What Is a Cash Balance Plan?
Cash balance plans look and behave like defined contribution plans but are in fact defined benefit plans. For this reason, they are subject to the higher maximum benefit and deduction limits afforded to defined benefit plans. This gives business owners the opportunity to defer taxation on much higher levels of income than their current 401(k) plan allows, accumulating significantly higher retirement nest eggs.
Cash balance plans are a rapidly growing segment of retirement plans because of their attractive provisions for business owners:
- Simple and easy to understand
- Possible substantial tax deductions and personal retirement savings
- Plan assets protected from lawsuits/bankruptcy
How Do Cash Balance Plans Work?
A cash balance plan provides a theoretical account for each participant. This account gets credited with contributions usually defined as a percentage of pay or a flat dollar amount. The account is also credited with interest at a rate stated in the plan. Generally, this rate is unrelated to the actual return on assets under the plan. Because they are defined benefit plans, cash balance plans are subject to minimum funding requirements and require the services of an actuary to annually certify that the plan has met minimum funding obligations.
The Benefits of Cash Balance Plans
- Tax Advantaged* – Business owners and professionals can achieve large corporate tax deductions that are unattainable with a 401(k) plan alone and have the ability to accelerate retirement savings.
- Efficient – The ability to leverage your existing 401(k) plan contributions to employees is a key advantage. It’s possible you may have little to no additional contribution obligation to employees in order to receive the benefits of a cash balance plan.
- Protected – Assets are ERISA protected from creditors and are typically invested in conservative investments that tend not to be as vulnerable to market volatility.
Contributions are a deductible expense at the company level; therefore, cash balance plans are particularly attractive for business owners who are searching for a way to decrease their current tax liability while significantly increasing their retirement accumulation. As of 2020, businesses may now adopt these plans after the close of their tax year and still receive a deduction for that year, offering a powerful opportunity to reduce or eliminate tax liability after fiscal year end.
Considerations for Getting Started
The success of a cash balance plan is highly dependent on individual company demographics. To get started, reach out to an actuary to have an individual analysis prepared for your unique situation and help you decide if a cash balance plan is right for you.
*Please consult a tax advisor for specific tax implications relating to your situation.