We all know about the large contributions that you can make with cash balance plans. But happens if you can’t fund your plan for a given year? In this post, we examine the cash balance plan minimum contribution. You may have more options than you thought.
There is a one common concern among business owners. Let’s assume you are making a lot of money this year and you want to make a large plan contribution. You always want to make a large contribution when you are in a high tax bracket.
But you might be worried about next year. Maybe you are looking to reduce your hours? What if that large contract doesn’t renew?
In any case, you have concerns about making future year contributions. We hear the concern all the time. We already discussed the fact that cash balance plans are permanent plans. You can’t start and stop as you please. You could find yourself getting the attention of the IRS. Not a good thing.
But we also know that business revenues can and do fluctuate from year to year. So we have a some strategies that you can use in years when funding is a concern.
#1 – Fund the low end of the range
When actuaries calculate annual contribution levels, they utilize a variety of estimates and assumptions. This results in a range of funding outcomes.
They will provide a target contribution, but will also include maximum and minimum contribution levels. For example, let’s assume you were provided with a target funding of $100,000. You might have a range of $70,000 on the low end and $150,000 on the high end.
This allows you some discretion to contribute larger amounts in your good years and reduced amounts in lean years. A broad range is generally not in place for year one, but it will widen with years of service.
#2 – Adjust your compensation
When your company is structured as an S-Corporation or C-Corporation, a big component of the annual contribution amount results from your W2 compensation.
So if your business income has substantially decreased, then possibly your W2 compensation should be down as well? Decreasing your compensation can reduce your required funding. But realize that you must pay yourself reasonable compensation under the law. But this can be an option if looking to make a cash balance minimum contribution.
All corporations should do a reasonable compensation review at least annually with their CPA. This would be a good opportunity to address the topic.
If they have low compensation for the year and they have overfunded in prior years this could lead to no contribution in the current year.
#3 – Plan Amendment
You do have another option available to you. A plan can always be amended to allow for lower contributions (subject to certain conditions and IRS testing).
However, there is one concern. You are not allowed to lower benefit amounts once employees have met eligibility requirements for any given year. Typically, they meet eligibility upon meeting the 1,000 hour requirement.
#4 – Establish a Low Flat Dollar Amount
One option you do have is to establish a lower, flat dollar amount up front when you set up the plan. Many people don’t realize that this is an option.
In fact, you can set the interest crediting rate a low level and this will lower the overall funding level. This can be a great option if you have high income, but are considering making smaller contributions.Looking for more information on cash balance plans? Take a look at our ultimate guide to cash balance plans. Discover our favorite strategies!
For example, let’s assume that you are 50 years old, have an S-Corp and your W2 wage is $150,000. A baseline contribution for you may be around $120,000. But you could establish a fixed dollar amount of, for example, $50,000 for year one. You could have an interest rate credit of say 3% and this would keep the cash balance plan minimum contribution relatively low going forward.
#5 – Terminate the Plan
As you probably know by now, the IRS considers a cash balance plan to be a permanent plan. It is adopted by the company and will be subject to contributions on an ongoing basis.
The assumption is that the plan exists indefinitely or for a minimum of a “few years.” The IRS does not clearly specify what a “few years” truly means. Of course each situation is unique, but the IRS has typically not questioned plan terminations for plans in existence for 5-10 years. You should certainly plan on having the plan open for a minimum of 5 years. The IRS wants to see a “business necessity” when terminating a cash balance pension.
There are many situations where a “business necessity” could exist. This could be because of lower net profit, partner or shareholder changes, or a complication that limits the company’s ability to further fund the plan. The IRS has also in the past accepted the adoption of a different retirement structure as a valid reason for terminating a plan.
Cash Balance Plan Minimum Contribution
So in reality you do have many options available to you if you are looking to make minimal contributions. It is important to understand your funding options. These plan allow for large contributions, but if you plan carefully you do have the ability to fund minimal amounts in lean years or in years in which you have other cash considerations.