Most small- to mid-sized business (SMB) owners tend to plan for their retirement the same way. They continue to build a profitable business until it’s time to retire. Then they sell it for big bucks and live well indefinitely. Traditional retirement plans don’t work for owners of successful businesses, because their profits tend to far exceed the standard annual 401k contribution limits. Owners of profitable SMBs assume they can sell their businesses for an amount that will see them through retirement without cramping their lifestyle. But in my experience, business owners tend to overestimate the resale value of their business and find that their retirement plan isn’t as rock solid as they thought. The cash balance plan, a hybrid of defined contribution and defined benefit plans, is the retirement planning solution for business owners whose future selves want a secure retirement nest egg.
Traditional Owners’ Retirement Plan
Retirement plans sponsored by SMBs are generally designed around rank-and-file employees – not owners and not highly-compensated employees (HCEs). If the plan sponsor and advisor can devise and maintain a plan that gives most employees a way to reach their retirement goals, most business owners consider that a success. But if you’re the owner of a SMB, where does that leave you? If your business is profitable, you’re probably enjoying the lifestyle that comes with the success you’ve earned. You invest what you can back into the business – it’s your livelihood. You’re not saving for retirement because you know the standard IRA or 401k won’t work for you. The contribution limits mean that in retirement, the balance you could accumulate would never let you match the lifestyle you’re leading now. So, you’re not saving for your future, because your plan is to sell your business and live off the proceeds.
Building A Solid Nest Egg
You run a successful business, so you’ll sell it for what it’s been worth to you, right? Maybe. When SMBs don’t fetch the selling price that owners expect or even count on, they find their retirement nest egg shorted. Happily for SMB owners, the cash balance retirement plan is a solid solution to this problem, provided their businesses fit a certain profile. The owner of an eligible business can sock away a maximum of $2.8 million for their future self while the plan is in effect, potentially up to $250,000 each year. At the same time, the corporate tax deduction on the plan can cover a 5 to 7 percent ‘defined contribution’ to ordinary employees’ accounts.
The Candidate Profile
What type of business is the best candidate for a cash balance plan? Companies that:
- Are highly profitable, regardless of type or size
- Are closely-held or family businesses
- Are high-earning sole proprietorships with significant cash flow
- Are medical practices or law, CPA, management consultant, engineer, architect or financial services firms
- Have older owners who delayed or minimized their retirement plan savings
- Are already providing a defined contribution of 5 to 8 percent of compensation
- Are interested in boosting benefits for executives/key/HCEs
Cash Balance Meets 401k
This hybrid “cash balance x traditional 401k” plan has elements of a defined contribution plan for ordinary employees and a defined benefit plan for owners and HCEs. It may sound too good to be true, but there are a couple of conditions attached to a cash balance plan. Unlike a profit-sharing plan, the yearly contribution for all participants must stay the same, and the business must be able to fund the plan as designed for a minimum of three years. The defined contribution part of the plan must meet ERISA standards for participation, contribution levels and fee levels. The owner can max out her own contribution but can’t change what she contributes to the other employees. The plan must be funded as designed or it isn’t legit.
The cash balance plan lets owners, depending on age, accumulate a total of $2.8 million in a retirement nest egg. Are you this person? Do you own this kind of small- to mid-sized business? You may be wondering why you’ve never heard of this kind of plan or why you don’t already have one. Designing a cash balance plan is complex, and most plan advisors are reluctant to suggest one when they don’t have the resources to design one that meets all the ERISA requirements. Business owners whose exit and retirement plan are the same – sell the business for big bucks and live the high life – should consider the cash balance plan. A retirement based on today’s profits is more secure than one based on tomorrow’s unknown selling point.