Tag Archive for: small business

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When might a cash balance plan be a good fit?

“How can I determine if a cash balance plan might be a good fit for a business owner?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with an advisor in New Mexico is representative of a common question related to maximizing retirement plan contributions.

Highlights of Discussion

The question of whether to set up a qualified retirement plan has important tax ramifications. Therefore, business owners would be best served by seeking the guidance of a tax professional when making such a decision.

As a type of defined benefit plan, a cash balance plan requires an adopting employer to fund the plan to provide participants with a promised retirement benefit. Cash balance plans are most popular among smaller, well-established firms that have significant and consistent cash flow (e.g., law firms, medical groups, and professional firms such as CPAs, architects, and consultants). They also work well 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.

To determine suitability for a cash balance plan, consider the following questions. The more “yes” responses the greater the possibility a business could benefit from having a cash balance plan.

Question Yes No Why it Matters
1.   Is the business owner over age 50?     The potential to contribute more income to a cash balance plan increases with age.
2.   Does the business owner have less of a need to reinvest in the business?     If the owner has put money into the business in prior years, the business is now, likely, well established, freeing up capital.
3.   Does the owner have significant pass-through income?     This can lead to discussions on how to reduce a large tax bill.
4.   Does the owner want to catch-up on saving more for the future?     Cash balance plans allow for higher contribution and deduction limits than defined contribution plans.
5.   Has the business owner shown interest in setting up a nonqualified deferred compensation plan (NQDC) to save more?     NQDC plans do not reduce taxable income for business owners of pass-through entities.
6.   Has the business owner shied away from a define benefit plan due to complexity and employee coverage issues?     Cash balance plans are less complicated to maintain than traditional defined benefit plans, and design features allow owners to maximize contributions for themselves.

As the table below illustrates, cash balance plans can allow much higher levels of contributions than a profit sharing or 401(k) plan. That equates to higher tax deductions for business owners. For some businesses, having both a defined contribution and cash balance plan may be appealing.

2022 Cash Balance Chart

Conclusion

There are some key characteristics to look for in a business owner when evaluating whether a cash balance plan might be a good fit. For the right candidate, a cash balance plan—or even a combination cash balance and defined contribution plan—can provide significant benefits. Above all, whether or not to set up a qualified retirement plan is an important tax-related question that a business owner should only answer with the help of his or her tax professional.

© Copyright 2022 Retirement Learning Center, all rights reserved
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Remember Plan Tax Credits for 2021

“Can you remind me of the special tax credits available for small businesses who set up qualified retirement plans, please?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Arizona is representative of a common inquiry related to incentives for setting up retirement plans.

Highlights of Discussion

My pleasure! Small business owners (with fewer than 100 employees) are eligible for additional tax credits for setting-up retirement plans and/or adding an automatic enrollment feature. The credits are available if the owner establishes a 401(k), a SEP or a SIMPLE IRA plan. The business must

• Have had fewer than 100 employees who received at least $5,000 in compensation for the preceding year;
• Have at least one plan participant who was a nonhighly compensated employee; and
• Not have maintained a plan in the past.

The “Startup Credit” is up to $5,000 (a formula applies), available for the first three years the plan is in existence and offers real benefits to owners by freeing up tax dollars for other important business purposes. The credit was greatly improved as part of the Setting Every Community Up for Retirement Enhancement of 2019 Act (SECURE Act), effective January 1, 2020 (increasing the maximum credit from $500 to $5,000). It is intended to encourage owners to establish retirement plans by helping make the plan more affordable during the startup process. In addition, the owners receive full tax deductions for all contributions made to the plan.

On top of that, if an owner elects to add an automatic enrollment feature to the plan, an additional $500 credit (for the first three years) is also available. The automatic enrollment feature calls for newly eligible participants to be enrolled automatically in the plan with a specified default deferral rate. The IRS provides additional details about the startup and auto deferral credits here.

Eligible businesses may claim the credit using Form 8881, Credit for Small Employer Pension Plan Startup Costs.

See the Instructions for Form 8881 for more details.

Conclusion
Tax credits for setting up a plan and having an automatic enrollment feature are great tools to help small businesses defray the initial costs of starting and maintaining a plan. Business owners should discuss the credits with their accountants and advisors to determine if it makes sense for them to establish a plan.

 

© Copyright 2022 Retirement Learning Center, all rights reserved