So you thought tax loopholes went away with tax reform? Not so fast. There are a few loopholes left for the self-employed. Let me explain.
The benefits to business owners are pretty clear. But prior to establishing any plan, make sure that you understand the advantages and disadvantages. In this article we will take a closer look.Smart Navigation
- How does a cash balance pension work?
- Can you roll a self-employed plan into a 401k?
- The small business plan for the sole proprietor or S-corp
- What about the contribution limits for the self-employed?
- Cash balance plan small business
How does a cash balance pension work?
A cash balance plan is a retirement benefit provided by companies to their employees. A few different types of benefits you may be familiar with are 401(k) plans or a defined benefit plan. Both of these are retirement benefit plans provided by an employer for qualifying employees.
A cash balance plan is another retirement benefit plan that simply states that the employer will contribute a percentage of your yearly salary plus interest charges to an account designated for retirement. The interest charges that are given to your cash balance plan are usually between 4% and 5% give or take, and varies per employer.Looking for more information on cash balance plans? Take a look at our ultimate guide to cash balance plans. Discover our favorite strategies!
In a cash balance plan, your money is set aside into a “hypothetical account” designated for the named employee. This account is not the same as an employer’s trust account for its employees, but rather is pooled together in one account for all employees with the designated amount for each employee.
Can you roll a self-employed plan into a 401k?
Like a 401(k), the funds in a cash balance plan are professionally managed. This means that you don’t have direct control over the investments, but rest assured they are in the hands of a trusted investment adviser selected by your company.
Cash balance plans are technically defined benefit plans. The rules are governed by the requirements and limitations of defined benefit plans. But cash balance plans really function more like a “hybrid” plan (which is their nickname). This means that they are a combination of defined benefit plans defined contribution plans (401ks for example).
The small business plan for the sole proprietor or S-corp
Under a traditional cash balance plan, the employer will credit a participant’s account balance with a specific percentage of his or her annual compensation. In addition, the account will get an interest credit which is added to the account.
Changes that are reflected in the actual investment accounts will not impact any final benefits that are received by the participants. The company itself will bear the ultimate risk of investment returns in the portfolio.
Contributions to cash balance plans are based on actuarial assumptions. As a result, an actuary will be required to review the plan investment returns on an annual basis. This will ensure that the plan will provide adequate benefits to plan participants at retirement age. The actuary must use specific assumptions and calculations to ensure proper contribution levels.
Once the plan is initiated, the plan sponsor must continue to make annual contributions until the plan is terminated or frozen. Large companies will set-up plans for long periods, while small employers may terminate plans during the first 10 years of inception.
If you are setting up a cash balance plan for self-employed, make sure that you do plenty of diligence to make sure that you understand the plan requirements and have the financial ability to fund the plan for an ongoing period of time.
What about the contribution limits for the self-employed?
Like most retirement benefit plans and other individual retirement account plans, there are limits as to how much you can contribute on a yearly basis. For cash balance plans, those limits are not subject to the regular $56,000 yearly contribution limit that traditional defined contribution plans abide by.
The yearly contribution limit of a cash balance plan are age dependent, meaning the amount you can contribute depends on how old you are. The reason for this rule is because an older person has fewer years to save, giving them a smaller advantage in the amount that they can contribute.
The plan document will specify how much that contribution limit is. Subject to the IRS, that contribution limit is detailed in the plan document based on a pre-determined contribution formula.
Does a cash balance plan for the self employed require the same contribution to each employee? No. The plan has the ability to pay different credits for different groups of employees. The different groups may be defined by things such as age, service, area of operation within the company, and ownership percentage. These differences will be defined in the plan document.
Cash balance plan small business
Is a cash balance plan considered a “qualified” plan by the IRS? Yes. A qualified plan indicates that the plan has designated tax benefits, grows tax free, and contributions aren’t taxed until retirement or withdrawal. Most qualified plans also include other benefits such as protection from any filed bankruptcy, and different rollover options.