Cash Balance Plans for Business Owners

Summary

• Cash Balance Plans are defined benefit plans that credit a pay credit and an interest credit to a hypothetical account.

• Best fit: profitable businesses with stable cash flow wanting larger, deductible retirement contributions than a 401(k) alone.

• Works alongside a 401(k)/profit sharing plan using cross-tested designs to steer benefits and manage costs.

• Requires annual actuarial funding, a written investment policy, and a multi-year commitment.

What Is a Cash Balance Plan?

A Cash Balance Plan is a type of defined benefit plan. Each eligible participant receives:

• Pay credit: a percentage of pay or flat dollar amount set in plan terms.

• Interest credit: a guaranteed rate set by the plan document, often tied to an index or a fixed rate.

Balances are “hypothetical” for recordkeeping; actual assets are pooled and invested at the plan level. At termination or retirement, participants can take a lump sum (subject to limits) or an annuity.

Who It Fits

• Owners and partners with high, steady income who want to accelerate tax-deferred savings.

• Professional practices and closely held companies that can commit to multi-year funding.

• Firms with age/comp structures that support targeted benefits for principals while offering fair benefits to staff.

Why Pair It With a 401(k)?

Most installations run Cash Balance + Safe Harbor 401(k) + Profit Sharing. The 401(k) allows employee deferrals and flexible year-end profit sharing. The Cash Balance plan delivers the larger employer contribution, driven by actuarial limits and the owner’s age and compensation. Designs are coordinated so total employer cost and staff benefits meet testing requirements.

Contributions and Funding

• Employer contributions are actuarially determined each year to fund the promised credits, subject to minimum required and maximum deductible ranges.

• Funding flexibility exists within a corridor, but underfunding triggers required contributions.

• Older owners generally can target higher deductible contributions than younger owners, within actuarial and IRS limits.

Investment & Risk Management

• Assets are pooled and invested to match the plan’s interest crediting rate with lower volatility than typical 401(k)s.

• A written Investment Policy Statement aims to reduce contribution volatility and funded status risk.

• Annual actuarial valuation monitors funded status; surplus or shortfall influences future funding needs.

Taxes: Advantages and Trade-offs

Advantages

• Employer contributions are generally tax-deductible to the business.

• Participants defer tax on benefits until distribution.

• Can materially increase deductible retirement savings for owners compared with a 401(k) alone.

Trade-offs

• Ongoing required funding regardless of business cycles.

• Administrative complexity: actuarial services, annual filings, and potential Pension Benefit Guaranty Corporation considerations for certain employers.

• Investment risk and longevity risk remain at the plan level, managed by funding and asset allocation.

Setup Checklist

1. Feasibility study: census review, cost modeling, and benefit targets by owner.

2. Plan design: pay credit schedule, interest crediting method, eligibility, vesting, and coordination with the 401(k).

3. Service providers: third-party administrator, enrolled actuary, recordkeeper, custodian, and ERISA counsel.

4. Adoption timeline: typically effective for the current plan year if established and funded by statutory deadlines.

5. Funding policy and IPS: define target asset mix and rebalancing aligned to the crediting rate.

6. Employee communications: clear summaries of benefits and eligibility.

Ongoing Management

• Annual valuation and contribution range determination.

• Monitoring funded status, cash requirements, and testing with the 401(k).

• Periodic plan design reviews as ownership, headcount, or compensation changes.

• Exit planning: freeze, merge, or terminate options with clear timelines and participant communications.

Common Pitfalls to Avoid

• Launching without a 3–5 year funding commitment and cash flow plan.

• Investing the pool too aggressively relative to the crediting rate.

• Ignoring workforce changes that alter testing and cost.

• Missing coordination with payroll and 401(k) providers.

Practical Scenarios

Objective	Possible Design Move	Considerations
Maximize owner deductions	Higher owner pay credits with coordinated 401(k) profit sharing	Ensure testing passes and staff benefits remain competitive
Stabilize required contributions	Choose a market-based interest crediting rate and matching asset mix	Reduces funded-status volatility but requires disciplined IPS
Control staff cost growth	Eligibility and vesting designed appropriately	Balance retention goals and fairness
Plan exit in 3–5 years	Freeze accruals, improve funded status, then terminate	Requires careful timing and communications

FAQs

Is a Cash Balance Plan a 401(k)?

No. It is a defined benefit plan with pooled assets and actuarially determined funding. It often runs alongside a 401(k).

Can participants invest their own accounts?

No. Investments are managed at the plan level to support the interest crediting rate and funding objectives.

What happens if investments underperform?

The sponsor may need higher contributions within the required range. An appropriate asset mix and funding policy help manage this risk.

What if business conditions change?

Plans can be amended or frozen prospectively. Termination is possible, subject to rules and timelines.