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    Is the Cash Balance Plan Your Key to Catching Up for Retirement?

    The Cash Balance Plan the Key to a retirement on the beach

    Cash Balance Plan are Now More Appealing under New GOP Tax Plan

    My phone has been ringing off the hook with people looking to capitalize on the provisions in the GOP Tax Plan. Ok. Who am I kidding? I’m in California and the majority of my callers are people who want to know how badly they will get screwed by Trump and the GOP with this new tax bill.

    For business owners who are a little behind on retirement planning – now is a great time to play catch up. The value of contributing to a Cash Balance Pension Plan has never been greater. Never heard of a Cash Balance Defined Benefit Pension Plan? You aren’t alone.

    By David Rae Certified Financial Planner™, Accredited Investment Fiduciary™

    Many Americans are failing when it comes to retirement planning. Business owners are not immune from this pervasive issue. The average retirement savings balance is just under $125,000 for households between ages 50 and 55. This is according to the Economic Policy Institute. But wait, it gets worse, way worse. This “high” number of $125,000 is skewed heavily by a few bigger savers. The median savings amount for this group is just $8,000. Put simply, 50% of people have less than $8,000 saved.

    What does this mean for your retirement? If your household is one of the few that has $125,000 in savings, that translates into about $417 per month in retirement assuming a 4% withdrawal rate. I don’t know anyone who could live on that, do you? Even with Social Security, most will have a tough time getting by.

    Getting Serious about Retirement Savings

    Many small business owners think of the SEP IRA or SOLO 401(K) plans as their best bet to make large retirement contributions. This may be great for many people across the country but for those with higher incomes looking for more tax breaks, these plans may not be enough. For those playing catch up for retirement, who may need a little more help getting on track for financial freedom, this is where a cash balance plan comes into play. This plan may ensure that someday work will just be an option, not a requirement.

    For those business owners who are looking to supercharge their retirement savings, and are already maxing out their 401(K) accounts, there is another option to put away even more money. At the same time, owners are able to save a ton of money on taxes. (Who doesn’t love to save money on taxes). I’ve helped high earning business owners set up these plans for years. They are called a Cash Balance Plan. You may also hear it called Defined Benefit Plan, DB Plan or even Personal Pension.

    What the heck is a Cash Balance Plan?

    I have no idea why so few financial planners and CPAs are aware of these types of plans. Perhaps they just don’t run into many people who are able to save more than the 401(K) contribution limits. Or don’t have the balls to tell a client they need to save $200,000 per year to maintain their standard of living in retirement. To be fair these personal pensions aren’t right for everyone. But for those who do use them, the allowable tax-deductible contributions can be huge.

    The premise of a Cash Balance Pension Plan is to provide a specifically defined income benefit at retirement. Think of it as a monthly payout similar to Social Security or in terms of a pension which provides income for your lifetime. In order to fund these future benefits, the entrepreneur is allowed to contribute substantial amounts of money to the plan now in order to fund future benefits. To encourage people to save for retirement – contributions are tax deductible.

    Another reason many financial advisors and tax pros don’t recommend these plans is that they are complicated to design, and some brokers are likely not allowed to sell them at the Broker-Dealer or Wirehouse where they work. The Registered Investment Advisory space, where Fiduciary Financial Advice is more prevalent, seems to be where many of the Cash Balance Plans are implemented.

    Contributions to a Cash Balance Plan:

    Contributions from business owners can depend on their age and compensation. On the other hand, 401(K) contributions are limited to $55,000 in 2018. An additional $6,000 in contributions is allowed for those over 50. I normally start with having my clients max out their 401(K). This is followed by looking at a cash balance plan to help high-earning entrepreneur clients minimize their taxes and maximize their retirement account balances.  Potentially contributions to the business owner can easily top $150,000 per year including the 401(k).

    The tax benefits from these plans can be substantial for business owners in a wide range of professions. But remember, these plans are not for everyone.

