Tax season is over and many auto dealers may be left wondering how they could have paid fewer taxes in 2011. While 401(k) and profit-sharing plans offer some relief from the tax burden, it may not be enough for auto dealers who earn more than $200,000 a year. Enter cash balance plans. First used in 1984 by Bank of America, cash balance plans (CBPs) gained in popularity following the passage of the Pension Protection Act of 2006. Currently, there are over 6,500 CBPs in the United States.
The cash balance plan offers accelerated retirement savings and a respite from soaring taxes. Eligible participants can contribute up to $16,500 (or $22,000 if age 50 or older) to 401(k) plans. Those with profit-sharing plans can contribute an additional $32,500, or up to $54,500 total (depending on age). However, for many auto dealers and other highly-compensated individuals, this may not be enough. Depending on age, when combined with 401(k) and profit-sharing plans, CBP participants can contribute over $250,000 per year to retirement accounts.
CBP contributions are made on a pre-tax basis, allowing for the greatest possible growth of contribution dollars and helping dealers defer a large amount in taxes.
CBPs require a set contribution level each year. Dealerships can allocate different contribution amounts for various participants, and these values can be amended. However, the frequency of amendments is limited without a valid business reason. For example, a plan can be amended if a dealership’s profit is not expected to support the cash balance plan contributions. CBPs can also be frozen or terminated.
Cash balance plans can specify the contribution level of each participant. This amount can be either a percentage of salary or a flat dollar amount. CBPs credit interest on contributions at a guaranteed rate, which is detailed in the plan document. This rate does not depend on the plan’s investment performance and changes each year as a floating benchmark. In many plans, the rate of return is equal to the yield on the 30-year Treasury bond – around three percent in previous years.
Unlike other investments, the objective of CBPs is not to maximize returns, but instead to achieve a targeted return amount. The plan’s vesting schedule determines vested portions of account balances. If a participant leaves a dealership or if an employee is terminated, their portion can be paid out or rolled over into another retirement account. CBPs must be established by December 31 each year to take advantage of that year’s tax deferrals.
Dealerships make ideal candidates for cash balance plans, especially dealers who want to contribute over $49,000 (or $54,500 if age 50 and older). Many dealers desire large tax deferrals that are not available through 401(k) and profit-sharing plans. Some dealers may also require larger contributions to retirement accounts in order to offset recent portfolio losses or to make up for years when money was invested in building their dealership rather than in their retirement.
CBPs have many distinct advantages. Dealers who want to contribute more than $54,500 (depending on age) or who desire large tax deferrals (up to $250,000 in some cases) are ideal candidates. Cash balance plans allow dealers to defer taxable income while greatly increasing savings to qualified retirement accounts.