Approximately 16 million people in the U.S. are self-employed, according to data from the Bureau of Labor Statistics. About one-fourth of those self-employed workers have employees, according to a 2019 report from the Pew Research Center.
For many of these self-employed individuals and small business owners, retirement planning can be far more complex than it is for traditional employees, said Irene Damaryan, a wealth planner at City National Bank.
“Younger business owners often reinvest most of their proceeds back into their business to grow it, especially before it is well-established, but that may mean they accumulate less money than they would like in their retirement plan over time," said Damaryan.
As a result, some business owners find that they need to find a way to boost their savings during the decade or so prior to their anticipated retirement date.
“One business owner we worked with, who was about 55 and planned to retire in 10 years, had an existing 401(k) and a profit-sharing plan," said Damaryan. “But after we analyzed his cash flow and retirement needs, it turned out he would need a way to turbocharge his savings in order to sufficiently maintain his desired lifestyle in retirement."
While there are several options to consider for a comprehensive retirement plan, one that's less well-known than a 401k or an IRA is a Cash Balance Plan. Damaryan recommends that self-employed individuals and small business owners who have steady revenue and want to build up their retirement savings explore this option with their tax advisors and wealth planners.
Whether you're a solo entrepreneur or you have a few employees, there are two primary methods to prepare yourself and any employees for retirement: defined contribution plans and defined benefit plans.
A Cash Balance Plan is a form of defined benefit plan with some defined contribution plan attributes.
"It is designed to accelerate retirement savings while allowing income tax deferral," said Damaryan.
Cash Balance Plan distributions are taxable as ordinary income and are not accessible without a penalty before someone is 59 1/2.
The Cash Balance Plan allows for a greater contribution limit than 401(k) / Profit Sharing Plans (up to $336,000, depending on age, instead of $63,500 for those over age 50 in 2020), and thus provides a greater tax deduction.
“Cash Balance Plans work best for small business owners who have a high income that they want to defer and who have the need, capability and desire to save more than the defined contribution limits," said Damaryan. “In addition, these individuals must have a five to 10-year span over which they can save prior to retirement because the plan must stay open for at least five years."
Cash Balance Plans also allow the company to receive tax deductions on contributions made to the plans as well as for owners to decrease their taxable income.
“It's a comfort to most people to know they'll receive a set monthly benefit during their retirement," said Damaryan.
However, there are some disadvantages to these plans that business owners also should consider. For example, you must keep the plan open for at least five years and make minimum annual contributions even if business is slow.
“If your business has employees, you have to make contributions for them as well. And those contributions, as well as an interest credit rate, must be guaranteed annually. If the market declines one year, the burden is on the employer to make up for the losses in the accounts," said Damaryan. “That's why this is best for businesses with only a few employees because that can be a big financial commitment."
Another disadvantage is that they can be complex to establish and require administrative expenses because of the ongoing actuarial efforts.
“If you're the owner of a closely-held business and are between five and 15 years from retirement, establishing a Cash Balance Plan may be something to discuss with your tax advisor and wealth planner," said Damaryan. “A Cash Balance Plan can be a great way for you to catch up on your retirement funding goals faster than you could with a 401(k) and profit-sharing plan alone."
Depending on whether you are self-employed and whether you have employees, there are other options to explore, including a Traditional or Roth IRA, a Solo 401(k), a SEP IRA and a SIMPLE IRA.
“There is no one-size-fits-all retirement planning solution, especially for self-employed people," said Damaryan. “You and your advisors should evaluate what plan would fit your current situation and if a Cash Balance Plan is right for you."
If you'd like to learn more about a Cash Balance Plan or any other retirement vehicle that could boost your retirement savings, visit City National Bank.
This article is for general information and education only. It is provided as a courtesy to the clients and friends of City National Bank (City National). City National does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors or persons quoted as of the date of the article with no obligation to update or notify of inaccuracy or change. This article may not be reproduced, distributed or further published by any person without the written consent of City National. Please cite source when quoting.
City National, as a matter of policy, does not give tax, accounting, regulatory or legal advice. Rules in the areas of law, tax, and accounting are subject to change and open to varying interpretations. You should consult with your other advisers on the tax, accounting and legal implications of any proposed strategies based on your particular circumstances.
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