Is the Cash Balance Plan Right for You?

Cash Balance Plan: Learn the Advantages and Drawbacks of this Hybrid Retirement Plan

As a small business owner, you likely have a lot on your plate. Between making sure the day-to-day operations of your business run smoothly and scaling your services in the most efficient way, it can be easy for your personal retirement planning to fall by the wayside.

The good news is that even if you’ve fallen behind in your personal savings, there are ways to catch up. One way for small business owners to accelerate their savings is by utilizing a cash balance plan. Read on to learn more about what this plan entails and how to tell if it’s right for you.

What Is a Cash Balance Plan?

A cash balance plan is a hybrid retirement plan that has characteristics of both a defined benefit (pension) plan and a defined contribution (401(k)) plan. Unlike a typical pension plan, cash balance plans are managed at the employee level. Each participant will have their own account to which the employer will contribute every year. Contributions consist of both a “pay credit” which is a percent of the employee’s salary and an “interest credit” which is a guaranteed rate of return to the participants.

Advantages

Cash balance plans are technically defined benefit plans because employees are promised a certain benefit amount at retirement, regardless of the investment performance of their account. Because of this, there are technically no annual contribution limits. Rather, the business must commit to contributing whatever amount is actuarily necessary to produce that benefit in retirement. The maximum retirement benefit amount under a defined benefit plan is the lesser of the:

• 100% of the participant’s average compensation for his or her highest 3 consecutive calendar years, or
• $265,000 in 2023

That means a business owner could potentially contribute hundreds of thousands of dollars in a single year to their own cash balance plan, depending on their age and specific circumstances. For high-earning small business owners, this can be an extremely effective way to accelerate retirement savings especially if combined with a 401(k) or another profit-sharing plan.

Small Business Owner Retirement Planning

Small business owner retirement planning can require considerable preparation including creating a business succession plan in writing and thinking about your goals.

For comparison, 401(k) plans have a combined employer and employee contribution limit of just $66,000 in 2023. This jumps up to $73,500 if you are over the age of 50.

What’s more, contributions to a cash balance plan are fully tax-deductible. So not only are small business owners increasing their retirement savings, but they are also reducing their current year tax liability—often by a significant amount.

Drawbacks

Despite the benefits of these plans, there are important drawbacks to consider before you decide if it’s right for you. As the owner, you are required to contribute to the accounts of all eligible employees. If you have an inconsistent cash flow, or too many employees to sustain that level of contribution, then a cash balance plan may not be the best option.

Not only that, but employers must also adhere to extensive requirements to maintain qualified status which can add to the cost and complexity of plan administration. For instance, cash balance plans require the use of actuaries to determine the annual contribution amount for each participant’s account. Not utilizing an actuary or not contributing the correct amount to each participant can result in fines, penalties, and plan disqualification.

Small Business Owner Financial Planning: Benefits of Using a Financial Advisor

Small business owners have a lot to manage, from day-to-day operations to bigger-picture plans for the company’s future. As you lean into your expertise and passions to bring your business vision to life, it can be helpful to lean on a financial advisor to help you manage things like your tax strategy, optimizing your cash flow, or building a budget that can help meet all your major milestones.

Additionally, the investment risk of each account is borne by the employer. Ultimately, the retirement benefit you pay each employee is dependent on the amount promised in the plan document. If the accounts do not perform well in the years leading up to retirement, you are still required to pay a set amount. This may not be a big deal if you have little to no employees and most of the contributions are going to your own personal account. If you have many employees, on the other hand, this can be an unnecessary burden to bear depending on the size and profitability of your business.

Making the Right Decision as a Small Business Owner

At Aviance Capital Partners, we can help you make the right decision for your small business. No matter where you are in your business journey, we have the tools and expertise to help you navigate your retirement decisions. To learn more about financial planning for small business owners, or if you have questions about your specific situation, please email us at wealthrelations@aviancepartners.com, or schedule a complimentary call. We can’t wait to hear from you!

Aviance Capital Partners, LLC (“ACP”) is an SEC registered investment adviser located in Naples, Florida. Registration as an investment adviser is not an endorsement by securities regulators and does not imply that ACP has attained a certain level of skill, training, or ability. While information presented is believed to be factual and up-to-date, ACP does not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. Not all services will be appropriate or necessary for all clients, and the potential value and benefit of ACP’s services will vary based upon the client’s individual investment, financial, and tax circumstances. The effectiveness and potential success of planning strategies discussed in this publication depends on a variety of factors, including but not limited to the manner and timing of implementation, coordination with the client and the client’s other engaged professionals, and market conditions. The information provided is general in nature, which should not be construed as specific advice tailored to an individual reader. ACP suggests that readers consult a financial professional, attorney or tax advisory professional about their specific financial, legal or tax situation. All investment strategies have the potential for profit or loss, and different investments and types of investments involve varying degrees of risk. There can be no assurance that the future performance of any specific investment or investment strategy, including those undertaken or recommended by ACP, will be profitable or equal any historical performance level. Additional information about ACP, including its Form ADV Part 2A describing its services, fees, and applicable conflicts of interest and its Form CRS is available upon request and at https://adviserinfo.sec.gov/firm/summary/146597.