I’ve talked in this space several times about Supreme Court Justice Louis D. Brandeis (1856-1941), a strong advocate of tax-wise giving, and consequent legal interpretation over the years of the U.S. Tax Code and “Legitimate Tax Avoidance” and driving the extra mile to avoid the D.C. toll bridge to his chambers: “For my tax evasion, I should be punished. For my tax avoidance, I should be commended. The tragedy of life is so few people know that the free bridge even exists!”
His commute across the Potomac, while a great metaphor, does not do justice to the sheer number of “free bridges” actually located within the Internal Revenue Code which allow you to legitimately avoid unnecessary taxes – especially if you are a highly profitable business owner. The key is to know where to find them, but even more importantly, how to recognize the sections in the code designed to automatically take you across costly toll bridges, where the price for crossing is the payment of higher taxes.
The Tax Management Journey
It is but one leg of what we consider a journey. A journey that begins with understanding the “Order of Money.” Not all money is taxed the same, and it can filter down to your personal tax bracket sequentially. Along the way, your tax bracket becomes dynamic. Like Justice Brandeis suggests, it requires effort to go the extra mile to find the free bridge – when you do, the benefits for you, your family, and even your community can be substantial.
One such Free Bridge (deduction) that many professionals have not been exposed to from their advisory team is Cash Balance Plans. These plans can allow you to deduct income on a dollar-by-dollar basis, reducing your tax burden while accelerating your retirement savings at the same time. When combined with an existing 401(k) profit-sharing plan, a cash balance plan can increase annual contribution limits by up to $245,000+ per year.
What is a Cash Balance Plan? Well, it’s a defined benefit plan (think traditional pension plan where employees receive fixed benefits upon retirement). A Cash Balance Plan looks and functions like a defined contribution plan on the participant’s end, much like a 401(k), where participants maintain an individual account balance.
But contributing to a cash balance plan not only reduces taxable income, but also adjusted gross income (AGI).
Many large, well-known U.S. organizations like IBM, AT&T and Boeing have cash balance plans. They are especially popular with small businesses though; over 85% of the plans belong to companies with fewer than 100 employees. At last count there were over 13,000 of these plans in place.
Ten years ago, implementing and running a cash balance plan was prohibitively complicated. The rules that governed them were unclear or nonexistent, and lack of information left many business owners and financial advisors ignorant of their potential. A number of lawsuits also caused business owners and their advisors to avoid a possibly controversial plan, despite the benefits offered.
Today, however, the increasing availability of information regarding cash balance plans and a series of legislative acts and IRS regulations have brought these unique hybrid plans more into the mainstream. In 2006, the Pension Protection Act officially recognized their legality and removed several roadblocks that had previously made administering them difficult. In 2010 and 2014, the IRS released further measures that clarified the 2006 legislation and introduced some exciting new investment options.
Is a Cash Balance Plan for you?
- Professional practices with high income
- Older employers who’ve not saved enough for retirement and would like to accelerate their savings.
- Sole proprietors with a high income or large cash flow.
- Family businesses.
- Any highly profitable companies.
- Companies looking to attract and retain highly talented employees, who are often attracted by defined benefit plans, pension opportunities.
What do other Free Bridges look like?
- Captive Insurance strategies
- Sequenced Roth IRA Conversions
- Leveraged Charitable Gifting
- Leveraged Life Insurance
- Qualified Opportunity Zones
- Use of different entities
- Expense Auditing/Reduction: savings of $1K – $4K per EE per year
- Expensing instead of Depreciating
For the cost of your time on a 15-30 minute phone call, why not give our team a chance to guide you to a few of these bridges. We’d love to hear from you!