    Below are just some of the professions who stand to benefit the most from Cash Balance Plans:

    1. Business owners that have steady profits
    2. The entertainment industry – like Producers, Directors, Screenwriters with their own corporations
    3. Professional service businesses (lawyers, physicians, CPAs, etc.)
    4. Companies with small but important works force. A Pension plan is great for employee retention and even morale.
    5. Business owners who are looking to catch up their retirement accounts
    6. Entrepreneurs who don’t want to pay too much in taxes
    7. Husband and Wife businesses with high incomes
    8. Business owners with large amounts of money invested in taxable accounts

    Some people shy away from the Cash Balance Plan because there are annual minimum contribution requirements. Keep in mind those requirements are generally tied to your net income. If you have a bad year or end up with a bunch of other tax write-offs, your expected contribution will drop. You could also cut back further on the 401(K) portions of the plan – as those tax-deductible contributions are not required.

    The biggest motivator I’ve seen for clients who reach out to set up a Defined Benefit Cash Balance Pension plan is the tax savings. When you combine the federal and state tax rates, it can make a cash balance plan a no brainer. The savings here in California, with our highest in the nation state taxes, are huge. The savings can approach 50% for the highest earners. Would you rather write a check to Donald Trump or yourself? Speaking of a no brainer.

    The Consultant and his Cash Balance Plan

    Assume a 52-year-old consultant making around $600,000 a year is looking to minimize his taxes. Catching up on retirement security is also a priority. This high-powered consultant works alone and won’t have to contribute to the plans for any employees.

    For 2018, this solo-preneur will be able to contribute $171,000 to his cash balance plan. That is on top of $42,000, in this case, to his solo 401(K) Profit Sharing Plan. That is a total contribution of $212,000. By combining the employee and profit sharing contributions, the consultant will be able to contribute nearly four times as much in 2018 with a Cash Balance Plan / Solo 401(K) combo compared to 2017 when his previous advisor only set up a SEP IRA- Nearly quadrupling his tax savings.

    How would you like to lower your taxable income by $212,000 per year? This would translate into a potential tax savings of over $100,000 per year. Your actual net tax savings will vary depending on your state income tax rates and other tax deductions you may have.

    Funding a Cash Balance Plan

    Many of my business-owner clients who are maxing their 401(K) and Cash Balance Plan contributions make much more income or have accumulated substantial amounts of money in taxable investment accounts. I even worked with one client who used an inheritance to fully fund a Cash Balance Plan / 401(K) profit sharing combo to nearly wipe out his entire income tax liability.

    As your business success grows, the typical contribution to a typical 401(K) will leave you paying way too much in taxes. We’ve had a ton of success working with clients to structure Cash Balance Plans specifically for their financial goals and income levels. Work with your Financial Planner and CPA to explore which Cash Balance Plan structures will give you most tax and retirement benefits. It may take a bit of extra effort but the tax savings make it more than worth it.

    Remember these plans are not for everyone. But if you feel you are paying too much in federal income taxes, or if you are playing catch up for retirement, these plans can be a great way to get back on track for financial freedom. Feel free to reach out to see what else you can be doing to keep more of your hard-earned money.

    David Rae and Nick Watt on ABC Nightline talking taxes and the Cash Balance Plan
    David Rae and Nick Watt on ABC Nightline talking taxes and the Cash Balance Plan

    Live for Today, Plan for Tomorrow.

    DAVID RAE, CFP®, AIF® is a Los Angeles Financial Planner with DRM Wealth Management. He has been helping friends of the LGBT community reach their financial goals for over a decade. Nightline has called him a “Tax Wizard in an Expensive Suit” He is a regular contributor to the Advocate Magazine, Investopedia and Huffington Post as well as the author of the Financial Planner Los Angeles Blog. Follow him on Facebook or via his website www.davidraefp.com

    If you like this Cash Balance Plan post you may also like this article on Retirement Plans for Small Businesses:

    How to Choose the Best Retirement Plan for your Small Business

    Connect With David Rae, Financial Planner LA

    David Rae, CFP® AIF®

    President / Founder DRM Wealth Management LLC

    1(323) 905-4380


    "Is the Cash Balance Plan Your Key to Catching Up for Retirement?"

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