For many high-income business owners, traditional retirement accounts are simply not enough to make a meaningful difference. For example, individual retirement accounts (IRAs)—with their annual contribution limit of $7,500—can leave high-income earners feeling unprepared, even when they max out their contributions.
However, many business owners are unaware of a powerful strategy that enables them to contribute nearly $300,000 or more to their retirement in a single year while significantly reducing their current tax bill.
It’s called a cash balance plan, and it’s one of the fastest-growing retirement planning tools available to high-income business owners. This guide will explore the basics of cash balance plans for businesses and discuss whether or not they’re right for you.
Looking for personalized advice about whether a cash balance plan makes sense for your business? Contact ARQ Wealth at (480) 214-9572 for a free consultation to learn more about cash balance plans for business owners.
What Is a Cash Balance Plan?
A cash balance plan is a type of defined benefit plan that provides a specific benefit at retirement for each eligible employee. Here’s how they work:
- The plan establishes a “hypothetical investment account” for each participant.
- Each year, the account receives two credits: a pay credit (typically a percentage of compensation) and an interest credit (usually a fixed rate of 4-5% or tied to an index, such as the 30-year Treasury rate).
- These credits are guaranteed regardless of how the actual investments perform, with the employer bearing the investment risk, not the employee.
These plans combine the high contribution limits of traditional pension plans with the account-based transparency of a 401(k). Your employees can see their hypothetical account balance grow each year predictably, while you—the business owner—can contribute amounts that dwarf what’s possible in a standard 401(k) plan.
Another key distinction: Cash balance plans are employer-funded retirement plans insured by the Pension Benefit Guaranty Corporation (PBGC). Unlike 401(k)s, where employees contribute their own money, cash balance plans are funded entirely by employer contributions.
Cash balance retirement plans are growing in popularity, with the number of plans growing 15X over the past 20 years.
Who Are Cash Balance Plans Good For?
A cash balance pension plan can be ideal for successful business owners, professional practices, and even solo practitioners. The most common types of companies that implement cash balance plans include:
- Medical and dental practices
- Law firms
- Engineering and architecture firms
- Successful consultants
- Real estate developers
- Established franchisees
These businesses typically have high income, manageable employee counts, and owners focused on maximizing personal retirement savings.
In particular, data from Ascensus shows that companies with nine or fewer employees make up over 60% of all cash balance plans. Small business owners are drawn to these plans because of their ability to help catch up on delayed retirement savings as well as attract and retain top talent.
If you’re earning $250,000+, run a consistently profitable business, and are interested in preparing for retirement while mitigating your tax burden, then you may be a perfect candidate for a cash benefit plan.
Integrating With Your Existing 401(k)
Most businesses considering cash balance plans already have 401(k) profit-sharing plans in place. The good news is that you don’t replace one with the other. You can run both qualified retirement plans simultaneously and enjoy the benefits of both plans.
Here’s how the integration works: Your 401(k) continues to operate normally with employee elective deferrals and employer matching or profit-sharing contributions. The cash balance plan layers on top, providing substantial additional contributions primarily benefiting owners and highly compensated employees.
The contribution stacking typically looks like this:
- 401(k) elective deferrals: $24,500-$32,500 (from employee)
- 401(k) profit sharing: ~$40,000-$47,000 (from business as employer)
- Cash balance: $100,000-$336,000 (from business as employer)
All three can coexist, maximizing your personal retirement contributions while providing appropriate benefits to staff.
Costs and Risks to Be Aware Of
Cash balance plans come with several notable costs and risks to be aware of, including:
- Setup and Ongoing Costs: Setting up a cash balance plan typically involves actuarial work and cross-testing, which can be more expensive than establishing other retirement plans.
- Employee Contributions: You’ll be responsible for contributing on behalf of your employees and will typically need to contribute 5-7.5% of compensation for non-owner staff. If you have 10 employees averaging $60,000 in salary, you’re looking at roughly $30,000-45,000 in annual staff contributions.
- Investment Risk: You also incur 100% of the investment risk for the plan assets. If the investments underperform, you must make up the difference with increased contributions, which can further add to your costs.
There’s also a time commitment.
Cash balance plans work best when they run for a minimum of 3-5 years, and you’ll be responsible for funding the plan each year. You can’t selectively skip years without formally amending the plan.
However, if necessary, you can terminate the plan and have all benefits immediately vest, allowing your employees to roll the balances into other accounts. You could also freeze the plan.
The Year-End Tax Advantage
One major benefit of cash balance plans is their ability to reduce your tax liability. Every dollar your business contributes to a cash balance plan is 100% tax-deductible. This isn’t a tax credit or a partial deduction; it’s a complete dollar-for-dollar reduction in your taxable income. For high-income business owners in the top tax bracket, the math becomes incredibly attractive.
Here’s an example of how cash balance plans can help reduce your federal income tax.
The top federal income tax rate is 37% for married couples earning over $751,600, and the Arizona state income tax rate is 2.5%, resulting in a combined rate of just under 40%.
Assume you contribute $300,000 to a cash balance plan and your combined federal and state effective tax rate is 40%. That $300,000 contribution generates $120,000 in immediate tax savings. Your net cost to fund $300,000 in retirement? Just $180,000.
Implementing a Cash Balance Plan with ARQ Wealth
Cash balance plans represent a powerful wealth-building and tax-reduction strategy for high-income business owners. While they’ve been growing in popularity over the past two decades, they remain underutilized.
If you’re a consistently profitable business owner who feels that standard retirement accounts are inadequate to fully prepare for retirement (and you’re interested in taking advantage of a significant tax deduction), then a cash balance plan may be the right fit for you.
Yes, there are costs, including set-up and administrative expenses, the commitment to provide benefits to employees, and the burden of investment risk. However, for many business owners, the benefits of cash balance plans outweigh the drawbacks.
At ARQ Wealth, we specialize in providing comprehensive financial planning services to high-income business owners and professionals. Our advisors understand the unique challenges you face, including balancing business growth, tax efficiency, and personal wealth accumulation.
Contact ARQ Wealth at (480) 214-9572 for a free consultation to learn more about cash balance plans for business owners.
Frequently Asked Questions About Cash Balance Plans for Businesses
Can I adjust my contributions if my business income fluctuates from year to year?
Yes, cash balance retirement plans offer flexibility within limits. While you must make minimum required contributions annually, the actual amounts can vary based on actuarial calculations and business performance.
What happens to my cash balance plan if I sell my business or retire early?
You can terminate the plan at any time, though it’s most cost-effective to run plans for at least 3-5 years. Upon termination, the cash balance plan assets immediately vest, and participants can roll their balances into IRAs or other qualified retirement accounts.
How long does it take to set up a cash balance plan, and can I really establish one quickly?
The setup process typically takes 3-4 weeks from initial consultation to plan establishment. This includes gathering employee data, running actuarial illustrations, reviewing non-discrimination testing results, and executing plan documents.
Can I establish a cash balance plan if I’m a sole proprietor with no employees?
Yes, solo practitioners and owner-only businesses can be ideal candidates for cash balance plans. Without employees, you avoid the complexities of non-discrimination testing and can structure the plan entirely for your benefit.
If I contribute to my employees’ cash balance accounts and they leave, do I lose that money?
If an employee is fully vested when they leave, they retain the entire benefit. If they are partially vested, they are entitled to the vested portion, while the unvested portion is forfeited back to the plan. If they are not vested at all, the entire balance is forfeited. Forfeited amounts become plan assets and may be used to reduce future employer contribution requirements or to pay allowable plan expenses.