The truth hurts. Retirement planning is something that most Americans fail at.
According to the Economic Policy Institute, for households between the ages of 50 and 55, the average savings balance is just under $125,000. But this number is a little skewed. As a result of a handful of big savers that bring the average up, the median savings amount for this age group is a meager $8,000.
Herein lies the problem. In your early employment years, you simply aren't making enough money to put much away. In your later and higher earning years, life gets in the way. You have child education expenses, vacation plans, etc. As a human being, you make every excuse possible.
But at some point, you need to get serious. When people think of contributing to a retirement plan, they often think first of 401(k) plans. These plans are definitely great options, but they do not allow participants to maximize contributions. As you know, it is often tough to catch up when you have fallen behind.
What if there was a retirement strategy that would allow business owners to supercharge their retirement? Well, there is. It is called a cash balance plan and it has been used by wealthy business owners for years.
What is a cash balance plan?
Cash balance plans have been around for decades, but few financial planners and CPAs are aware of them. Simply put, they allow the plan participant to contribute a substantial amount into retirement and take a significant tax deduction.
The goal of a cash balance plan is to provide a specific benefit at retirement like a monthly pay-out similar to social security. In order to reach this benefit, the entrepreneur is allowed to contribute substantial amounts.
Business owner contributions, which depend on age and compensation, can be as high as $270,000. In contrast, 401(k) plans have maximum contribution limits of $54,000 ($60,000 if over 50). 401(k) plans can also be combined with cash balance plans to skyrocket your retirement.
Who are great candidates for cash balance plans?
The reality is that these plans work for entrepreneurs in a variety of industries. While there are many great candidates, here are some of the best:
- Business owners that have steady profits;
- Professional service businesses (lawyers, physicians, CPAs, etc.);
- Companies that desire to improve employee retention and morale;
- Business owners with minimal retirement funds and are looking to "catch-up"; and
- Entrepreneurs interested in maximizing tax deductions.
You don't have to have high profits (or consistent profits) for a cash balance plan to make sense for you. But of course, it helps. If your business is very cyclical and subject to boom years as well as bust years, it can be more challenging. Ideally, consistently high cash flows and the expectation of decent cash flows over the foreseeable future make the most sense.
Saving for retirement is great. But reducing taxes is what drives many entrepreneurs to cash balance plans. When combining federal and state tax rates, it makes a cash balance plan a no-brainer for business owners looking for tax savings. This savings could exceed 40 percent in taxes, depending on state tax rates.
Assume a 50-year-old consultant makes $400,000 a year and is looking to maximize retirement. Let's also assume, for the sake of simplicity, that the consultant has no qualifying full-time employees that require a contribution.
The consultant contributes $140,000 into a cash balance plan. The cash balance plan combines with a solo 401(k) that has a profit-sharing component and the consultant contributes an additional $35,000. The consultant now has a total of $175,000 in retirement and it is fully deductible for tax purposes. Not a bad deal.
I have been using cash balance plans with clients for years with much success. There just are not many options available for entrepreneurs who seek significant contributions and large tax deductions.
A cash balance plan may not work for everybody. But for the right person, it can be a home run.