Page 19 - NC Triangle Vol 6 No 4

PATRICKH.YANKE |FINANCIAL
Cash Balance Plans for Greater Savings
Potential
Lisa is a law rm partner who just turned 60 and is changing her perspective. Until now, she had invest- ed mostly in her business and her family. Retirement
wasn’t the largest image on the radar. It’s time for a change and a Cash Balance Plan could be part of the solution.
Over the years, Lisa contributed to the rm’s retirement plan up to the amount matched. She gured that gave her an immediate boost from the tax savings and a 100% initial return through the company match. Over the last 30 years, her retirement account grew to about $2 million (invested 60/40 in stocks and bonds). She’s heard that she could ex- pect about 4%/year in retirement withdrawals. Between Social Security and this account, she’s expecting close to $10,000/month in retirement income. e problem: this isn’t enough to maintain her current lifestyle into retire- ment! How can she save even more to bridge this gap?
ere are two main types of business retirement plans; De ned Contribution (DC) and De ned Bene t (DB) Plans. Lisa has so far used a DC plan to save for retire- ment. In these plans, there is a “de ned” amount that is contributed by the employee or on the employee’s behalf. e 401K is the most notable plan of this type.
In DB plans, it’s the retirement bene t that is de ned rather than the contribution. Based primarily on an em- ployee’s age and income, older highly-compensated em- ployees may be able grow retirement assets more rapidly than in other types of plans. O en generally referred to as “pension” plans, DB plans are intended to provide predict- able retirement income.
CASH BALANCE PLANS
Cash Balance Plans are a hybrid of DC and DB plans. Rather than provide retirement income, they build cash for plan participants. When paired with a pro t-sharing plan, they can allow older, highly-compensated key per- sonnel to build wealth rapidly.
When pitching the merits of the Cash Balance Plan to her partners, Lisa mentioned some notes of caution. e rst consideration is that this type of plan is generally more expensive than a run-of-the-mill 401K. However, it is possible that much (or even all) of the increased expense may be o set by greater tax bene ts to the business. Also, since the end bene t is de ned, it should only be used in businesses with stable cash ow... annual contributions are set by an actuary and required.
Lisa calculates that she might save as much as $300,000/ year if the rm o ers a Cash Balance Plan in addition to the 401K! How does that work? Since she is over 50 years old, she can make “catch-up” contributions to the 401K which, when combined with rm contributions, help her max out
at $60,000/yr. Additionally, at
age 60, the rm could deposit
as much as $245,000 to the
Cash Balance Plan due to ac-
tuarial calculations. If the rm
has an assumed tax rate of 45% (federal and state), it could see about $126,450 in potential tax savings from these contributions.
BENEFITS TO THE FIRM
For employers, the bene ts of a Cash Balance plan in- clude the exibility to contribute either a percentage of pay or a at dollar amount. It may be easier to boost ben- e ts for owners and other key employees while controlling the cost of bene ts to others. e rm maintains control over the investment strategy.
For plan participants, the Cash Balance plan is easier to understand than traditional DB plans. is plan is more portable than a DB plan since accounts can be distributed or rolled over to an IRA (or other employer-sponsored plan) at separation of service. It permits higher contribu- tion limits for key employees and older participants. ere is little or no investment risk to the participant, depending on plan design, as sponsors must guarantee each partici- pant’s payout will not be less than the sum of the employ- er’s contributions to the plan.
If investment returns do not keep up with actuarial funding requirements, additional contributions will have to be made by the employer. Excess returns can be used to o set future contributions. Plan sponsors are responsible for the di erence if the underlying investments, net of ex- penses, return less than the stated interest-crediting rate.
Cash Balance Plans are best suited to organizations with predictable cash ows and consistent pro ts. ese could include professional groups (lawyers, doctors, dentists, engineers, accountants, et al), closely-held businesses, and organizations already maximizing contribution limits to their current DC plans. e potential bene ts to both employers and employees certainly call for an exploration. is article is not tax advice. Please consult your tax advi- sor concerning a particular situation.
PATRICK YANKE IS A RALEIGH FINANCIAL PLANNER WITH A NATIONAL BUSINESS. HE DELIVERS NEWSLETTERS AND SPEAKING PROGRAMS ON A WIDE RANGE OF FINAN- CIAL TOPICS AND REGULARLY PRESENTS AT THE NCBA AND NCAJ ON FINANCIAL TOPICS. OPINIONS EXPRESSED HERE ARE PATRICK YANKE’S AND NOT NECESSAR- ILY THOSE OF RAYMOND JAMES. PLEASE CONSULT YOUR FINANCIAL ADVISOR IF YOU HAVE QUESTIONS ABOUT THESE EXAMPLES AND HOW THEY RELATE TO YOUR OWN FINANCIAL SITUATION. THIS HYPOTHETICAL REPORT IS NOT INDICATIVE OF ANY SE- CURITY PERFORMANCE AND IS BASED ON INFORMATION BELIEVED RELIABLE. WWW. YANKEFINANCIAL.COM.
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