Tax deductions are hard to come by, especially those that directly reduce ordinary income dollar for dollar.
Contributions to Cash Balance Plans have the same tax effect as a deduction that reduces ordinary income dollar for dollar!
With combined Federal and State income tax rates as high as 45%, the tax savings from the contributions and the subsequent earnings on these contributions can be very significant.
For example, one single contribution of $130,000 earning 5% a year for 30 years, would be worth $561,852 at the end of 30 years. However, if the $130,000 had been taxed in the year contributed so that an “after tax” amount was invested, and if subsequent earnings on this contribution had also been taxed in each year (assuming the highest tax rates indicated above), then at the end of 30 years the total value would be only $162,937; 29% of the amount calculated above!
Cash Balance Plans are part of a group of plans called “qualified plans,” indicating their tax-favored status with the IRS. Tax advisors generally agree that these plans should be funded to their maximum before other tax-efficient strategies are explored.
In summary, contributing to a Cash Balance Plan can provide tremendous tax benefits. These benefits apply to both the amount contributed and the subsequent earnings on those contributions. Furthermore, the investment earnings on the contribution will compound, enabling it to grow to a very significant amount.