With the limitations of traditional retirement plans such as 401(k)s and IRAs, high-income professionals and business owners may find it harder to reach their retirement goals.
Fortunately, there is an alternative retirement savings option available: the cash balance plan.
A cash balance plan is a type of defined benefit plan designed to benefit high-income earners, particularly those who are self-employed or own a small business, to accumulate retirement savings at an accelerated rate on a tax-favored basis.
Here's how they work:
- The employer may contribute a specified percentage of the employee's salary to the plan each year.
- Contributions should be invested in a conservative portfolio of fixed-income securities that are intended to earn a stable rate of return designed to reach the plan’s internal crediting rate.
- Each year, the plan credits the employee with a specified interest rate on their account balance, typically around 3% to 5%, but can be higher in certain situations.
- When the employee reaches retirement age, they can choose to receive their benefit as either a lump sum payment or an annuity that pays a specified amount each year for the rest of their life depending on the language of the plan document.
Here are the benefits from a cash balance plan:
For starters, the contribution limits for these plans are much higher than those of traditional retirement plans. In 2023, the maximum contribution limit for a 401(k) is $22,500, while the maximum contribution limit for a cash balance plan is $300,000 or more depending on plan design.
This means that business owners can save significantly more for retirement each year through a cash balance plan.
Additionally, cash balance plans offer a number of tax benefits that can further boost retirement savings:
- The contributions made to the plan are tax-deductible, which can help lower taxable income.
- Moreover, the plan's investment earnings are tax-deferred, which means that savers won't have to pay taxes on their investment gains until they withdraw the funds in retirement.
Of course, like any retirement savings option, cash balance plans have their drawbacks. These plans are subject to strict funding requirements, which means that employers must make contributions each year even in difficult financial times.
Still, for high-income earners and business owners who are looking to maximize their retirement savings, a cash balance plan can be an excellent option.
By taking advantage of the higher contribution limits and tax benefits, participants can help ensure that they have the financial resources they need to enjoy a comfortable retirement.
Curious how a Cash Balance Plan can help boost your retirement and tax savings? Let's connect for a quick call!