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The Power of the Cash Balance/401(k) Combo Plan

In a cash balance plan, the rules do not limit the annual contribution amount but instead limit the ultimate benefit payable from the plan. The lump sum equivalent of that benefit at retirement age is over $2.5 million.

The ideal candidate for a combo plan is a highly compensated business owner that is seeking larger contributions and greater tax deductions. The business should anticipate consistent profits and strong cash flow for a number of years for a couple of reasons. Firstly, because retirement plans are supposed to be permanent. Although there is not an objective standard of permanency, three-five years appears to be sufficient time to satisfy the permanency requirement. Secondly, cash balance plan contributions are not discretionary but are determined by an actuary and are an annual obligation to the plan. In addition, when combining plans, the employer’s contribution to the 401(k) plan is no longer totally discretionary. There will normally be a minimum employer contribution amount required to the 401(k) plan to cover top heavy, minimum gateway, and non-discrimination testing requirements.

Examples of the Cash Balance/401(k) Combo Plan

Example 1. ABC, Inc has two owners and four employees:
Owner A is 60 years old and earns $285,000
Owner B is 45 and also earns $285,000
Employee 1 is 40 and earns $75000
Employee 2 is 35 and earns $50,000
Employee 3 is 30 and earns $40,000
Employee 4 is 25 and earns $30,000

ABC’s owners want to make high annual contributions and after speaking with a third-party administrator (TPA) company, they decided to establish a combo cash balance 401(k) plan.

Below is an estimation on how much the owners of ABC company will be able to defer in 2020:

In this example, owner A & B will be able to max out their 401(k) plan make high annual cash balance contributions, creating significant tax deductions while incurring minimal cash expenses for cash contributions made to their four employees.

Example 2: XYZ Service, Inc has two owners and no employees. A doctor and his spouse.

Doctor is 62 years old and earns $285,000
Spouse is 55 years old and earns $285,000

The doctor and his spouse have consistent large amounts of annual income and are looking at ways of generating annual tax deductions while also saving for retirement.

Below is an approximation on how much the owners of XYZ Service company will be able to defer in 2020:

In this example, the doctor and his spouse will each able to make $43,100 of 401(k) plan contributions and over $200,000 of cash balance plan contributions for the year. In each plan, the actuary will determine the minimum and maximum defined benefit contribution and deduction allowed under the plan.

In both cases, establishing a defined benefit plan helped the business owner generate almost five times more deductions and savings than a 401(k) plan.

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