Much uncertainty exists in the business world - and particularly in the health care environment. Physicians are dealing with vast amounts of new regulations and costs not planned for in previous years. Many are looking at their savings and questioning whether they are prepared financially for retirement and will be able to sustain the lifestyle they envision. All are inquiring about was to increase tax-advantaged retirement savings.
A cash balance plan is becoming an increasingly appealing retirement savings option for health care professionals and other successful business owners seeking to catch up on retirement savings or even accelerate their retirement timeline.
A cash balance plan is a type of defined benefit pension plan that is designed to provide retirement benefits to employees. A cash balance plan combines elements of traditional defined benefit plans with those of defined contribution plans, such as 401(k)s. In a cash balance plan, the employer contributes a fixed amount, or “cash balance,” to an account for each employee, which earns a guaranteed rate of return. The employee’s account balance is portable and can be taken with them if they leave the company.
For tax year 2023, cash balance plan participants can contribute up to as $3.4 million. This assumes you pay yourself a maximum wage (currently $265,000) and have the plan open for at least 10 years. Of course, participants aren't required to contribute the maximum amount.
As of 2023, the maximum contribution that an employer can make to a cash balance plan is the lesser of:
100% of the participant’s compensation, or
The maximum contribution limit for defined benefit plans, which is currently $265,000 per year (indexed for inflation).
The amount that can be contributed to a cash balance plan is determined by a number of factors, including the terms of the plan, the age of the participant, and any applicable laws and regulations. In general, cash balance plans have contribution limits that are set by the Internal Revenue Service (IRS) and are subject to annual cost-of-living adjustments.
Features of cash balance plans:
Employer contributions: In a cash balance plan, the employer contributes a fixed amount each year to the employee’s account. This contribution is typically a percentage of the employee’s salary.
The guaranteed rate of return: The employer also guarantees a specific rate of return on the employee’s account balance. This rate is typically based on a formula that includes a fixed interest rate and other factors, such as the yield on long-term corporate bonds.
Tax deductions: You get an immediate tax deduction for any plan contributions.
Account balance: Each employee has their own account balance, which reflects their contributions and the guaranteed rate of return. The account balance is portable, meaning it can be taken with the employee if they leave the company.
Vesting: Employees are typically fully vested in their account balance after a certain period, usually five to seven years. This means they are entitled to the full value of their account balance, even if they leave the company before retirement age.
Retirement benefits: When an employee retires, they receive their account balance as a lump sum or as an annuity, which is a stream of payments over time. This is calculated by the TPA.
There are several advantages to cash balance plans for both employers and employees. Cash balance plans are relatively easy to administer for employers and can provide a predictable cost for funding retirement benefits. For employees, cash balance plans offer the potential for a higher return on their contributions compared to traditional defined contribution plans, such as 401(k)s. However, there have been legal challenges to cash balance plans. Some argue that they disproportionately benefit higher-paid employees and may not provide the same benefits to lower-paid workers. As such, it is essential to speak with a qualified advisor and carefully review the terms of a cash balance plan prior to deciding if a cash balance plan is a appropriate retirement benefit for your company.
What do I need to run a cash balance plan illustration?
An illustration is a projection of the potential future benefits of a cash balance plan based on certain assumptions about future contributions, investment returns, and other factors.
To run a cash balance plan illustration, you will need detailed information about the plan design, employee demographics, contributions, investment assumptions, and retirement assumptions. It is essential to review all this information carefully and consult a qualified professional to ensure that the illustration accurately reflects the plan’s specific needs.
To run a cash balance plan illustration, you will need the following information:
Plan design: You will need to have a copy of the cash balance plan document, which outlines the terms and provisions of the plan, including the pay formula, vesting schedule, and retirement age.
Employee demographics: You will need information about the age, salary, and years of service of each employee covered by the plan.
Contributions: You will need to have information about the contributions that will be made to the plan, including employer contributions and any employee contributions.
Investment assumptions: You will need information about the investment assumptions used in the illustration, including the assumed rate of return on the plan’s investments.
Retirement assumptions: You will need information about the retirement assumptions used in the illustration, including the retirement age and any other factors that may affect the benefits.
If you are considering a Cash Balance Plan for your company and would like to know more, give us or your current CPA / Advisor a call to get the conversation started.
Cobalt PacWest | CPAs & Advisors
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La Jolla, CA 92037
23 Corporate Plaza #150
Newport Beach, CA 92660