Cash Balance Plans: The High Earner's Secret Retirement Weapon

The words "cash balance plan" are written in a notebook next to a calculator.

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For business owners, partners and high-income professionals looking to boost retirement savings and reduce taxes, cash balance plans offer a compelling solution.

They combine the structure of a defined benefit plan with the portability of a 401(k), making them a modern retirement tool with significant advantages.

What is a cash balance plan?

This plan is a tax-qualified retirement strategy that operates much like a traditional pension while maintaining the feel of a 401(k).

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Each participant has an individual account that grows annually through two components: employer contributions (defined by a formula) and an interest credit usually tied to a specified rate in the plan document.

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Upon retirement or departure from a job, the account balance can be rolled over into an IRA or another qualified plan.

While the mechanics are based on actuarial formulas, the end-user experience is straightforward: Participants see a clear account balance and can track growth over time, just as they would in a defined-contribution plan.

Why employers choose them

Perhaps the biggest advantage of a cash balance plan is the ability to allocate significantly more than what's allowed in a traditional 401(k) or profit-sharing plan — often more than $250,000 per year for older, high-earning participants.

These contributions are tax-deductible, grow tax-deferred and offer significant potential to reduce corporate or personal tax liability.

Business entities of all types can benefit. Corporations deduct contributions on their corporate tax returns, while partnerships and sole proprietors split the deduction between the business and the owners' personal filings.

The tax savings typically far outweigh the administrative cost of running the plan.

Beyond the tax advantages, these plans are a powerful way to attract, retain and reward key employees, especially in professional services firms such as law, accounting and medical groups.

In addition, assets in a cash balance plan are generally protected from lawsuits and creditors of the employer.

They've grown in popularity outside these industries as well, and the plans are now used by a wide range of businesses to support the larger contributions often made for business owners.

What to know before starting

Cash balance plans require an actuary to manage annual funding calculations, and there's an expectation of permanency; they're not intended as short-term strategies.

Contributions must generally be made every year, and the plan must meet minimum participation rules and nondiscrimination testing.

Consequently, these plans are often paired with a 401(k) and profit-sharing component to help meet those standards.

Staff and nonowner contributions typically fall in the 5% to 7.5% range of pay. The plans also have a lifetime IRS limit on how much an individual can accumulate, and most are covered by the Pension Benefit Guaranty Corporation (PBGC), though some are exempt, depending on structure.

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Despite these requirements, plan designs can be flexible. Employers can periodically amend contribution levels, option to freeze benefit accruals and have the flexibility of terminating the plan over time.

Who should consider one?

Cash balance plans are ideal for firms in which owners and key employees consistently earn $500,000 or more annually and are seeking to contribute well beyond 401(k) limits.

They're particularly efficient when layered on top of existing retirement programs such as profit-sharing contributions of 3% or more.

Firms of any size can implement a plan, but the more key employees involved and the higher their desired contributions, the more efficient the plan becomes.

Final thoughts

Cash balance plans are a strategic retirement solution for those who want to catch up quickly, lower taxes significantly and reward themselves and key team members in the process.

With the right design and ongoing guidance, these plans can potentially deliver tremendous long-term value that far exceeds their complexity.

For high-income professionals looking for a smarter way to save, the cash balance plan might be a great opportunity.

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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Jerry serves as Executive Vice President and Head of Retirement at Sentinel Group, where he drives the strategic growth of Retirement Plan Services. Jerry spearheads business development, cultivating partnerships and leading plan consulting to help ensure the financial strength of the business. A forward-thinking leader, Jerry is committed to elevating service quality for clients and partners. By prioritizing compliance, he fosters a culture that values accountability and continuous improvement. Jerry’s dedication to streamlining data-driven solutions helps clients and partners achieve exceptional outcomes and sustainable growth.