The Leading Edge - Spring 2011 - PKF - 13

finances

Cash balance pension plans: Boosting tax deductions and building retirement savings for business owners
By David A. Pitts, EA, FSA, MAAA, MSPA

s the economy rebounds and company revenues improve, many businesses will look to increase tax deductions, especially with the threat of tax rate increases. Also, business owners will try to rebuild their battered retirement savings after the market losses suffered in 2008 and 2009. Cash balance pension plans are an excellent means of achieving both goals, and the retirement plan industry expects to see an increase in the number of new plans. Of course, business owners need to understand the pros and cons of these arrangements to determine if they are a good fit. The big tax deductions provided by cash balance pension plans are the primary driver of their popularity. The maximum deductible contribution to an individual’s 401(k) profit sharing accounts in 2011 is $49,000 (or $54,500 for individuals older than 50). A cash balance pension plan, alone or in combination with a 401(k) profit-sharing plan, can dramatically increase the deductible contributions. As an example, the owners of a dental practice wanted to set up a retirement plan to allow them to make large tax deductible contributions while minimizing additional staff costs. The example in the chart below was created to compare a 401(k) profitsharing plan to a 401(k) profit-sharing plan with a cash balance pension plan.

From these proposals, two advantages of the combined 401(k) profit-sharing and cash balance plan are clear to the dental practice owners. Adding a cash balance pension plan increases their annual deductible contributions by approximately $206,000 with only $8,000 in additional staff costs. This also means that their annual retirement savings increased by about $200,000 or 200 percent over having only a 401(k) profit-sharing plan. And while the focus of the proposed plan design is maximizing the owners’ benefits with minimal staff costs, staff members would receive meaningful benefits that were higher than the 401(k) profitsharing only plan. Another appeal of cash balance pension plans is their simple look and feel compared to other pension plans. Benefits accumulate in a (hypothetical) account that receives annual allocations or “pay credits,” and investment earnings on their prior year’s balance or “interest credits.” Employees can see benefits accumulate on their annual statements like their 401(k) profit-sharing plan balances. And benefits are highly portable—employees are allowed to roll over their cash balance account from the plan into their IRA when they leave employment.

EXAMPLE: DENTAL PRACTICE PLAN DESIGN PROPOSALS ANNUAL EMPLOYER ALLOCATIONS
Employees Owner 1 Owner 2 Subtotal: Owners Staff Members Total Annual Compensation $245,000 $245,000 $490,000 $439,826 $929,826 Design 1: 401(k) Profit Sharing Only $54,500 $54,500 $109,000 $15,981 $124,981 Design 2: 401(k) Profit Sharing & Cash Balance $154,950 $152,500 $307,450 $23,752 $331,202 Design 2: Increase in Contributions from Design 1 $100,450 $98,000 $198,450 $7,771 $206,221

Of course, cash balance pension plans are not right for everyone. As required for all pension plans, employers are responsible for providing the promised benefit at retirement and they must make minimum annual contributions toward that goal. Therefore, good candidates for a cash balance pension plan will have a fairly stable income stream and available cash flow. In addition, employers should desire to contribute more than $49,000 annually toward their retirement, have a fairly stable employee group and generally be older than most of their staff (or plan demographics may limit the owner’s contribution). To learn more about whether a cash balance plan could benefit your business, contact your Leading Edge Alliance firm or me to illustrate the estimated contribution range for the desired benefit design. LE
David A. Pitts, EA, FSA, MAAA, MSPA, is a manager at Lurie Besikof Lapidus & Company, LLP, a member of the Leading Edge Alliance, and can be reached at dpitts@lblco.com or (612) 381-8776.

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The Leading Edge - Spring 2011 - PKF

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