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    How The Cash Balance Pension Helps You Reduce Your Taxes And Boost Retirement Security

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

    Proactive tax planning has always been important, but it can be even more valuable when there are tax law changes. My phone rang off the hook a few years back with people looking to capitalize on the provisions in the GOP Tax Plan. In 2022 people want to know how to implement more creative tax planning strategies ahead of a new tax plan from President Biden.  Others have seen their incomes spike during the coronavirus pandemic, and are now in need of more comprehensive tax planning for their businesses. There are a variety of options to use here, but if your income is high enough, and you are self-employed you should consider a Cash Balance Pension Plan. Why pay more taxes than you need to?

    For business owners who are a little behind on retirement planning – now is a great time to play catch up. The tax planning value of contributing to a Cash Balance Pension Plan has never been greater. Never heard of a Cash Balance Defined Benefit Pension Plan?  (you may even hear it referred to as the Rich Person Pension) You aren’t alone.  Many financial advisors aren’t allowed to set these plans up or even provide any real tax planning guidance.  Others just don’t have the resources and expertise to utilize these valuable retirement plans that can dramatically reduce high-income business owners reduce their incomes.

    How big can the tax savings be from a Cash Balance Plan?  I just designed a plan that would allow them to shelter $6 million dollars in income over the next decade.  This could help a Los Angeles or Palm Springs business save over $3 million in tax over the next decade.  (Between Federal and California Taxes combined). In case you didn’t know, California has the highest marginal tax rate in the US, making retirement plan contributions even more valuable.

    Keep reading to see how the  Cash Balance Pension Plan Can Help You Reducer Your Tax and Increase your Retirement Security.  We are here to help you reduce your lifetime tax burden.

    Update:  NEW Cash Balance Plan Establishment Deadline  (3/10/2022)

    For high-income business owners, great news was hidden in the SECURE Act regarding cash balance plans. Like the solo 401(k), the deadline to establish a cash balance plan has been extended to your tax-filing deadline, including an extension. Unlike the solo 401(k), all contributions to a cash balance plan are from the employer.

    You can still set up a Cash Balance Plan to lower your 2022 taxes.

    Ask your fiduciary tax planning financial advisor if they can help you set up a Cash Balance Plan to reduce your 2022 taxes and increase your future retirement income. Contribution limits are increasing for 2023.

    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 the ages of 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 income 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 the largest tax-saving 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.

    The higher your income the more valuable proactive tax planning can be for your business. Especially for high-income California business owners.

    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.

    You can potentially shelter several hundred thousand dollars of income per year with a Cash Balance Plan. Amounts will depend on your age, income and a few other factors.  Fully fund a Cash Balance Plan and you reduce your taxable income by millions of dollars over the next decade.

    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 that 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 stock brokers (usually try and pass themselves off as financial advisors) 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 $66,000 in 2023. An additional $7,500 in catch-up contributions is allowed for those over 50. I normally start by 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 $300,000 per year including the 401(k).  These numbers can easily double if you hire your spouse or other family members to work in your business.

    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 that stand to benefit the most from Cash Balance Plans:

    1. Business owners that have steady profits, typically above $300,000.
    2. The entertainment industry – like Producers, Directors, and 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 on 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  CA state taxes, are huge. The savings can approach 50% for the highest earners. Would you rather write a check to Uncle Sam or yourself? Speaking of a no-brainer.

    Top Financial Advisor Los Angeles David Rae

    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 2022, this solopreneur will be able to contribute $171,000 to his cash balance plan. That is on top of $61,000, in this case, to his solo 401(K) Profit Sharing Plan. That is a total pre-tax contribution of $232,000. By combining the employee and profit-sharing contributions, the consultant will be able to contribute nearly four times as much in 2022 with a Cash Balance Plan / Solo 401(K) combo compared to 2021 when his previous advisor only set up a SEP IRA- Nearly quadrupling his tax savings.  No surprise that he let the old financial advisor for this West Hollywood tax expert.

    How would you like to lower your taxable income by $232,000 per year? This could translate into a potential tax savings of over $116,000 per year.  Do this for 10 years and you could potentially see over a million dollars in tax savings.  Your actual net tax savings will vary depending on your state income tax rates and other tax deductions you may have. The tax savings can be substantial even when just accounting for Federal Taxes.

    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 the 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 Fee-Only 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 Forbes.com,  the Advocate Magazine 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 California Taxes:

    How Does California Tax Your Capital Gains?

    Connect With David Rae, Financial Planner LA

    David Rae, CFP® AIF®

    President / Founder DRM Wealth Management LLC

    1(323) 905-4380


    "How The Cash Balance Pension Helps You Reduce Your Taxes And Boost Retirement Security"

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