Retirement Savings Beyond a 401(k)
Written by: Nathan Boxx, AIF®, CFP® | Director of Retirement Plan Services
Maxing out your 401(k) Profit Sharing and want to save more? If you are:
- A business owner, executive, part of a physician’s group, etc.
- 50 years or older
- Consistently maxing out your 401(k) at $61,000 plus $6,500
Then it is time to consider a cash balance plan.
What Is a Cash Balance Plan?
Let’s talk about a cash balance plan and how it works. A cash balance plan combines a traditional defined contribution 401(k) plan and a pension plan. It’s like a 401(k) plan because everyone has their own account, but participants are promised a particular benefit at retirement. This differs from a traditional pension which promises a monthly income stream. These plans are also similar to pensions in that only the employer makes contributions; employees cannot defer into this plan. That’s the purpose of a 401(k).
Each participant will receive a pay credit, either a percentage or flat dollar amount, whatever is defined in the plan document. In addition to that, they will receive an interest credit which is the rate of return guaranteed to the participants.
Example of a Cash Balance Plan
We recently looked at implementing a cash balance plan for a medical group with a handful of employees. After accounting for the mandatory company contributions (more to come) of around $15,000 for the staff, it was estimated that the doctor/owner between their personal deferrals, profit sharing, and cash balance contribution could save more than $285,000. That’s not a bad deal!
The business owner was able to save $285k into tax-sheltered accounts earmarked for retirement, and the employees are all happy because their retirement savings also get a bonus. Did I mention these are all tax-deductible contributions? But, of course, not all cases will work out like this. Many variables come into play, such as the demographic of the workforce, cash flow, and the like.
What’s the Difference Between a 401(k) And a Cash Balance Plan?
And this is where it further departs from its 401(k) cousin. The employer’s amount contributed is defined in a 401(k), but the outcome is not. Meaning the employee bears the investment risk. On the other hand, the amount of money the employee can expect with a cash balance plan is defined. Thus, the employer is responsible for the investment results.
Something else to be mindful of is that the services of an actuary will be required to perform the calculations and ensure compliance with the relevant regulatory regimes. And while that cost will vary by provider, it is well worth it considering the overall benefits of the plan.
What’s the Difference Between a Pension And a Cash Balance Plan?
An important consideration with a cash balance plan is that you need to be committed to making this contribution year-in-and-year-out; it is not discretionary. This, however, is where it differs from a pension that theoretically could live in perpetuity. According to best practices, this needs to be funded for at least three years to avoid undue IRS scrutiny.
Often what we see is that these plans are set up and funded for a decade or so, giving the owners, partners, or practitioners a vehicle to significantly ramp up their retirement savings and then terminate the plan allowing participants to roll their funds to another retirement account.
Is a Cash Balance Plan Right for You?
While certainly not for everyone, a cash balance plan can be an excellent tool for business owners looking to save more for retirement. A cash balance plan is a big commitment. However, the ability to ramp up savings and reduce taxes can be worth whatever costs and hassles.
Is a cash balance plan right for you? Contact Fort Pitt Capital Group’s Retirement Plan Sponsor group for a consultation today!
About the Author:
Nathan Boxx, AIF®, CFP®
Director of Retirement Plan Services
Fort Pitt Capital Group, LLC
680 Andersen Drive, Pittsburgh, PA 15220
(412) 921-1822 | email@example.com