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Tax Advantages of Cash Balance Plans

| February 10, 2020
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Tax benefits of cash balance plans 

Tax considerations for employees 

When you contribute to a cash balance plan on behalf of your participating employees, those employer contributions are not currently included in the employees' taxable income. The employees will not pay income tax on the money contributed to the plan as long as that money remains in the plan. Similarly, because a cash balance plan is a tax-deferred plan, investment earnings on plan funds are not currently included in employees' taxable income either. These employee tax benefits exist for most qualified retirement plans, and are a key incentive for many employees to participate in such a plan. 

 

Of course, when a participating employee begins to receive distributions from the plan during retirement, he or she will generally be subject to federal (and possibly state) income tax on both plan contributions and related earnings.  

 

However, the rate at which a distribution is taxed depends on the employee's federal income tax bracket for the year, and many employees may be in a lower tax bracket when they begin receiving distributions. If an employee receives a distribution from the plan prior to age 59ó, he or she may be subject to a 10% premature distribution penalty tax (unless an exception applies), in addition to ordinary income tax. 

 

Tip: One important exception from the 10% penalty tax is for distributions made from qualified plans (like cash balance plans) as a result of an employee's separation from service during or after the year the employee reaches age 55 (age 50 for qualified public safety employees participating in certain state or federal governmental plans). 

 

Tax deduction for employer 

Your employer contributions to the plan are generally tax deductible on your business's federal income tax return for the year in which those contributions are made. To be eligible for this employer tax benefit, your cash balance plan generally must remain a "qualified" plan. 

 

The way in which an employer's tax deduction is calculated is generally more complex for a defined benefit plan (including a cash balance plan) than for a 401(k) or other defined contribution plan. In the case of a defined benefit plan, actuarial calculations are needed to determine benefits, liabilities, minimum funding requirements, and the maximum tax-deductible contribution under the plan, among other things. There are several possible methods that can be used to determine the employer's maximum tax-deductible contribution to the plan for any year. You should consult a tax advisor or retirement plan specialist for further guidance. 

The information in this newsletter is not intended as tax, legal, investment, or retirement advice or recommendations, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented, nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Broadridge Advisor Solutions. © 2019 Broadridge Investor Communication Solutions, Inc. CRN202110-255702

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