernie Guerriero and Consolidated Planning only. These are not the opinions of Park Avenue Securities, Guardian, or its subsidiaries.
