Connecticut Money: Hybrid retirement plan can boost savings

This article was published in the New Haven Register on July 31, 2020.

If you own a small business or a professional practice — medical, dental, law, accounting,
engineering — you should know about an alternative to 401(k) plans that can turbocharge
your retirement savings and ease your tax burden as well.

Cash balance pension plans offer much higher contribution limits than do 401(k) plans.
These plans — which date back to 1985 and were codified by the Pension Protection Act of
2006 — contain elements of both a defined contribution plan (401(k) plan) and a defined
benefit plan (traditional pensions). Many employers offer both a cash balance plan and a
401(k) plan.

With a cash balance plan, the employer contributes a pay credit per employee (usually
between 5 percent and 8 percent of salary) and an additional interest credit at a fixed or
variable rate. The employee does not contribute any funds. The pretax money is pooled into
a trust account and invested as a whole.

Owners and employees are guaranteed a certain amount at retirement, regardless of the
actual performance of the underlying investments. If the investment returns fall short of
the promised final pension total, the employer bears the loss.

The plan managers calculate annual benefits, and ultimately total retirement benefits, for
each owner and employee based on a formula that includes wages, the pay credit rate,
account balances and the interest credit rate. So high-earning owners are guaranteed
higher retirement sums than are rank-and-file employees, since, say, 8 percent of their
earnings is higher than 8 percent of an employee’s earnings. Federal regulations are in
place to protect the interests of employees in administering these plans.

Unlike a 401(k) plan, cash balance plans must offer employees the option to take either a
lump sum or annual annuity payments.

Business owners note: A cash balance plan is more costly than a 401(k) plan due to setup
fees and annual administration costs that include the requirement that an actuary must
certify every year that the accounts are adequately funded.

Despite the higher costs, many professionals and business owners have converted to cash
balance plans. One reason is because pay credits are allowed to reach far higher annual
limits than are traditional 401(k) contributions, reaching $200,000 a year and up in pretax
contributions for those 60 and older. That compares with a 2020 limit of $63,500 on
401(k) plan contributions by participants 50 and over.

The ability to contribute more money (in the form of employer-paid pay credits, not direct
employee contributions) not only boosts investment returns but also shields more income
from taxes because these are pretax earnings. With either type of retirement fund the idea
is to pay taxes at a far lower tax rate when you begin to withdraw the funds after you retire.
Since you can contribute far more under a cash balance plan, you save more in taxes over
the long run.

If you’re an older business owner or a professional, seek out a financial planner to run the
numbers and help you determine whether a cash balance plan might help you improve
your retirement planning and tax planning picture. Your financial adviser will also
consider whether setting up both a cash balance plan and a 401(k) plan would be your best
option.

Eric Tashlein is a Certified Financial Planner professional and founding Principal of
Connecticut Capital Management Group, LLC, 2 Schooner Lane, Suite 1-12, in Milford.
He can be reached at 203-877-1520 or through www.connecticutcapital.com. This is for
informational purposes only and should not be construed as personalized investment
advice or legal/tax advice. Please consult your advisor/attorney/tax advisor. Investment
Advisor Representative, Connecticut Capital Management Group, LLC, a Registered
Investment Advisor. Connecticut Capital Management Group, LLC and Connecticut
Benefits Group, LLC are not affiliated.