401(k), Cash Balance Plans and S Corps

How Self-Employed Can Save For Retirement today!

Formations Team

14 May
What is the "Cash hybrid plan", and how you can save on Self-Employment tax, while taking care of your retirement
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When we refer to S-Corp, we usually address the most common benefit, the limited exposure to self-employment taxes, that can save the taxpayer thousands of tax $$ every year. But what can you do when your revenue for the last few years exceed 500K or at times 850-900K? Then you require to take a higher wage 200-250K, pay Self-employment tax in full, and more, and even the max 401K contributions will not move the needle in tax savings.   

One option can be a DB Plan – Defined Benefit Plan or what we refer to in our professional language a “401K on steroids”. This is a plan that allows you to defer each year’s higher amount of revenue, contributing to your retirement plan.  

Before we explain more about DB plans let’s remind you the fundamentals of 401K:  From about $100,000 in net income up to $284,000 the 401(k) plan helps to reduce your personal tax liability in two major ways: 

  1. You as the employee of the S-Corp can contribute to your retirement through the payroll, much like a W2 employee at a Fortune 500 corporation would be able to. 
  2. Your S-Corp, as the employer, would also be able to MATCH those contributions – profit sharing, up to the yearly limit ($57,000-63,500 depending on age) 

As the employee of the S-Corp you can contribute up to $19,500 of your salary to the 401(k) (with an additional $6000 if over 50, called “catch up contributions”), and with a Profit-Sharing plan the company can contribute up to $37,500 of company profits or 25% of compensation (see “salary”).  

If you find yourself with a lot of profit you can severely reduce your current tax liabilities and defer it until you’re ready to retire. 

Another option is the Defined Contribution plan; unlike the Defined Benefit Plan, you set the amount you want to contribute each year based on your income. This allows for some cashflow flexibility but also makes it less certain you’ll reach the total amount you need to retire with. 

Now let’s talk about the Cash Balance Hybrid Plan which combines the Defined Benefit Plan with the Defined Contribution Plan to maximize both tax savings AND the accrual of retirement savings. This significantly increases the maximum amount that you can contribute between yourself as the individual and the business as an entity during a calendar year.  

The contribution limit of a 401(k) by itself is $63,500, max, if you’re above 50 with a profit-sharing component in the plan (which means you, the employer, matches the contributions of you, the employee, up to 6%). The contribution limit of a Cash Balance (defined contribution) plan is anywhere from $77,000 to $314,000 a year! When you combine these two plans you can have a contribution ranging from $134,000 all the way to $377,500 a year, which can save you upwards of $155,000 in federal income taxes.

Let’s take an example to look at: John is a real estate brokerage 45 making $285,000 per year after expenses (including payroll of $125,000 for himself). With a 401k by itself, he would only be able to contribute $19,500 from his wages as the employee and as the employer an additional maximum of $19,500 for a total of $39,000 for the year.  

Under the Cash Hybrid plan, adding in a Defined Benefit plan to go with his 401k, he could add an additional $90,000 contribution as an employer to the retirement savings of the 401k, bringing the total contributed to retirement to $129,000 per year! And that limit only goes up; as John will get older and if his business continues to get more profitable he can pay himself a higher salary and increase the amount contributed to the plan at the same rate.  

We’ll be discussing what to do with your retirement account when to alleviate the tax liabilities when you are about to retire on a later blog post. Contact your Formations representative today to see if any of these plans can save you on your taxes

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