Cash Balance Plans – What’s in It for Me?

February 23, 2021

Now that the political picture has come into sharper focus, many investors wonder what they should be thinking about in terms of tax planning.  While the Biden administration has yet to roll out specific tax-related priorities, most observers believe that some tax reform is forthcoming.  With that in mind, what should attorneys be thinking about in terms of proactive tax planning?

The good news is that being a lawyer means you can earn an excellent living.  The legal profession is a high-paying field.  The bad news is that lawyers make money in the least tax-efficient way possible – all of their compensation is taxed as ordinary income, which is subject to the highest tax rates.  So, there’s only so much you can do to lower your income tax burden. Over the years, that has led law firms to be proactive in finding innovative retirement plan solutions to help their partners and staff defer taxes while saving for retirement.

Today, I’ll focus on a particular trend that I’m seeing within law firm land – the Cash Balance pension plan.  More and more law firms are adopting these plans to go along with their more traditional defined contribution plans (i.e., 401(k) plans).  While Cash Balance plans might not be a perfect fit for every firm, it is at least worth knowing what it is and whether it could be a helpful savings tool for your team.

So why are so many law firms adopting Cash Balance plans?

Higher Annual Contribution Limits

One of the features that have been most attractive about Cash Balance plans is that they allow for much higher annual contribution amounts versus a 401(k).  For 2021, defined contribution plans like a 401(k) enable a participant to save a total of $58,000 in tax-deferred savings (combination of employee and employer contributions).  By contrast, a Cash Balance plan’s contribution limits can be much higher since contribution limits are based on a formula.  I won’t get into how those contribution limits are calculated since that’s the job of professional plan administrators.  However, I have seen instances where law firm partners can save upwards of $200,000 in a given year to their Cash Balance plan.  In a world where ordinary income tax rates are likely to increase, this can make a plan with higher contribution limits (and therefore more taxable income deferred) that much more attractive.

Attract and Retain Top Talent

Competition remains very tough for top legal minds.  Firms are now recognizing that retirement plan benefits are a significant way to attract and retain talent.  An interesting trend I’ve seen of late is smaller to medium-sized firms adopting new retirement plan solutions to better compete with larger firms. In the past, most of the Cash Balance plans that I saw were concentrated amongst the very largest law firms.  Over time, however, more middle-market firms have adopted these plans and have found it an effective recruiting tool.  In an industry where your people are far and away your most valuable asset, finding ways to attract better people becomes paramount.

If tax rates are, in fact, headed higher, it becomes increasingly important to look for opportunities to manage through that tax environment.  Perhaps taking a look at an additional retirement plan solution could make sense.  It may not work for every firm, but it might be worth a conversation with your partners and retirement plan consultant to see what is possible and appropriate for your firm.

Justin Peacock, MBA, CFP® is a Wealth Manager at BDF.  He works closely with clients to design wealth management plans that take into account the full spectrum of their career and personal concerns.  Justin graduated from Illinois State University with a B.S. in Mass Communication and earned his MBA from Northwestern University’s J.L. Kellogg School of Business.