Cash balance plans enable high income earners to grow their retirement savings in a relatively short period of time. Unlike other qualified retirement plans like a 401(k) plan, cash balance plan contribution limits are higher. In some circumstances, contributions in the 6 figures are totally within the rules.
If you are a small business owner or a corporate executive with ownership interest, there may be retirement contribution benefits available to you through a cash balance plan that aren’t offered through other retirement vehicles.
What are the Cash Balance Plan Contribution Limits?
Common retirement vehicles have contribution limits in efforts of keeping the offered benefits from being abused by the general public. Each type of retirement vehicle has a different contribution limit, and thus benefit different people in different ways depending on their circumstances financially.
The contribution limits of a cash balance plan differ slightly from that of a regular qualified retirement vehicle or defined benefit plan. Most have a set dollar limit per year, and others are based on your income.
The contribution limits of a cash balance plan are age dependent and varies per person and scenario. The older an employee is, the more they are able to contribute to their plan. Likewise, the younger an employee is, the less they will be eligible to contribute.
These limits are set in place to allow small business owners and corporate executives with ownership interest to “catch up” their contributions assuming they reinvest a large portion of their income in the beginning years of the business growth.
If you are a small business owner, no need to worry that you aren’t taking full advantage of contributing to retirement while your business matures. Cash balance plans allow you to catch up in the later years when the business has matured and has a more consistent and steady income flow.
How do Cash Balance Plan Contribution Limits Differ from Other Retirement Plans?
The most common retirement vehicle used for the majority of households is the IRA (Individual Retirement Account). There are two types of IRA’s; Traditional IRA’s and Roth IRA’s. An IRA is available through investment banks, and are not offered directly by an employer. Both types of IRA’s have annual contribution limits.
Another common retirement vehicle available to most, is an employer sponsored 401(k) plan. This is basically a retirement account offered by your employer that allows you to deduct a certain percent from each paycheck to set aside for retirement. The funds are invested in the stock market among the available investments offered for that plan.
Other common retirement vehicles such as a SEP IRA (Self Employed Pension IRA), which are designed for small businesses with fewer employees, work similar to a regular IRA account or a self-directed IRA. The contribution limits of a SEP IRA are the lesser of 25% of total compensation, or $66,000 yearly.
When comparing a Roth IRA, Traditional IRA, 401(k) plan, and a SEP IRA retirement vehicle, it’s evident that for some with higher income, you are not able to take advantage of tax benefits and saving heavily for retirement relative to your high income.
Cash balance plans were designed for those high income earners in mind, and allows you to contribute much more than a common type of retirement vehicle shown above. Take a look at an example.
Another important note that makes a cash balance plan very attractive, is the fact that you are able to take advantage of the contribution limits from both a 401(k) and an IRA, while contributing to a cash balance plan as well. This gives you the ability to save even more for retirement if circumstances suggest to do so.
Why are the Cash Balance Plan Contribution Limits Higher than Other Plans?
The reason for the higher cash balance plan contribution limits lies in the market they were designed for. Any small business owner would agree that the first years of launching their business is often very tight, and any money made is re-invested back into the business as often as possible. This makes it difficult for small business owners to stash money toward retirement in the beginning years of the business growth.
Cash balance plans were made with that small business owner in mind, allowing them to contribute much more relative to their age. They also provide for significant tax savings. For that reason, cash balance plans offer a higher contribution limit than most other retirement vehicles.
