Is a Cash Balance Plan Your Key to a Wealthy Retirement?

A man's fingers slot a key into a keyhole in the side of a piggy bank.

For many successful business owners, there comes a point when traditional retirement plans just don't move the needle anymore.

If you're hoping to further reduce your taxable income and accelerate your retirement savings — and you're already maximizing your 401(k) and profit-sharing contributions — a cash balance plan might be the solution you've been looking for.

What is a cash balance plan?

A cash balance plan is a defined benefit plan, which means it's similar to an employer-sponsored pension but has the flexibility and feel of a 401(k). It can be an especially useful tool for small business owners.

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About Adviser Intel

The author of this article is a participant in Kiplinger's Adviser Intel program, a curated network of trusted financial professionals who share expert insights on wealth building and preservation. Contributors, including fiduciary financial planners, wealth managers, CEOs and attorneys, provide actionable advice about retirement planning, estate planning, tax strategies and more. Experts are invited to contribute and do not pay to be included, so you can trust their advice is honest and valuable.

Here's how it works.

Each plan participant's benefit amount grows annually based on two components:

An employer contribution, or "pay credit," which may be a salary percentage or a flat dollar amount
An interest credit, which is a guaranteed rate, often 4% to 5%, and defined by plan documents

The assets in a cash balance plan are invested in a "pooled" account managed by the plan's investment adviser. But the value of each participant's benefit is guaranteed, regardless of market performance.

What are the advantages for business owners?

Think of a cash balance plan as a way to stack another retirement plan — one that allows significantly larger contributions and tax deductions — on top of your 401(k). This type of plan can provide:

Major tax deductions. Cash balance plans are designed for high-income professionals and business owners who want to reduce their taxable income.

Depending on age and income, it's common to contribute $100,000 to $300,000 a year, all of which is tax-deductible to the business. For someone in a 40% combined tax bracket, this could mean $40,000 to $120,000 in annual tax savings.

Accelerated retirement savings. Because contribution limits rise with age, these plans are ideal for owners in their 40s, 50s or 60s who want to "catch up" quickly on their retirement savings.

By combining a cash balance plan with a 401(k)/profit-sharing plan, total retirement contributions can exceed $300,000 a year in some cases.

Attracting and retaining key employees. A cash balance plan can also serve as a powerful employee retention tool. You can structure the plan so that owners receive the majority of benefits while still offering meaningful retirement contributions to employees.

It's a win-win: Employees appreciate the added benefit, and owners can enjoy significant savings.

Predictable and guaranteed growth. Unlike a 401(k), which depends on positive market returns, cash balance plans offer a guaranteed annual interest credit.

This makes future benefit projections more stable and creates a dependable foundation for your long-term financial plan.

Here's a hypothetical example of how a cash balance plan might work for Linda, a 55-year-old business owner who earns $400,000 annually and is maxing out her 401(k) each year.

By adding a cash balance plan, Linda could contribute an additional $150,000 to $200,000 annually. This helps reduce her taxable income and saves $60,000 to $80,000 in taxes each year, while building her retirement assets much faster.

Are there any downsides to consider?

A cash balance plan may not be a good fit for every business or business owner. Both the planning and follow-through can be complicated, and you should be prepared for a long-term commitment.

Some considerations:

As with any investment strategy, you'll have to remain in line with IRS rules. The IRS expects consistent annual contributions, though some flexibility is available.
It's also important to note that any investment risk with this strategy is the employer's responsibility — so you'll want to give careful consideration to your selections and to the administrator you choose to establish and run the plan.
It's also important to work with a financial adviser you can trust, along with other professionals (such as a CPA or an attorney), to help you build a plan that meets your specific needs and goals. You'll also have to hire an actuary each year to calculate the annual funding requirements. Still, for many high-income business owners, the tax and retirement benefits far outweigh the costs.

Is a cash balance plan right for you?

When structured correctly, a cash balance plan can supercharge your retirement strategy and create significant long-term wealth while allowing you to keep more of what you earn.

If your business is consistently profitable and you want to optimize taxes while accelerating your retirement savings, it's worth exploring what a cash balance plan could do for you.

This Department of Labor FAQ offers some basic information, but I highly recommend that you work with a financial adviser or fiduciary who has experience with this complex strategy to determine whether it's right for you.

Kim Franke-Folstad contributed to this article.

The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Megan Clark is CEO and executive wealth manager at Clark & Associates Inc. Financial Solutions and is an Investment Adviser Representative, an insurance professional and a Retirement Income Certified Professional®. As a financial adviser, she is passionate about helping families create a holistic financial plan, and she often holds "For Women by Women" informational seminars to reach out to and assist women in pursuing their goals. Clark has been recognized for several achievements, including Forbes Best-In-State Next-Gen Wealth Advisors 2019 and America's Top Women Advisors 2020.