Business owners lost ground on retirement in the pandemic; cash balance plans may help them recover

The COVID-19 pandemic and lockdown wreaked havoc on businesses, as closures, labor shortages and supply chain constraints cut into revenues and profits. Businesses that have recovered are reassessing their retirement plan strategies and goals.

A recent survey from TD Wealth Management[1] found that nearly two-thirds (65%) of business owners surveyed made meaningful changes to their retirement plans in the past 12 months, including their asset allocation (31%), postponing retirement (30%) and lowering contributions (30%). Today, many are seeking out advice on how to make up lost ground creating an opportunity for financial advisors.

One underutilized strategy to help build back up retirement assets is the implementation of a cash balance plan. As a powerful tax qualified retirement vehicle, cash balance plans are designed to afford companies the ability to contribute more than what the IRS allows under a standardized qualified retirement plan such as a profit sharing or 401(k) plan. Larger annual contributions can reach $250,000 or more per year[2], compared to just $66,000 (plus a $7,500 catch-up contribution for investors over age 50) who participate in a Profit Sharing 401(k) plan.  [3]

When businesses set up a cash balance plan, the employer credits each participant with a “pay credit” (such as 5% of compensation) and an “interest credit” that is guaranteed as either a fixed or variable rate, linked to a benchmark index such as a 30-year treasury. Increases and decreases in the value of the plan’s investments do not directly affect the benefit amounts promised to participants.

These plans can work for a wide variety of businesses including family or closely-held firms with succession planning issues and professional services companies such as law firms, medical or CPA practices, engineering and architecture businesses. They can also be a suitable option for sole proprietors.

In addition, the plans are ideal for companies with owners or partners (typically at least 40 years old) looking for ways to reduce their taxable income. The funds contributed are tax deductible in the first year the plan is implemented and are considered an “above the line” deduction that reduces the business’ taxable income dollar for dollar.

Cash balance plans are specialized, which require tax advisors and actuaries for implementation and administration. Managing these plans also requires investment knowledge and experience to meet the annual interest credit rate determined within the plan document. As they are qualified plans regulated by the Employee Retirement Income Security Act (ERISA), they come with certain complexities that can be outsourced into a turnkey solution that integrates tax, fiduciary, actuarial and investment expertise into a single easy-to-administer program.

However, it’s important to remember that once your clients set up a cash balance plan, they should feel confident that they can meet the required contribution each year in order to maintain their plan’s qualified status. That is why these plans are best suited for owners of companies that have demonstrated consistent and predictable cash flows.

By offering cash balance plans, advisors can increase their value to clients who have already delegated their non-retirement wealth business to them, protecting these relationships from competing advisors. These plans also build up substantial assets under management with increased revenue streams. The accounts tend to be long-term and “sticky” in nature, so when the business owner and/or their employees retire, they become portable to roll over into an IRA, requiring the on-going need for financial advice and guidance.

The last several years have been challenging for your business owner clients, and many have been more focused on short-term survival than long-term retirement security. By offering a cash balance plan, you may be able to get them back on the road to recovery with their retirement goals.

This article is for illustrative purposes only and not intended as professional tax, legal, or financial advice. Please consult your tax, legal, and financial adviser to review your specific circumstances. The statements and opinions herein are current as of the date of this document and are subject to change without notice. Additionally, the opinions expressed in this article may not necessarily be indicative of the house view of Payden & Rygel. This material may not be reproduced or distributed without Payden & Rygel’s written permission.

[1] “Economic Uncertainty Delays Retirement Plans for Business Owners,” TD Wealth, January 11, 2023. https://www.prnewswire.com/news-releases/economic-uncertainty-delays-retirement-plans-for-business-owners-301719371.html

[2] Contribution amount stated may fluctuate based on actual ages, incomes, plan document provisions as well as the IRS maximum deduction limits.

[3] Retirement Topics – 401(k) and Profit-Sharing Plan Contribution Limits | Internal Revenue Service (irs.gov)