You may be wondering: Are cash balance plan contributions tax deductible? This question is especially important for high-income earners because they face steep taxes and other retirement contribution restrictions. Luckily, this type of retirement savings plan can help them save even more money for retirement.
However, to receive full tax benefits, you must make contributions by the due date on your federal income tax return. In other words, you must make your required minimum funding contribution before the end of the tax year. In other words, you cannot contribute to the plan later than the last day of the tax year.
Table of contents
Significant Tax Strategy
The money that is contributed to cash balance plans is credited into hypothetical accounts. The interest earned on these accounts is based on the index selected by the plan sponsor. A 30-year treasury yield, for example, is an example of a benchmark index.
The amount that a participant can contribute is subject to complex non-discrimination testing. It must be at least 100 percent for highly compensated individuals.
Employer contributions to cash balance plans are tax deductible to the employer sponsoring the plan. An employee in the third- and fourth-years of employment can save as much as $35,000 in federal taxes by contributing $100,000. In addition, income-tax states also benefit from greater tax savings.
The money saved by making these contributions is then invested in a tax-deferred Trust account. So, is your contribution to a cash balance plan tax deductible? If you think so.
How do I take the tax deduction?
If you are wondering if your contributions are tax deductible, make sure you read the fine print. Your employer should keep track of the IRS’s rules about cash balance plans. If your employer has a cash balance plan, you can deduct your contributions.
But, you should check your plan documents for any limitations and requirements. Also, be aware of the IRS’s IRA laws. This means that you should never use your retirement funds for investment without first checking if they are tax-deferred.
As with other retirement plans, cash balance plan contributions are tax deductible. In fact, the maximum contribution an employer can make is $500 per year. In addition, the total contribution amount that can be withdrawn in one year is also tax refundable.
In the meantime, your employer’s cash balance plan will have a higher contribution limit. You can designate different amounts for your employees. Your employer may freeze or terminate the Cash Balance Plan without further notice.
Here are the steps to maximize your tax benefit
Step #1: Determine marginal tax rate
Work with your CPA to determine your marginal tax bracket. This includes the federal and state tax brackets—the higher the rates, the more benefit from the cash balance contributions.
Step #2: Review funding range
You can establish a flat dollar contribution or a variable amount. Most will choose a flexible variable amount and go up and down depending on compensation.
Step #3: Examine employee contributions
Remember that you will have to contribute to the plan for any eligible and qualifying employees. The goal would be to have at least 85% to 90% of the contribution made for the owners.
Step #4: Determine cash requirements
Even though you may want to make a significant contribution, your cash needs might not make sense. You may be looking to expand your operations or may just be looking to keep additional working capital on hand.
Step #5: Coordinate funding with CPA and administrator
Once the funding has been determined, ensure that you coordinate with your CPA and the plan administrator. Contributions must be made by the date you file your taxes.
The IRS considers cash balance plans qualified plans. In Section 401(a) of the Tax Code, the plan’s contribution limits depend on the participant’s age, compensation, and other factors. In addition to contributing to an individual retirement account, cash balance plans also qualify for a company’s matching program.
In many cases, cash balance plans are not tax taxable for employees. Therefore, your tax-deductible contributions will vary from year to year.