Are your clients making the maximum allowable tax-deductible contribution to their defined-contribution plans (as much as $49,000 in 2006)? Would they be interested in contributing much more if possible? If the answer is "Yes," they should consider a cash balance plan.A CB plan is a qualified retirement plan established for the owner of a business and his employees. Tax-deductible contributions are made to the plan in the form of managed assets (stocks, bonds, mutual funds, variable annuities, etc.) with the option of purchasing life insurance inside the plan.
CB plans are designed to provide a monthly retirement benefit that is defined by the plan formula. Contributions are based on actuarial assumptions and are determined by an actuary as to the amount needed to provide the benefit at retirement.
Life insurance is the most overlooked, underappreciated investment option for these plans. The benefits of the insurance policy in a plan are threefold:
1. In most instances, the policy increases the annual tax-deductible contribution to the plan for the owners.
2. The policy cash-value guarantees provide a secure foundation for the plan, as well as a hedge against potential under-funding issues.
3. The tax-free death proceeds provide "family working capital" in case of the premature death of the owner.
The death benefit proceeds may be used by the survivors to maintain lifestyle, address estate-planning needs or to "pay up" existing life insurance policies on other family members.
Cash balance plans afford significantly larger tax-deductible contributions (in excess of $100,000 per owner) than defined-contribution plans. Furthermore, plan assets are protected from creditors pursuant to current federal guidelines.
Custom combination plans comprised of a cash balance plan layered on top of an existing defined-contribution plan are popular with midsized-to-large professional corporations (e.g., medical groups and law firms with 10-plus partners and 50-plus employees). In such cases, large tax-deductible contribution upgrades are provided to interested partners, while the employees remain in the defined-contribution plan subject to non-discrimination testing.
Most professional corporations want their retirement program to be tax efficient, meaning that more than 75 percent of the employer plan deposit is attributable to the partners of the corporation. This tax efficiency is achieved through the careful balancing of the CB plan and the defined-contribution plan.
With proper design work, CB plans are ideally suited for small to midsized medical practices, law firms, accounting firms, architectural firms, engineering firms and such. For small companies, including sole practitioners and consultants with significant income, cash balance plans provide an attractive solution, offering large tax-deductible contributions and a multitude of exit strategies including life income, lump-sum distribution and rolling over to another qualified plan.
Eugene C. Gordon is chief executive of The Graduate Group Inc./PensionQuote, a marketing, consulting and third-party administrative firm providing services to the brokerage, financial and insurance industries. Lance Wallach speaks and writes extensively about VEBAs, retirement plans and tax reduction strategies. Reach him at (516) 938-5007.
