How to Take Advantage of Retroactive Cash Balance Plans – A Tax-Friendly Solution

How to Take Advantage of Retroactive Cash Balance Plans – A Tax-Friendly Solution A cash balance plan is designed to maximize tax deferrals to the owner and key staff and significantly accelerate the process of saving for retirement, often suitable for small to mid-sized business owners. Cash balance plans are defined benefit retirement plans that enable business owners to make meaningful tax-deductible contributions each year and accumulate significant retirement savings on a tax-deferred basis. An Innovative, “Hybrid” Retirement Plan A cash balance plan is employer-funded with the contribution/benefit formula clearly defined for participants. While a cash balance plan is a defined benefit plan, it is generally viewed as a “hybrid” between a defined benefit plan and a defined contribution plan because a participant’s benefit is stated in terms of a current account balance, like a 401(k) plan. In a typical cash balance plan, the participant’s account is credited each year with a “pay credit“¹ and an “interest credit“². Cash balance plan assets are typically invested in a “pooled” trust account maintained in the plan’s name and managed by the plan’s investment advisor. Enhanced Timing Flexibility The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 allows an employer to adopt a cash balance plan after the close of the taxable year but before the employer’s tax return filing date³. As an employer, you may have the flexibility to treat the plan as adopted in the prior tax year, which may be beneficial for tax purposes. Advantages of Cash Balance Plans include: 

• Benefit from Healthy Contribution Limits – cash balance plans allow for higher contribution limits than defined contribution plans. The total annual contribution limit for cash balance plans in 2022 could be potentially greater than 100% of compensation depending on the plan design and the age of the participant versus $61,000 for defined contribution plans⁴.
• Profit from Tax Deductibility – significant tax savings can be realized starting with the first year the plan is adopted. Cash balance plans have the same tax effect as a deduction that reduces ordinary income dollar for dollar. Some business owners may be able to reduce their adjusted gross income enough to qualify for the 20% qualified business income tax deduction.
• Begin Now for Start-Up Tax Credits – eligible employers may be able to claim a tax credit of up to $5,000, for three years, for the costs of starting a plan.
• IRA Rollovers – a cash balance plan account total may be rolled over to an IRA when a participant retires or changes jobs.

Adopt Your Cash Balance Plan Today Small businesses continue driving cash balance plan growth. According to a recent study, 94% of cash balance plans are in place at firms with fewer than 100 employees. The needs of small business owners to catch up on delayed retirement savings and attract and retain top talent are key factors. Companies with consistent profit patterns and strong cash flow tend to be good candidates for these plans, as are partners or owners who desire to contribute more than $61,000 a year to their retirement accounts. You Get the Best of Both Worlds Business owners no longer need to make trade-offs between the advantages of defined benefit plans and defined contribution plans when choosing retirement designs. For most firms, a cash balance plan may complement an existing retirement plan, such as a 401(k). The owner and key employees can take advantage of the higher savings potential of the cash balance pension plan while still contributing to a 401(k) plan, enabling them to boost their annual retirement savings. ¹  A percentage of compensation or a fixed dollar amount. ² Either a fixed rate or a variable rate linked to an index such as the one-year treasury bill rate. ³ Including extensions. ⁴ Including both employer and employee contributions in the defined contribution plans.