Max and Inigo

CONTEXT Inigo Montoya owns an IT services company, ITSC, in Florin. Due to his technical and organizational skills, the company has grown to more than 25 employees, and consistently generates $800,000 or more in annual free cash flow for Inigo. Vizzini, his right-hand man, has been with him more than 20 years. The remainder of the employees are in their 20’s and 30’s with much less tenure.

Inigo and his wife Maria Padilla’s five children are grown. Maria’s family has Texas roots which date to the zenith of the Spanish Empire. Since Florin is a U.S. protectorate, Inigo is subject to U.S. tax law.

STRUCTURE ITSC offers a 401(k) to its employees with a generous match which includes a safe harbor feature. In addition, ITSC has made annual profit-sharing contributions to the plan for several years. Inigo, believing that tribute paid to Prince Humperdinck is more than enough in taxes, detests his U.S. tax bill. So, several years ago, ITSC established a separate retirement plan called a cash balance plan. And each year, ITSC has contributed about $180,000 annually to this plan.

OUTCOMES Results for ITSC employees? His employees appreciate the generous match and safe harbor feature of the 401(k) plan. And are grateful for the annual profit-sharing contribution.

Results for Inigo? Inigo, due to the safe harbor feature, is able to defer his full $30,000+ each year from his own paycheck. Further, more than 60% of the $50,000 in annual profit-sharing contributions accrue to him. And finally, due to his generous provisions to employees within the 401(k)/profit-sharing plan, more than 90% of the benefit under the cash balance plan accrues to Inigo. In dollar terms, close to $250,000 in annual tax-deductible and tax-deferred contributions accrue to Inigo’s benefit.

But wait!!

CONTEXT After traveling the world for 20 years as an Army officer and heart surgeon, Max Meridius has retired and settled in the Texas hill country. He and his wife Sophia Lorenzo have built a villa there which reminds Max of his parents’ home in Spain. Further, Max has opened a heart and vascular care practice, Heart and Vascular Care of the Hills (HVCH).

The practice employees include his office manager Juba, a few administrative employees, and a number of med techs and nurses, a total of 18 employees. Juba is in his late 40’s though the remainder of the employees are under the age of 35. The practice thrives and Max consistently generates $2 million in annual personal income.

STRUCTURE HVCH offers a 401(k) to its employees with an 8% match, the first 4% of which is a safe harbor match. Further, HVCH makes annual profit-sharing plan contributions of about $100,000. Max, believing that most of his income should belong to him instead of the U.S. government, set up a separate retirement plan several years ago called a cash balance plan. For those years, HVCH has contributed more than $400,000 annually to the cash balance plan.

OUTCOMES Results for HVCH employees? A generous 8% match and an annual profit-sharing contribution. Max has found that this along with other employee benefits is the key to retention.

Results for Max? Due to the safe harbor feature, Max is able to defer his full $30,000+ each year from his paycheck. Further, more than 60% of the $100,000 in annual profit-sharing contributions accrue to Max. And finally, because of the generous provisions of the 401(k)/profit-sharing plan, more than 90% of the cash balance benefits accrue to Max. in dollar terms, close to $500,000 in annual tax-deductible and tax-deferred contributions accrue to Max’s benefit.

FICTION? While the characters are pure fiction, the stories are real. They are an amalgam of client experience, and the numbers are based on actual client situations.

TAKE AWAYS When there is a meaningful difference in ages between owners/principals and the average of the rest of the employees, a cash balance plan can add significant benefit to the owners.

When there is a meaningful difference in earned incomes between owners/principals and the average of the rest of the employees, a cash balance plan can add significant benefit to the owners.

When the business model features meaningful recurring revenue, it can support annual cash balance contributions.