401(k) Corner – Contribute $260,000 every year!

Ok, so it’s not technically a 401(k) that you can defer income into, but many are surprised by just how much can be deferred into retirement plans by using advanced planning.

A recent interaction with a business owner is representative of many conversations we have.  Mr. Johnson (fictitious name) has worked hard and re-invested in his business for many years.  Mr. and Mrs. Johnson sacrificed a lot of time and money in the first decade of the business, even putting retirement contributions on hold for the sake of future growth.   Now, however, the business is profitable and all of their hard work has paid off. 

“I know I need to create my retirement savings, but I’m starting late and, being able to contribute only $22,000 per year into my 401(k) just isn’t going to cut it.” Mr. Johnson complained to us.

We discussed adding a Profit Sharing component to his plan, which increased the amount he can save to $54,000, however, we all realized that we needed even more tax advantaged savings. 

Enter the Cash Balance Plan

Upon further review of his company’s employees, an often overlooked plan made perfect sense for him.  The design allowed him to defer an additional $150k per year and also grant an additional $35K to a highly valued employee, which he used instead of a raise.  In total, he had to give an additional $20K to other employees.  All in all, Mr. Johnson and his valued employee received 90% of the benefits of the plan.  If Mr. Johnson had paid taxes on just his portion alone, he would have had a tax expenditure of approximately $60k!

What is a Cash Balance Plan?

A cash balance plan is technically a defined benefit plan, however, it looks and feels like the defined contribution plans that most are more familiar with. 

Who is a Cash Balance Plan good for?

Generally, cash balance plans will be good for companies with fairly stable profits.  It works best if the people you are trying to skew benefits towards are highly compensated and older than the general employee population. It can work very well for closely held businesses, law firms, medical practices, etc.  The benefits of a cash balance plan are the ability to defer significant sums and the ability to recruit and retain highly qualified candidates with specialized skills. 

How much could I potentially defer into a Cash Balance Plan?

While it depends on the demographics of your company, the maximum contributions are below[i]:

How are the investments handled?

While details are beyond the scope of this article, the Cash Balance investments should be designated as the client’s “safe money” and should be invested conservatively.

How long do I have to keep the plan?

While all corporate retirement plans are technically intended to be permanent, most experts recommend that you should be able contribute to and maintain the plan for at least three years. 

Can I exclude certain employees?

Yes.  There can be a lot of flexibility in the initial plan design phase. 

Why haven’t I heard of this before?

Like many retirement planning  methods and strategies, they can become highly complex and specialized.  While all advisors do “retirement planning” many do not focus on the intricacies involved with ERISA and non-ERISA based plans.  In addition, an actuary experienced in cash balance plans is required in the initial analysis and ongoing maintenance of the plan.  

How do I see if this is right for me?

We will conduct an initial interview to determine if this type of plan is right for you or if a different plan may benefit you more.  If we believe it may benefit you, we would collect an employee census (that includes employee payroll information and birthdates) and work up an analysis of what a potential plan would look like, including how much you could defer and how much would be given to other employees. 

Will future Tax Reform affect this?

Potentially.  While this plan will certainly be on the chopping block if the President’s deficit commission’s advice was taken, we believe it would be an extremely low probability event for any legislation to affect previous deferrals into 401(k)s, Profit Sharing Plans, or Cash Balance Plans.  We would encourage any business owner to see if this is a good opportunity now to take advantage of it before the door closes, if, in fact, it does close. 

[ii] Assuming a 40% combined federal, state, and local tax.  Savings shown are deferred taxes.  Taxes are required to be paid upon withdrawal from the plan.