The Benefits of Cash Balance Plans

Kari Wolfson, CFP^®, AWMA^®

Partner, Wealth Advisor

Cash balance plans can be a game-changer for small business owners who earn a high income, are within 10 years of retirement and are behind on their savings. Here’s why.

These plans are a type of pension, but instead of being based on your salary, your payout in retirement is based on what is contributed. This makes cash balance plans more like a 401(k) or IRAA type of account in which funds can be saved and invested without being subject to tax until the account holder reaches retirement age. than a traditional pension plan. They offer a great deal of flexibility, potential tax benefits and a higher contribution limit.

If you earn $250,000 or more a year through your business, cash balance plans allow you to take substantial deductions on your contributions, which could move you into a lower tax bracket. The plans can also help you avoid excess Medicare tax (levied on married taxpayers who file jointly with over $250,000 in income).

Since these plans allow for significantly higher annual contributions than solo 401(k)s or simplified employee pension plans—up to $398,000 in tax year 2023—they can be a good fit for high earners looking to make that final sprint toward a comfortable retirement.

Key Considerations for Cash Balance Plans

Small business owners weighing a cash balance plan should be aware of the higher administrative fees involved and the need for a consistent return on the assets within the plan.

Like a 401(k) or IRA, you can choose how the plan is invested. But a critical component of these plans is a guaranteed rate of interest on contributions, known as the interest crediting rate (ICR). The ICR is used to calculate each year’s contribution requirement. Losses in the portfolio will translate into higher contribution requirements to get to the ICR threshold. For this reason, lower-risk investments are typically the best choice.

The contribution requirement also means that these plans work best for businesses with predictable revenue—funding shortfalls could result in an excise tax penalty.

The ICR is also where those higher administrative fees come in. You will need to hire a certified public accountant or actuary to administer your plan. They will make sure the plan is compliant with IRS regulations and handle the contribution calculations each year.

If you will be offering the plan to employees, note that you as the plan sponsor are responsible for all contributions on their behalf—unlike a 401(k), employees are not permitted to contribute to their cash balance plan.

Is a Cash Balance Plan Right for You?

If you think a cash balance plan might be a good fit for you, call us today and we will connect you with a small business wealth advisor specialist.

We can provide valuable perspective to make sure your cash balance plan works in harmony with your overall strategy, especially since they are typically paired with a 401(k) or IRA funding plan. We will collaborate with the plan administrator on the documents and on streamlining the annual contribution requirements. And when you’re ready to take payouts from the cash balance plan, we’ll help find the best solution for you, whether that’s annuitizing, taking a lump sum and rolling it into an IRA, or something else.