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For a change, let’s take a look at a special kind of pension plan, shall we?
There is a growing interest in a type of pension plan called the cash balance pension plan that was little understood till a few years ago. Small businesses have come to realize that a cash balance fund that guarantees a return of 4% annually, and which compounds over a period of 30 years can provide them with immediate tax savings and retirement benefits later on without much risk. So in 2009, most small companies started working with their actuaries to implement such plans for their firms.
Cash balance plans were actually a long-kept secret of companies looking to establish retirement plans. Also, it seems that not too many CPAs were aware of this plan until recently. So how about let’s take a look at how such a plan works? Given that a cash balance plan is a defined benefit plan rather than a defined contribution plan, it actually does not require annual employee contributions. This type of plan looks to benefit companies that have less than twenty employees with profits in excess of $50,000 annually; such plans are a great alternative to your traditional pension plan that’s based on terminal earnings formulas. The difference here is that cash balance pension plans are based on the average earnings of employees over the life of their career and the employer is the one who takes on the risks and rewards of the investments. Employees therefore benefit from this plan by receiving funds as a form of annuity. These funds are a great complement to an employee’s retirement program, that may include their own investments in high interest savings accounts, certificates of deposit, equities and real estate.
If you look at trends, many small business owners don’t save enough for their retirement and won’t start saving aggressively until they’re ready to hang their hat. Why? Because they tend to use their profits for the purpose of growing their business, which then leaves little or no money for their own retirement savings and discount brokerage accounts. Hence, we can see how a cash balance pension plan may actually be a blessing in disguise for such business owners. This gives them a chance to make up for lost ground while saving on their taxes (and nothing excites business owners more than increasing their profit margin).
Here’s another matter of note: such funds offer a guaranteed annual benefit which accrues until the time the participant reaches retirement or any pre-specified age. The participant can also set the investment amount they’d like to withdraw (whether lump sum or per annum), based upon their income and in consultation with an actuary. The benefits they ultimately receive are guaranteed throughout their retirement regardless of how the stock market behaves; the stock market is something that defined benefit plan participants need not worry about. It’s also worth noting that many of these plans are typically quite conservative and aim for slow and steady growth.
While employees can enjoy retirement benefits from such a plan, business owners and company sponsors of such a program can also enjoy tax savings. While plan owners have to invest a portion into employeesâ€™ retirement schemes, the tax savings derived from a cash balance fund still makes it worth establishing.