Better Together: 401(k) and Cash Balance Plans
So many things are simply better together—peanut butter and jelly, baseball games and hot dogs, summer and a good book. Add to that list a 401(k) plan with a cash balance plan. When it comes to retirement plans, too often the discussion focuses on one or the other: Defined benefit (a cash balance plan is a hybrid version) versus defined contribution. While each of these plan types (in their own right) is a great benefit option, the highest levels of contributions, tax deductions and flexibility come when the two plans work together. Of course, both may not be a good fit for a particular business, but why not consider having the best of both worlds?
401(k) plans offer a great degree of flexibility for business owners. First off, there is no funding requirement. They can consist of strictly employee contributions or a combination of employee and discretionary employer contributions. With catch-up contributions, the maximum annual contribution amount in a 401(k) with profit sharing is good. Consider a 65-year-old owner; in 2024, he could defer up to $30,500 plus make an employer contribution up to $46,000 to a 401(k) plan, for a total maximum contribution of $76,500, saving $30,600 in taxes.[1] That’s good, but often not good enough, especially for older small business owners who are no longer making heavy investments in their businesses, and have significant amounts of pass-through income, resulting in high tax bills.
Now, combine the 401(k) with a cash balance plan and see the difference. Because of their unique plan design features, cash balance plans enable key employees to save more than they can under the current defined contribution plan limits, while still enjoying the ERISA protections that come with a qualified retirement plan. If the same 65-year-old owner in our earlier example adopts a cash balance plan, he finds he, potentially, could contribute up to an additional $344,190 for 2024, for a total annual contribution to the two plans of $420,690. That would have the potential to save him $168,276 in taxes.[2]
Keep in mind, cash balance plans are not for every business. They require an adopting firm to fund the plan to provide participants with a promised retirement benefit. For that reason, cash balance plans are most popular among smaller, well-established businesses that have significant and consistent cash flow. For example, generally, cash balance plans work best for professional groups or closely held family corporations with strong profit margins (e.g., engineers, lawyers, medical specialists, CPAs, architects, and consultants).
If your business is seeking an opportunity for a greater tax deduction and a way to help key employees maximize benefits, especially over a short period of time, consider a cash balance/401(k) combo plan. The question of whether to set up a qualified retirement plan, let alone two, has important tax ramifications. Business owners would be best served by engaging with a tax professional when considering their retirement plan options.
[1] Assuming 40% tax rate. Varies by state. Taxes are deferred. For illustration purposes only. Actual contributions depend on the demographics of the workforce and specific retirement plan provisions.
[2] Ibid
The information, analyses and opinions set out herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity. Nothing herein constitutes or should be construed as a legal opinion or advice. You should consult your own attorney, accountant, financial or tax advisor or other planner or consultant with regard to your own situation or that of any entity which you represent or advise.