Posted by Guest Blogger Michael A. Chisnell, Jr., CFP®, QPFC, AIF®, CBC - Vice President – Institutional Services, Sequoia Financial Group, LLC
As summer starts to cool off, year-end tax planning begins heating up. Even if your business has had consecutive successful years and you expect that success to continue, you may:
- Be frustrated with your tax bill,
- Have extra cash in the business,
- Have focused your investment strategy on your business and not retirement (especially for business owners 40 or older),
- Be on an executive team or partnership group and need to “soak up” compensation dollars for tax planning or retention purposes, or want to save more than $50,000 a year tax deferred, or
- Be in the succession planning phase of buying or selling an entity.
Wherever you fit in, you want to reduce your tax bill, enhance you or your employees’ retirement readiness and capitalize on your planning opportunities. A possible solution is the cash balance plan.
What is a Cash Balance Plan?
Over simplifying the answer, a cash balance plan is a hybrid defined benefit/contribution plan that often gets bolted on to a new or existing 401(k) plan. A 401(k) Profit Sharing combination will limit someone to an annual maximum of $54,000 or $60,000 (age 50-plus). A cash balance plan combined with a 401(k) Profit Sharing Plan may allow the following approximate annual savings amounts based on ages, non-highly compensated employee contributions and actuarial valuations:
- 35 – 39 - $117,000 - $132,000
- 40 – 44 - $136,000 - $156,000
- 45 – 49 - $162,000 - $188,000
- 50 – 54 - $201,000 - $235,000
- 55 – 59 - $244,000 - $288,000
- 60 – 62 - $301,000 - $328,000
- 63+ - $317,000+
As an example, let’s take a look at the 50-year-old numbers. How does the IRS allow a deferral of around $200,000 a year? First, he would back out the $60,000 you deferred to the 401(k) Profit Sharing Plan. Then he would have $140,000 left on the $200,000 limit.
Due to the hybrid defined benefit nature of the cash balance plan, the calculation effectively works out to approximately a $2.6 million at age 62 lifetime deferral limit. The IRS discounts the $2.6 million based on the current age and an assumed interest rate over a 10-year deferral period. Due to the higher limits, business owners and executive team members are allowed to leverage their highest earning years to help them catch up on their retirement savings needs.
What’s the Catch?
A wise person once said, for every gimmie — there’s a gotcha. In this case, likely it means increased contributions to employees, specifically those earning less than $120,000 per year in 2017. Typically, total employer contributions to these employees’ profit sharing accounts ranging in the 5% to 7.5% level in a design strategy called “Offset” (more on that another time). If your plan already uses a 3% Safe Harbor Non-Elective Contribution and/or any profit sharing contribution amounts, you can subtract that total percentage from the 5% to 7.5% range. If you are doing a company match, those dollars do nothing to reduce the total employer contribution cost of the plan.
Prior to making a final assessment on the viability of this strategy for your personal planning needs, you would need to perform a census study to assess the required company contribution amount. An ideal strategy will permit you to keep more of your dollars. Yes, you may have to increase the amount you are contributing to your employees; however, an analysis by independent financial advisors would determine whether you would be better off paying the government or your employees.
Additional Considerations and Opportunities
There are additional nuances to be aware of prior to determining if this planning strategy might be a right fit. For example, the IRS looks for these plans to demonstrate permanency, generally meaning a period of operation of three years or more. Also, to maximize the tax deductibility, the rate of return objectives tend to be similar to fixed income, which is resolved by possibly assuming more equity exposure in other areas of your investment portfolio, if that is appropriate to your planning needs.
It is important to note, this piece provides an introduction to the cash balance plan concept and possible situational strategies. Like all tools in a tool box they should only be used for the right job. A cash balance plan can be a fantastic tool when matched with the right job.
Michael A. Chisnell, Jr. is Vice President of Institutional Services at Sequoia Financial Group, LLC. Contact him at email@example.com to discuss this topic further or visit www.sequoia-financial.com.
Cohen & Company is not rendering legal, accounting or other professional advice. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts and circumstances.
The material contained herein is for informational purposes only and is not intended to provide specific advice or recommendations for any individual nor does it take into account the particular investment objectives, financial situation or needs of individual investors. Sequoia Financial Advisors, LLC does not provide tax or legal advice. These professionals should be consulted separately before implementing changes to your tax or legal matters. Though related entities, Sequoia Financial Group, LLC and its affiliates, and Cohen & Company, Ltd. are separate companies with common, but not identical ownership. Investment Advisory Services offered through Sequoia Financial Advisors, LLC, an SEC Registered Investment Advisor. Registration as an investment adviser does not imply a certain level of skill or training.