We hear this question repeatedly from business owners, perhaps because they are concerned that higher tax rates may be right around the corner. One answer really grabs their attention: a “cash balance” retirement plan. Establishing a cash balance plan along with an existing 401(k) profit-sharing plan can multiply the pre-tax contributions owners and highly compensated employees (HCEs) can set aside for retirement (as well as benefiting the rank and file). Like other qualified retirement plans, company contributions are subject to IRS limitations, are tax-deductible to the business and offer potential investment growth that is tax-deferred until it is withdrawn by the participant.

CASH BALANCE AND PAIRED PLANS
A cash balance plan is an ERISA-covered defined benefit (DB) plan subject to the PBGC insurance program. The benefits provided are described in terms of a hypothetical “individual account” and benefits are described in reference to how the “account” performs. When a participant retires, benefits, defined by the account balance, are payable in either an annuity or lump sum payment generally equal to the value of the account.

As the sponsor of a DB plan, the employer retains all investment risk and must fund the plan to provide participants with a target level of income at retirement, determined by an actuary.

To implement a “paired” plan, the company: 1) retains a 401(k) plan with profit-sharing contributions; and 2) establishes a cash balance plan. This approach increases pre-tax contributions for owners and HCEs.

As with other DB plans, companies must have consistent profits to make annual contributions. Since plan benefits are subject to a vesting schedule and are generally higher than contributions under a DC plan, the plan has “golden handcuff” advantages in retaining employees. A full range of investments are available including equities, annuities, life insurance and fixed income.

A PAIRED PLAN ILLUSTRATION
To illustrate: A professional practice has two partners, ages 60 and 48. The senior partner earns $500,000, the junior partner $350,000. The practice’s four employees, 25 to 45, earn a total $180,000.

The company offers a 401(k) plan with 100 percent participation. Both partners contribute the maximum 401(k) deferral, and the practice makes a 3 percent “safe harbor” contribution for eligible participants. Once the cash balance plan is added:

• The practice makes cash balance contributions of $160,000 for the senior partner, $110,000 for the junior partner and $6,400 for the other employees (contributions may be adjusted according to IRS rules).

• An additional 5 percent profit-sharing contribution (above the 3 percent safe harbor) is made to all eligible employees to meet IRS requirements.

The senior partner then sets aside a pretax $197,500 annually in the plan and the junior partner, $155,000. The practice’s tax-deductible contributions total $333,800. Different amounts will result, depending on normal retirement age, interest rates and benefit levels for non-highly compensated employees.

This is a powerful tax-saving idea small businesses can afford. This concept is best implemented by professionals focused on business retirement plans. Fortunately, that is exactly what many business owners can do to reach their retirement goals, starting right now.

This illustration is hypothetical and shown for illustrative purposes only. The illustration is not intended to predict the returns of any particular investment, which will fluctuate with market conditions. Actual results may differ from those depicted in the illustration. Tax laws are complex and subject to change. Morgan Stanley Smith Barney LLC (“Morgan Stanley”), its affiliates and Morgan Stanley Financial Advisors and Private Wealth Advisors do not provide tax or legal advice and are not “fiduciaries” (under ERISA, the Internal Revenue Code or otherwise) with respect to the services or activities described herein except as otherwise agreed to in writing by Morgan Stanley. This material was not intended or written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Individuals are encouraged to consult their tax and legal advisors (a) before establishing a retirement plan or account, and (b) regarding any potential tax, ERISA and related consequences of any investments made under such plan or account. Oscar Cantu is a Financial Advisor with the Wealth Management division of Morgan Stanley in New York City. The views expressed herein are those of the author and may not necessarily reflect the views of Morgan Stanley Smith Barney LLC. Morgan Stanley Financial Advisor(s) engage Worth to feature this profile. Oscar Cantu may only transact business in states where he is registered or excluded or exempted from registration morganstanleyfa.com/therockgroup. Transacting business, follow-up and individualized responses involving either effecting or attempting to effect transactions in securities, or the rendering of personalized investment advice for compensation, will not be made to persons in states where Oscar Cantu is not registered or excluded or exempt from registration. The strategies and/or investments referenced may not be suitable for all investors.