Are you a business owner that has mostly invested growth back into your business through the years? This happens with a good portion of the business owners that I meet. They may have a 401K in place but feel that their balances aren’t where they should be. That could be because of poor performance, not saving enough, or a combination of both. So what options are available to help pump up your retirement savings. If the conditions are right, cash balances plans can be the boost that business owners need.
What is it?
Cash balance plans are a hybrid of a defined contribution plan and a defined benefit plan. Like a DB plan, the growth inside of the plan is a yearly interest credit that could be a fixed rate or a possibly a variable rate tied to the 30 treasuries. Limiting investment risk. Also, like a DB plan, participants can annuitize their balance at retirement. On the other hand, much like a DC plan, the cash balance is also portable, it doesn’t have to be annuitized. Participants also received 5-8% of their pay much like the employer contribution of a 401K. They can used on their own or in combination with an existing 401K.
Why do I want one?
To boost your retirement savings is the easy answer. For business owners it could mean the ability to for a 50-year-old to stack away $143,000 annually or for a 60-year-old to contribute $235,000. All of those contributions are also tax deductible. A great way to help shield income from taxes. The actual amounts would be based on age and income. It’s also a great way to reward key executives and participants.
Should I have one?
Everyone wants to be able to contribute six figures into their retirement, but cash balance plans do have some features that you need to make sure you can handle. First you need to have a good amount of income. If you are bringing in more than $250K per year, then you are probably a good candidate. You need to also have a steady income year to year. If there’s a high variability in your income, then it’s probably not a good fit.
What are the drawbacks?
With any financial products, there are some drawbacks. Cash balance plans are no different. For one they are expensive. They are expensive to setup, they are expensive to administer, and they are expensive to fund. The plans can be costlier to employers than 401(k) plans, in part because an actuary must certify each year that the plan is properly funded. Typical costs include $2,000 to $5,000 in setup fees, $2,000 to $10,000 in annual administration fees, and investment-management fees ranging from 0.25% to 1% of assets. You are also committing to at least a 5-year time frame.
What should I do?
If the cash flow is steady and the desire to boost your retirement is there, then the cash balance plan could be a great match for your 401K. Even with the high cost, the ability to not only increase contributions considerably, while at the same time giving a fantastic benefit to participants, is hard to pass up. The contributions combined with the tax savings outweigh any cost in most situations.
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