The Short AnswerA cash balance plan is a defined benefit pension plan that expresses each participant's benefit as an account balance. Because contributions are set by an actuary to fund a target benefit, business owners in their 40s to 60s can often contribute $100,000 to $300,000+ a year pre-tax, on top of a 401(k).
How Does A Cash Balance Plan Work?
Each year the plan credits every participant with a pay credit (a percentage of salary or a flat amount) and an interest credit. An actuary calculates the contribution needed to fund those credits. Because older owners are closer to retirement, the allowable contribution rises with age, which is why the plan fits owners in their 40s, 50s and 60s best.
Who Is A Cash Balance Plan Right For?
- Consistent profits and an owner who wants to shelter six figures a year
- Owners in their 40s or older, often professionals such as physicians, attorneys and consultants
- A small staff, since employees must also receive benefits
- An owner willing to fund it for at least several years
Can You Have A Cash Balance Plan And A 401(k)?
Most cash balance plans sit alongside a 401(k) with profit sharing. The 401(k) covers the elective deferral and profit sharing; the cash balance plan adds the large age-weighted contribution on top. A third-party administrator designs both so they pass nondiscrimination testing together.
How Is Cash Balance Plan Money Taxed When It Comes Out?
The contributions are deducted today, but every dollar is taxed as ordinary income when it comes out. The same balance can carry very different federal tax depending on how it is withdrawn. See the spread on your own plan and read about retirement tax planning.
Common Questions
What is the difference between a cash balance plan and a 401(k)?
A 401(k) is a defined contribution plan with annual contribution caps that are the same regardless of age. A cash balance plan is a defined benefit plan where an actuary sets the contribution to fund a promised benefit, so older owners can contribute far more.
Can I stop contributing to a cash balance plan?
Contributions are required each year the plan is active, but plans can be amended or frozen, and they are generally expected to run for several years. Design it around profits you expect to be consistent.
Do I have to include employees?
Yes, eligible employees must receive benefits under nondiscrimination rules. For a small staff the cost is often modest relative to the owner's tax savings, but it has to be modeled.
