Cash balance plans were considered to be extinct or on the verge of extinction just some few years ago, until the Pension Protection Act of 2006 was enacted, shading light to what cash balance plan needed to get IRS approval. Business owners have a lot on their shoulders to ensure that a cash balance plan is a success and meets the standards required by IRS.
Cash balance plans are mainly used by business owners to maximize their own contributions and to retain key employees who have been loyal and dedicated to their company. But IRS requires that a plan should meet the non-discriminatory test, a plan should not only benefit a small group of employees.
So how can a business owner achieve what he wants while staying within the IRS rules? Let’s look at some few strategies that can be used.
1. Only Include 40% of the Employees
You should be aware that the cash balance plan is not entirely required to cover all employees; in fact, IRS only requires 40% of employees to be covered. Section 401 (A) (26) requires that 50 employees or 40% of them, whichever is lesser should receive benefits under the cash balance plan, and that the contributions should be meaningful. A business owner could consider the age-weighted capacity of the cash balance plan and eliminate some older employees allowing for an overall lower employee contribution while providing meaningful benefit.
2. Combine Cash Balance Plan with 401 (K) and Profit-sharing Plans
Cash balance plans are not always the ultimate security after retirement; you will possibly need additional income may be from profit-sharing or 401(K) plans. A good plan is the one that combines profit-sharing and 401(K). Discuss the topic with a good TPA.
3. Include your Spouse in the plan
If your spouse works with you in the business and is included in the business payroll, it is best to include them in the cash balance plan. A spouse in a payroll is entitled to receive benefits, they can contribute to the available cash balance plan, profit-sharing or 401 (K) plans. Spouses are eligible to receive Social Security payments worth as much as 50% of the retired worker’s benefit, surviving spouses are entitled to 100% of the higher earner’s benefit.
4. Set Higher Wages for Yourself
Contributions to a cash balance plan consider the level of compensation one has, the owner can increase their W-2 wage in order to increase their contribution to the cash balance plan. This could also be applied to the owner’s spouse. Even though this will lead to higher income taxation, the company will get a higher deduction and the owner will get a larger contribution towards social security.
5. Consider Over-funding
Cash balance plans are based on actuarial calculations with numerous assumptions. Using a calculator can help. These assumptions may allow flexibility in funding of a plan, and a plan can be over-funded in a given year. This will lead to lower funding levels in the future. A business owner can make larger contributions than anticipated and increase the deductions on the taxable income, therefore reducing the tax liability.Cash plans have a significant advantage over other traditional types of pension plans. Cash balance plans have interest rates; the returns can be predicted more easily giving business owners greater peace of mind. The above strategies can be utilized to achieve maximum owner contributions, but IRS rules must be followed. A solo cash balance plan is a great retirement strategy if it is well structured.