Cash balance plans have been growing in popularity in recent years – especially among small employers. But for 2018 we are seeing an even higher number of requests for cash balance plans. This due, in large part, to the Section 199A/Qualified Business Income Deduction (QBID) that came into effect January 1 as part of the Tax Cuts and Jobs Act. The addition of a cash balance plan, either by itself or on top of a 401k/Profit Sharing plan, could help your business qualify for this deduction.
Cash balance plans can create some large tax deductions but don’t let those potential deductions keep you from seeing the complexities, and potential pitfalls, from these plans. A qualified third-party administrator will help you navigate the setup and operation but here are a couple of things that we make sure clients understand from the beginning:
Be committed – The QBID has generated a lot of excitement and as we get closer to the end of the year we anticipate a lot of last minute plans being setup as clients go through their year end tax planning. But a cash balance plan is not something that you should jump into on a whim just to save some taxes. Those plan contributions, sometimes very large plan contributions, need to be made for at least 5 years or the plan could run into some serious problems – including disqualification by the IRS. Make sure you understand the financial commitment.
Be careful – Our standard retirement plan agreement states we use an income focused investment approach for cash balance plans. This is also something that is made clear to clients upfront. It’s definitely a balancing act when it comes to cash balance returns. A high-risk portfolio combined with falling markets could result in a significantly underfunded plan. That could mean a significantly higher contribution requirement than you are prepared for. There’s also the potential for much smaller contributions being allowed when the investment returns are too high. That could cost you some tax savings. Make sure you understand what the plan’s interest crediting rate is and use an acceptable investment strategy.
Cash balance plans can be a great tool both from a tax and retirement planning standpoint. Just be sure you are well informed and have a good team in place to help with the details.