What is a Cash Balance Plan?

A cash balance plan is a type of defined benefit plan—similar to a pension—that defines your benefit as an account balance rather than a monthly payout. It combines features of both traditional pensions and 401(k)s, offering the higher contribution limits and guaranteed benefits of a pension, but with the clarity and flexibility of an account-based plan.

How It Works

Each year, your account receives:

• A pay credit (usually a percentage of your compensation), and

• An interest credit (a fixed rate or one tied to an index, like the one-year Treasury rate).

The employer bears the investment risk and guarantees the benefit. Upon retirement, participants can typically take their balance as a lump sum (often rolled into an IRA) or a lifetime annuity.

How It Differs from Other Plans

Cash balance plans are “hybrid” pension plans—offering predictable, tax-deductible contributions and guaranteed growth.

Contributions and Business Structure

Contributions depend on your age, income, and entity type:

• S-Corp/C-Corp: Based on W2 wages (simpler to manage).

• Sole Proprietor: Based on business profit (more complex).

Your CPA can help determine which structure allows for the most flexibility and contribution control.

Plan Duration

The IRS expects cash balance plans to be long-term, typically lasting at least 5–10 years. Early termination should be due to legitimate business reasons such as lower profits or ownership changes.

Employee Inclusion

If you have employees, the IRS requires non-discrimination testing. You’ll need to make contributions for eligible employees, though plan design can often ensure 90%+ of contributions benefit the owner.

Interest Crediting Rate (ICR)

Most small plans use a fixed 5% rate, which simplifies administration and allows for higher funding. Larger plans may use variable or market-based rates to manage funding more precisely.

Required Info for an Illustration

To prepare a custom illustration (typically within 3–5 days), we’ll need:

• Owner age or birth date

• Desired total contribution

• Business profit or W2 income

• Number of employees (and census data, if available)

Other Common Questions

• Roth option? No, cash balance plans do not allow Roth contributions.

• Rental income eligibility? No—rental income is passive. You must have earned income or W2 wages.

• Is it like Social Security? Conceptually, yes—it provides a promised benefit at retirement—but funds are usually rolled into an IRA upon plan termination.

I’m not sure if a Cash Balance Plan is right for me. How can I decide?

Cash balance plans make the most sense for high earners who want to reduce taxes and accelerate retirement savings. Ask yourself three questions:

1. What’s your tax bracket? The higher your tax rate, the greater your savings. These plans are most beneficial for those in the 35–40%+ brackets.

2. How much will you contribute—and who benefits most? If you can contribute $100,000+ annually and allocate 85–90% to yourself, the plan is usually worth it.

3. Are you comfortable committing for a few years? Plans are meant to be long-term but can be ended after 5–10 years for valid business reasons. You’ll need to fund them each year.

I’ve heard I’m too young or have too many older employees. Does that matter?

Possibly. These plans work best when older, higher-income owners are paired with younger, lower-paid employees. If you’re a younger owner with older or well-paid staff, required employee contributions can become expensive, reducing the plan’s efficiency.

In that case, a 401(k) or SEP IRA may be a better fit. Plans also have annual actuarial and admin costs (typically around $2,000), which should be factored into the decision.

How can a group of physicians with different goals make a plan work?

Medical groups often have mixed goals—some physicians want aggressive contributions, others prefer flexibility. A combined 401(k)/cash balance plan can accommodate both.

Here’s how:

• Physicians choose whether to contribute to the 401(k) only or both the 401(k) + cash balance plan.

• The plan is designed so contributions and deductions align with each physician’s goals and tax structure.

• Coverage under the PBGC can allow partners to maximize both plans while keeping employee costs minimal.

Start by identifying which physicians want to participate and at what level. The plan can then be structured so partners receive the tax benefits, and employee contributions remain compliant and affordable.

I didn’t process payroll for myself last year. Can I still do it and make a contribution?

Probably not. Cash balance plans require W2 income, since they are only for employees—not investors or owners without payroll.

You can technically run late payroll, but doing so often triggers significant IRS penalties and interest—sometimes exceeding 50% of payroll taxes—and those penalties are not deductible.

In most cases, it’s better to wait and establish the plan for the current or next year instead. Always confirm your specific situation with your CPA or payroll provider before proceeding.

Why does the IRS require a 401(k) plan restatement every six years?

Every six years, the IRS requires 401(k) plans to be restated to stay compliant with updated tax laws and regulations.

This restatement:

• Incorporates recent legal and regulatory changes,

• Keeps the plan qualified for tax benefits, and

• Prevents penalties or disqualification.

Restating also allows employers to update plan features or adjust contributions. Following this cycle ensures your plan stays legally compliant and tax-advantaged.

What Are the Disadvantages?

1. Conservative Investments Cash balance plans require stable, low-risk investments—typically targeting around a 4% annual return. While this keeps funding predictable, it limits growth potential. Many owners offset this by investing more aggressively in their 401(k) or IRA accounts.

2. Higher Costs These plans have actuarial and administrative fees (around $2,000–$2,500 per year) and setup costs of about $990. However, for business owners contributing $100,000+ annually, the tax savings often outweigh the fees. If you plan to contribute less than $35,000 per year, a 401(k) or SEP IRA may be more cost-effective.

3. Long-Term Commitment The IRS expects these plans to be permanent, typically operating for at least several years. You can amend or freeze the plan during tough times, but it’s best suited for businesses with steady income and a long-term outlook.

4. Mandatory Contributions Unlike a 401(k), contributions to a cash balance plan are not optional—you must fund the plan each year within a set range. Missing contributions can trigger penalties, but you have until your tax filing deadline (with extensions) to make them.

5. Complex Administration Cash balance plans require annual actuarial calculations and careful coordination between your administrator, CPA, and advisor. They’re more complex than 401(k)s, but with proper guidance, they can deliver significant long-term tax and retirement benefits.