Many business owners wish they could have the best of both worlds with their retirement plan, combining the large benefit and tax deduction provided by a defined benefit plan with the flexibility of a defined contribution plan. The solution may be a type of defined benefit plan referred to as a cash balance plan.
Cash Balance Plans
A cash balance plan is a hybrid plan that allows greater contributions than a 401(k) or profit sharing plan while still maintaining the look of a defined contribution plan. Rather than having a benefit that is defined as a series of payments as in a traditional defined benefit plan, the benefit in a cash balance plan is defined in terms of a stated account balance. This hypothetical “account balance” grows in two ways:
• First, by the required annual employer contribution, and
• Second, by crediting a guaranteed rate of return on the hypothetical account balance.
The annual contribution is calculated based upon the plan formula and actuarial assumptions. Unlike a traditional defined benefit plan formula, the cash balance plan formula considers salary only. As a result, the cash balance formula can be designed to equalize the contribution for owners or highly compensated employees with the same compensation but different ages. For older, non-highly compensated employees, the contributions may be minimized. The cash balance plan is typically combined with a 401(k) profit sharing plan to maximize the annual contribution.
An Attractive Benefit
A cash balance plan can be a centerpiece for attracting and retaining employees, while providing a large contribution for the owner and a sizable tax deduction for the business. Since benefits are expressed as a hypothetical account balance, it’s easier for employees to understand the true value of the benefit being provided. The cash balance plan provides an attractive benefit to owners in a mobile workforce, encouraging stability in a business’ workforce
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