Cash balance plans are powerful, tax-qualified retirement vehicle designed to help your business owner clients rapidly accumulate retirement assets, especially if they've fallen behind in their savings goals. Considered hybrid plans, they combine the high employer contribution amounts of traditional defined-benefit plans with many characteristics found in defined-contribution plans such as 401(k)s.
Here are eight reasons to consider offering them to your clients:
1. They help business owner clients rapidly catch up on retirement saving. Cash balance plans are ideal for companies with owners or partners (typically at least 40 years old) that generate consistent and predictable cash flows and are looking for ways to reduce their taxable income. These plans are designed to afford companies the ability to contribute more than what the IRS allows under a standardized qualified retirement plan such as a profit-sharing or 401(k) plan.
Larger annual contributions can reach $250,000 or more per year, compared to just just $66,000 (plus a $7,500 catch-up contribution for investors over age 50), for those who participate in a profit-sharing or 401(k) plan.
2: There are significant tax savings. Cash balance plans offer business owners distinct tax advantages and deductions. The funds contributed are tax-deductible in the first year the plan is implemented and are considered an “above the line” deduction that reduces the business’ taxable income dollar for dollar. For participants, contributions are made pretax, and given that contribution limits are higher than with other retirement plan types, high-earning individuals can accelerate their retirement savings. Furthermore, plan setup and administration fees may be tax-deductible for the business owner, although owners should consult with a tax attorney or advisor before proceeding.
3: Assets are protected from creditors. Cash balance plans are IRS-qualified retirement plans under the Employee Retirement Income Security Act and are protected from creditors in the event of bankruptcy.
4: The goal of a cash balance plan is not to maximize the investment return. When businesses set up a cash balance plan, the employer credits each participant with a "pay credit" (such as 5% of compensation) and an "interest credit" that's guaranteed as either a fixed or variable rate and is linked to a benchmark index such as the 30-year Treasury. Increases and decreases in the value of the plan's investments do not directly affect the benefit amounts promised to participants.
5: This is an attractive benefit that can help small firms attract and retain talent. Recruiting and keeping top-tier employees remains a significant challenge for many business owners. Younger professionals may value an employer-funded retirement plan that could offer greater long-term benefits as they remain with the company.
6: Cash balance plans work for many different types of businesses. These plans can work for small to midsize businesses, including family or closely held firms, as well as those with succession planning issues. Professional services firms such as law firms, medical practices, accounting, engineering and architectural businesses are also good fits. Finally, they can be a suitable option for sole proprietors.
7: These plans can help you deepen client relations and attract additional assets. By offering cash balance plans, advisors can increase their value to clients who have already delegated their non-retirement wealth business to them, protecting these relationships from competing advisors. These plans also build up substantial assets under management with increased revenue streams. Cash balance accounts tend to be long term and “sticky” in nature, so when the business owner or their employees retire, the accounts are portable and can be rolled over into an IRA, creating an on-going need for financial advice and guidance.
8: Turnkey plans can simplify administration. Cash balance plans are specialized and require tax advisors and actuaries for implementation and administration. Managing these plans also requires investment knowledge and experience, to meet the annual interest credit rate determined within the plan document. As they are qualified plans regulated by the ERISA, cash balance plans come with certain complexities that can be outsourced into a turnkey solution that integrates tax, fiduciary, actuarial and investment expertise into a single easy-to-administer program.
Ross K. Brown is vice president of business development at Payden & Rygel, a global asset management firm.
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