How to Frontload a Cash Balance Plan for Maximum Tax-Deferral

You have probably heard how wonderful cash balance plans can be for high-income business owners. But what if you want to frontload a plan? Is it possible and what are the pros and cons?

Cash balance plans have the highest tax-deductible contributions compared to most other plans. But there are a few things you can do to get even higher contributions.

But just don’t be too greedy upfront because every dollar you contribute today is one less dollar you can contribute in the future. We will break it down for you in this post.

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The basics

A cash balance plan is a type of defined benefit pension plan that is designed to provide retirement income for employees. There are several reasons why a cash balance plan may be a good retirement plan for some people.

A cash balance plan is a defined benefit pension plan that combines elements of traditional defined benefit plans with those of defined contribution plans, such as 401(k)s.

Cash balance plans offer several advantages for both employers and employees. For employers, they are relatively easy to administer and can provide a predictable cost for funding retirement benefits. For employees, cash balance plans offer the potential for a higher return on their contributions compared to traditional defined contribution plans, such as 401(k)s.

In addition, cash balance plans offer tax benefits for both employers and employees. Contributions to a plan are tax-deductible for the employer and made on a pre-tax basis for the employee. Plus, the investment earnings on the account balance are tax-deferred, allowing the employee to save on taxes until retirement.

How do I frontload a cash balance plan?

Frontloading a cash balance plan is a strategic approach employed by employers to accelerate contributions in the first plan year. Unlike traditional defined benefit plans, where contributions are typically evenly distributed over years, frontloading involves injecting a significant portion of the total planned contributions upfront. This “frontloaded” plan design allows for significant tax deductions in the first year and allows contributions to compound upfront.

By frontloading a cash balance plan, employers can offer their employees the advantage of quicker accumulation of retirement assets. This can be particularly beneficial for younger employees who have more time for their investments to grow and compound.

However, it’s essential for employers to carefully consider the implications of frontloading a cash balance plan. While it can offer advantages in terms of increased retirement savings and employee satisfaction, frontloading must comply with IRS regulations and nondiscrimination rules to ensure fairness and equality among plan participants.

Any problems with frontloading?

While front-loading a cash balance plan is perfectly legal from a compliance standpoint, there certainly are some headaches to consider.

Remember that a cash balance plan is a type of defined benefit plan. Define benefit plans are very different from defined contribution plans. With a defined benefit plan, we are actually defining a benefit amount at retirement. Assuming that amount is fixed, every dollar you contribute towards the plan in a given year is one less dollar you can contribute in future years. Some people have used the old expression “robbing Peter to pay Paul.”

Every year, we give you a funding range that includes minimum, target (or recommended) and maximum allowable amount. When funding is at the maximum level, you’re just pulling from future years. So, the result is future year contributions will go down.

As a result of the defined benefit amount at retirement, we generally advise clients to make steady, consistent contributions. This way, they can better tax plan and know their deduction levels.

But frontloading a plan can make a lot of sense, especially if you have a very high income this year and you expect to decrease in the future.

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For example, what if you were going to make $1 million this year but forecasted $200,000 for each of the next couple of years? In this case, front-loading makes a ton of sense. You’ll be able to get large contributions upfront when you’ve got a tax bracket that is substantially higher than what you expect in the future.

The problem with front loading is often clients forget that they’re doing it. They make a large contribution in a given year with a lower salary. The following year, they keep their salary the same, and they expect to contribute the same amount. Unfortunately, that’s not how it works.

If you’re a physician with consistent income, we will often not recommend frontloading. However, if you’re a real estate agent with volatile income, frontloading can make a lot of sense.

What if I overfund a cash balance plan?

Overfunding a cash balance plan means contributing more money than is required by law or the plan’s terms. A cash balance plan is a defined benefit pension plan that combines elements of traditional defined benefit plans with those of defined contribution plans, such as 401(k)s.

Overfunding a cash balance plan can be risky and may negatively affect both the employer and employees. Here are some factors to consider when deciding whether to overfund a cash balance plan:

  1. Number of employees
  2. Annual compensation
  3. State tax rate
  4. Plan design and pay formula
  5. Investment risk:

Overfunding a cash balance plan may result in a larger account balance that is more exposed to investment risk. This could result in lower investment returns or losses, impacting employees’ retirement benefits.

It is vital for employers to review the plan terms and to consult with a qualified professional before making any decisions about overfunding the plan.

Final thoughts

Overall, a cash balance plan can be a good retirement plan for those who value guaranteed benefits, the potential for higher contributions and investment growth, and the portability of their retirement savings. However, it is important to carefully consider the potential advantages and disadvantages of a cash balance plan before deciding whether it is the right choice for you.

Paul Sundin

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