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Tax planning is a great way to help increase your take-home pay as a small business owner. Setting up a Cash Balance Plan could save a business owner $100,000 or more in yearly taxes. These tax savings can be even higher for business owners in high-tax states like California or New York.

Who benefits the most from a Cash Balance Plan?

A Cash Balance Plan is one of my favorite tax-planning tools. For the right business owner, the tax savings could be huge. With many successful business owners behind when it comes to funding a secure retirement, the higher contribution limits of a Cash Balance Plan could help you play catch up for retirement during your peak earning years.

Even with all the benefits of a Cash Balance Plan, they are only suitable for some business owners. Here are some attributes of people who will benefit the most from setting up this type of retirement plan for their business.

  • You are looking to increase your contributions to retirement accounts.
  • You want to save more than is allowed in a basic 401(k) plan or SEP IRA.
  • You have a relatively consistent business income.
  • Your household income is $275,000 or greater.
  • You would like to save $50,000 or more in taxes each year.
  • Your business has 16 or fewer full-time W-2 employees.
  • The business owner is older than the average employee.
  • Extra credit if you live in a high-tax state (higher state taxes = greater tax savings)

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What are the main benefits of a Cash Balance Plan?

There are a few benefits to a Cash Balance Plan. I’ve found that many business owners who set up a pension plan are motivated by the considerable savings a Cash Balance Plan can provide. Similarly, the large annual contribution limits allow older business owners to accelerate the amount of income going into a retirement account pre-tax. Lastly, a Cash Balance Plan could be a nice employee benefit that helps your business retain top talent.

How does a Cash Balance Plan work?

By utilizing a Cash Balance Plan, each participant’s retirement benefit grows annually in two ways: employer contribution and an interest-crediting rate. Contributions to a Cash Balance Plan are typically deposited the following year before the business taxes are filed. In plain English, contributions for the tax year 2022 would be made in 2023.

The annual employer contribution could be a flat dollar amount or a percentage of income; for example, $10,000 annually per participant or four percent of a participant’s annual salary. This contribution varies between employees and owners so long as the plan passes ERISA compliance testing. The annual funding formula is specific for each company and is dependent on employee demographics and employer goals. Hopefully, your trusted Fiduciary Financial Planner has the ability to help illustrate your Cash Balance Plan options, to help you determine if setting up this type of plan will work for your specific tax-planning and retirement-planning goals.

When designing a Cash Balance Pension Plan, an actuary calculates the contributions required by the employer each year based on the market growth of plan assets, plan census data (essentially employee data), and the interest-crediting rate. Your actuary will also help ensure that the plan passes annual compliance testing. Your tax planning-focused financial planner can help optimize this plan design to maximize the benefits to the business owners while still meeting ERISA requirements.

All assets within a Cash Balance Plan are pooled, and the employer makes all contributions. Typically, the investment allocation within the plan seeks returns that are consistent with the interest-crediting rate to minimize risk for the employer.

Cash Balance Plans are almost always designed in conjunction with a 401(k) Profit-Sharing Plan to allow for the largest tax benefits and to help ease the process of passing compliance testing.

A hypothetical Cash Balance Plan example

A highly successful small business owner, age 56, wants to supercharge his retirement saving and reduce his tax liability. He earns over $1 million annually, with a salary of $330,000. While this business owner has quite a few “employees,” they are all part-time or independent contractors and don’t need to be included in these retirement plans.

The Cash Balance Plan design calculations allow the owner to contribute $250,000 pre-tax to the cash balance. He can also max out a 401(k) profit-sharing plan with additional pre-tax contributions of $73,500 (employee, employer, and catch-up contributions) in 2023.

In a scenario like this, if you can contribute $300,000 per year to fund your retirement, opening a Cash Balance Plan is a no-brainer. The more employees you have, the less of the contribution will go directly to you as the owner. If you have less than 15 full-time employees, it’s worth crunching the numbers to see how a Cash Balance Plan can be designed to meet your tax-planning and retirement-planning needs.

Not all financial advisors or financial planners are willing or able to help you optimize and set up a Cash Balance Plan. For best results, you should set up the plan during the tax year. However, the deadline to set up and fund a Cash Balance Plan is your tax-filing deadline, including an extension. So, there is still time to set up this tax-saving plan for 2022.

At Byline, we take the time to get to know your business. Whether you’d like to improve cash flow, expand operations or update equipment, our team can customize financing and treasury solutions to help. Sign up today!

This article was written by David Rae from Forbes and was legally licensed through the Industry Dive Content Marketplace. Please direct all licensing questions to [email protected].