Cash balance plans are not well known among the advisor community — but they should be. These excellent vehicles help business-owner clients catch up on retirement savings, realize tax benefits and strengthen the client-advisor relationship in the process.
Take the hypothetical case of Theresa who, at 53, leads a successful OB-GYN practice but has barely saved enough for what she feels will be a comfortable and secure retirement. With roughly $100,000 in retirement savings, she is starting to wonder if she’ll have to work forever.
A cash balance plan can accelerate the funding Theresa will need to reach her retirement goals. Under the plan, she may qualify to make substantially larger annual contributions — potentially up to $250,000 or more per year —compared to just $66,000 (plus a $7,500 catch-up contribution since she is over age 50) commonly found in standard retirement plans such as a 401(k) profit sharing plan.
Cash balance plans under the IRS are deemed qualified and tax favored. They are considered a hybrid instrument since they combine some of the savings benefits from a 401(k) profit-sharing plan along with those found in a traditional defined benefit plan. This combined structure offers higher contribution limits and, as such, can quickly build up retirement savings.
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 is guaranteed as either a fixed or variable rate, linked to a benchmark index such as a 30-Year Treasury. Increases and decreases in the value of the plan’s investments do not directly affect the benefit amounts promised to participants.
Cash balance plans can work for a wide variety of businesses including family or closely held firms with succession planning issues and professional services companies such as law firms, medical or CPA practices, engineering and architecture businesses. They can also be a suitable option for sole proprietors. In addition, they are ideal for companies with owners or partners (typically at least 40 years old) who are also looking for ways to reduce their taxable income.
However, it’s important to remember that once you set up a cash balance plan, you are required to make the annual contributions. Therefore, these plans are best suited for companies that have demonstrated consistent and predictable annual cash flows. Business owners should be confident that they can meet this obligation each year in order to maintain the qualified status of their plan.
Cash balance plans are complex by design compared to other turnkey retirement plan options and therefore require tax advisors and actuaries for implementation and administration. Managing these plans requires knowledge and experience, particularly in creating a low-volatility investment portfolio that meets the annual interest credit rate determined within the plan.
However, many of these complexities can be outsourced when you choose a bundled offering that integrates tax, actuarial and investment expertise into a single easy-to-administer process. A seasoned retirement consultant with expertise in retirement planning can help you set up a plan and investment strategy that works for your client’s business.
By recommending 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 while protecting clients from creditors in the event of lawsuits or bankruptcy because cash balance plans are qualified retirement plans and fall under ERISA.
Finally, cash balance accounts tend to be long-term in nature, so when the business owner and/or their employees retire, they become portable to roll over into an IRA, requiring the ongoing need for financial advice and guidance.