How Business Owners Can Save $80,000 in Taxes Before April

May 14, 2023

Most tax strategies are best as part of a proactive tax plan. Sometimes though, life gets the better of us, we look up in January, and we realize that we’re going to owe a considerable amount in taxes.

This realization can lead people to chase ideas that sound too good to be true (and that’s where the danger starts). Are you a business owner in this situation?

Today we’re going to cover the following:

  • What is a cash balance plan?
  • How much can I potentially save?
  • Are there any possible downsides?
  • How to do it (with a video of a real example)

What Is a Cash Balance Plan?

Sometimes called a “cash balance pension plan,” a cash balance plan is a retirement plan offered by employers. The employee is credited with a percentage of their annual pay as well as interest charges. The strategy we’re discussing today is how using one can save you a significant amount in taxes each year.

The retirement plan deduction is one of the largest possible deductions still available to you before filing your taxes. A cash balance plan is only one particular type of retirement plan that is available to business owners. However, in the sections that follow, I intend to show you why it can be the most beneficial choice for entrepreneurs.

How Much I Can Potentially Save?

For our blog today, let’s assume Joe Sample is a 45-year-old, married, self-employed professional who earns $500,000 per year. The question for Joe becomes, “Why is a cash balance plan good for a business owner?”

The answer is simple: how much you can contribute. Here is how some popular plans stack up:

  1. IRA - $6,000
  2. SEP IRA - $61,000
  3. 401(k) - $61,000
  4. 401(k) + Cash Balance - $199,147

As you can see, the cash balance plan allows for three times the contributions of the other plans. This makes it pretty easy to see why these plans can make so much sense.

Are There Any Possible Downsides?

The natural follow-up is, “What’s the catch?” There have to be drawbacks, right?

Although there’s nothing I’d consider a deal breaker, there are a few items you need to be aware of when considering a cash balance plan:

1. Commitment.

Unlike a 401(k), cash balance plans have minimum contributions required each year. You need to be prepared to make the same contribution for at least 3-5 years, as a result. In other words, if your business isn’t profitable and doesn’t have stable cash flow, it may not make sense for you right now.

2. Investments.

Cash balance plans typically don’t allow your account to be solely invested in stocks. For the most part, you invest to reach certain return targets (such as 4-6%) each year.

3. Costs.

A cash balance plan requires an actuary. In most cases, this involves paying a $2,000-3,000 fee each year.

While there are some tradeoffs, the potential benefits are massive, especially right before filing.

Could Financial Planning Help 2023 Be a Fantastic Year for Your Business?

How Is the Maximum Cash Balance Contribution Calculated?

As we mentioned in our example above, Joe, a 45-year-old business owner, is earning $500,000 per year. There are a few items that will control how much can be contributed to his cash balance plan:

1. Your Age.

The older you are, the higher your benefit can be.

2. Your Income.

The higher your income, the higher your benefit can be (up to certain limits).

3. Your Business Type.

Your business structure will impact your benefits.

  1. For an S-Corp or C-Corp, it’s based on your W-2 wages
  2. If you’re an LLC or Sole Proprietor, it’s based on Net Earnings from Self Employment.

Each year, your actuary will be able to calculate how much you are eligible to contribute. It is too late to change your business structure and W-2 at the end of the year, but you can do it for future years, as necessary.

How To Do It (With Video of a Real Example)

If you think a cash balance plan makes sense for you, here is how I would go about setting one up:

1. Identify how much you can save each year and for how long.

2. Have a proposal prepared by a third-party administrator (TPA) or Actuarial Firm.

3. Evaluate your possible tax savings with your accountant, your advisor, or on your own. I believe you’re better off leveraging a professional for this one.

4. Identify a custodian to hold the money (Charles Schwab is an example of a custodian).

5. Engage a TPA or Actuary to do the yearly testing. This, typically, is a couple of thousand dollars (making it the main cost), but it’s also the most important piece.

6. Decide if you’d like to hire an advisor.

7. Finally, make sure to actually fund the plan. It doesn’t matter if you do all of the work and then don’t start saving.

A Video Example

I have a video that overviews a cash balance plan and how it affects Joe’s taxes here. It gives you a behind-the-scenes look at exactly how the $80,000 can be saved (and what tools I use to analyze these for clients). Overall, it shows:

  1. How contributions are calculated.
  2. How to calculate the tax savings.
  3. How a cash balance plan fits into a financial plan.

I hope that you found this helpful. If you need assistance analyzing these options, Ironclad Wealth Management is here to help. Contact us to learn more.

If Patrick Can't Save Your Business $5,000 in Taxes, You Get Your Money Back

MGO One Seven LLC ("MGO One Seven") is a registered investment adviser with the U.S. Securities and Exchange Commission (SEC). Registration with the SEC does not imply a certain level of skill or training. All titles listed for individuals associated with Ironclad Wealth Management represent the individual's role with Ironclad Wealth Management, and not their role with MGO One Seven. Services are provided under the name Ironclad Wealth Management, a DBA of MGO One Seven. Investment products are not FDIC insured, offer no bank guarantee, and may lose value. Please visit our website for important disclosures.

Please note, the information provided in this presentation is for informational purposes only and investors should determine for themselves whether a particular service or product is suitable for their investment needs. Please refer to the disclosure and offering documents for further information concerning specific products or services.

Nothing provided in this presentation constitutes tax advice. Individuals should seek the advice of their own tax advisor for specific information regarding tax consequences of investments. Investments in securities entail risk and are not suitable for all investors. This site is not a recommendation nor an offer to sell (or solicitation of an offer to buy) securities in the United States or in any other jurisdiction.

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