Cash Balance Plans – A Small Business Owner’s Guide to Optimal Tax Strategy and Retirement Savings

Business owners often can find themselves in a position where a 401(k) profit sharing plan isn’t meeting all of their retirement goals.  Perhaps their plan isn’t allowing them to make the deductions they want due to annual limits.  Or they’ve invested so much into their business that their retirement has fallen behind, and they can’t catch up under current contribution formulae.

A cash balance plan allows a plan sponsor to turbo-charge their deductions, and their benefits.  Instead of being limited to $70,000 in contributions per year, a cash balance plan in combination with a 401(k) plan can allow up to $400,000 in tax-advantaged contributions per year, dependent upon age.  Plan sponsors can now limit their tax exposure during their prime earning years, while also saving enough to retire comfortably.

What Is a Cash Balance Plan?

A cash balance plan is a specific type of defined benefit plan, often referred to as a “pension plan.”  Unlike traditional defined benefit plans, which always expressed their benefits as an annuity at retirement, a cash balance plan shows all participants’ benefits as a lump sum balance, much like a profit sharing plan or 401(k) plan.  Contributions to the plan are defined ahead of time, and usually are based on the job class of the participant.  For example, a plan may define an owner’s allocation as a flat dollar credit of $200,000, while a rank and file participant may receive 4% of compensation.  This is just an example, and these plans are amazingly customizable in order to meet the needs and goals of the plan sponsor.

Once the contributions are made to the plan, the benefits will grow at a pre-established rate, called the interest crediting rate.  If assets outperform this rate, future contributions may decrease.  Conversely, if assets underperform, larger contributions may be made in the future.

However, contributions can also vary from one year to the next depending upon the needs of the business.  It’s possible to deposit more than the benefits in one year, and less the following, depending upon the business cycle, goals, and tax strategies.  One of the benefits of a cash balance plan is that you will be presented with a contribution range every year, with a minimum required contribution, a maximum deductible contribution, and a recommended contribution.  While the benefits are pre-determined, the contributions can vary dependent upon your needs for the year.