When it is time to planning for retirement many folks think of classic tools such as 401(k)s or IRAs. But what if you've already maxed out your accounts, but still want to save in a tax-efficient manner? For high-income earners, there's a lesser-known but effective alternative called the cash balance strategy. If you're looking to learn how to boost your retirement savings and reduce the tax burden, be sure to keep reading. You might discover the "secret weapon" for building your retirement nest egg.
What Is a Cash Balance Plan?
Cash balance plans are a type of defined benefit plan. A cash balance plan is a kind of defined benefit plan that works a bit like a pension but with an intriguing twist: each participant has their individual "account" that grows every year by contributing and earning an interest-based credit. However, unlike the traditional 401(k), the cash balance plan provides an established retirement benefit. Think of it as a mix of a savings account and a pension. The most appealing feature? The contribution limits for 2024 could exceed $200,000 per year for high-income earners over age 50—which will blow the typical 401(k) maximum off the table.
Who Can Benefit Most?
Although anyone is technically able to create cash balance plans, they're particularly beneficial for proprietors of small-sized firms or partners in law or medical practices, as well as highly paid employees who operate on their own or with only a few employees. Cash balance plans are highly sought-after by dentists, doctors, and entrepreneurs looking to stash away large sums of money for retirement while reducing their current tax-deductible income. It's common for a company person in their 60s or 50s to take advantage of cash balance plans and to contribute up to three times the amount allowed in a 401(k).
How the Tax Benefits Add Up
The most significant benefit of cash balance plans is their tax benefit. Contributions from the employer (even in the case of a business owner) are tax-deductible. This means that if you deposit $150,000 into your account, your tax-deductible income could be reduced by the total amount. In time, compounding and ongoing contributions can make a huge difference. Many high-income earners view this as a method to boost their retirement savings as well as reduce their tax bill each year, sometimes by hundreds of thousands of dollars annually.
The IRS permits certain professionals to accumulate greater than $3 million in benefits for life via cash balance plans, which is among the most generous limits that are available.
What's Required to Set Up and Maintain a Plan?
This is not a DIY project. The process of setting up cash balance plans requires an actuary—a professional who determines the contributions and future benefits. It also requires regular administrative tasks. Be prepared for annual filings and checks for compliance. The majority of people opt for a retirement plan provider. Costs could range from $2,000 up to $5,000 per year; however, for those who can save tax savings of six figures, the savings could be worthwhile.
Comparing Cash Balance Plans to 401(k)s
Cash balance plans as well as 401(k)s provide tax-deferred growth; however, the contribution limits for the 401(k) ($23,000 for most people in 2024, and the possibility of a catch-up of $7,500 for those who are over 50) is only a fraction of the amount a cash balance plan allows. They also don't rely on market performance as much, which is a huge benefit if you want stability and predictability in your retirement plans.
Checklist: Is a Cash Balance Plan Right for You?
- Do you consider yourself a high-earning professional looking for greater pension contributions?
- Have you currently maxed out your 401(k) or IRA?
- Are you willing to make significant annual contributions for several years?
- Do you run an enterprise or are you an employee in an established firm?
- Are you looking to lower your tax-deductible income?
For me, the way these plans can change the way business owners retire is an inspiration. The potential to boost savings and reduce taxes feels like finding a hidden element in a game. It's legally accessible and above board. When you add up the tax-deductible contributions and the hefty annual limits, it's easy to understand the reason why people who are looking for "best retirement accounts for high earners" are increasingly attracted to cash balance accounts.
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