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Tax Savings for Business Owners Part 2 – Cash Balance Plans

Tax Strategies for Business Owners

Would Your Company Benefit from a Cash Balance Retirement Plan?

As a business owner, you are constantly focused on the long-term financial stability of your company. Retirement plans are a great way to help you reduce your taxable income while benefiting your and your employees’ retirement. Besides 401 (k) plans, cash balance plans are another type of retirement plan worth considering.

Cash balance plans are what I’m highlighting today in our continuing series on tax strategies you can implement using retirement plans. Considered a qualified plan by the IRS, a cash balance plan is a hybrid plan that has some characteristics of a defined benefit plan and elements of a defined contribution plan. It is an employer-funded plan where you set aside a percentage of each eligible employee’s pay like a 401(k) plan. However, unlike a 401(k), the ultimate benefit payout is guaranteed, much like a traditional pension plan. While cash balance plans may not be appropriate for every business, they are a great option for many companies.

Here are seven reasons you might find a cash balance plan an attractive option for your company:

Benefits of Cash Balance Plans

  • High contribution limits
  • Approved by IRS
  • Tax-deductible contributions
  • May be used in addition to other plans
  • Flexibility in employee coverage
  • Predictable benefits
  • Portable

High Contribution Limits

Let’s take a closer look at a few of these benefits. Cash balance plans are fully approved by the IRS and offer tax-deductible contributions, meaning that any funds you contribute as an owner for yourself and your employees will reduce your company’s taxable income by that amount.

One of the biggest advantages of a cash balance plan is that they offer significantly higher contribution limits depending on the participant’s salary and age. For example, in 2023, the maximum contribution limit for an individual in a cash balance plan could potentially be $398,000, whereas the maximum contribution allowed for a 401(k) plan is $22,500 per year or $30,000 for employees over 50. This dual contribution allows you as the owner and your highly compensated employees to save more for retirement each year.

2023 Maximum Contribution Comparison:
Cash Balance: Potentially $398,000
401 (k): Potentially $30,000

How is a cash balance plan funded? The amount of employer contribution is predetermined by you, the business owner, based on various factors, such as the employee’s age, salary, and length of service, in a formula that looks something like this:

Employee’s Salary x Pay Credit Rate
Account Balance x Interest Credit Rate
Annual Benefit to be Accrued

You determine the percentage per covered employee and set the interest credit rate for the growth of contributions as a fixed or variable rate linked to an index such as the one-year treasury bill rate. Once the contribution amount is determined, the employer is required to make that contribution each year, regardless of the business’s financial performance. There are options available if the business has a slowdown, but a cash balance plan is best for businesses with strong expected revenues. The maximum lifetime funding of a cash balance plan is currently $3.4 million. When an employee retires, depending on the provisions of the plan, their payment can be as a lump sum, have the option of receiving it as annuity payments or roll into another retirement account.

Can Be Combined with Other Retirement Plans

Cash balance plans may be used alongside other retirement plans you have. For companies that want to augment their retirement benefits, especially for owners and to benefit higher compensated employees, a cash balance plan can be an excellent additional retirement plan. You can have a 401 (k) plan in place for all staff and add a cash balance plan as an incentive to employees.

Flexibility in Coverage of Employees

There is some flexibility in the coverage of employees with this type of plan. You can set your cash balance plan up to be a vested plan where employees are not vested or eligible to receive benefits until they’ve been with the company for a predetermined number of years. If an employee leaves before the vesting mark, they will forfeit any contributed funds.

You can exclude employees in a cash balance plan, but must follow non-discrimination IRS testing requirements. You have the ability to cover various employee groups at various levels. These decisions are made within the plan documents when it is first opened.

Predictable Benefits

Cash balance plans offer predictable benefits for you and your employees.

These plans are calculated differently than pensions plans and show the account balance so employees can know what amount they can expect to receive when they retire. With a cash balance plan, it is the employer that bears any market fluctuation, not the employee, which allows them to have confidence in their defined benefit. These plans offer predictable benefits to help you and your employees plan retirement and are an alternative to small business owners who don’t have access to a traditional pension plan.


Another great feature of a cash balance plan is that, unlike pension plans, employees can take their accrued benefits with them if they leave. In today’s more mobile work environment where employees don’t always stay with one company their entire career, the cash balance plan is an attractive option because employees who desire to change jobs can receive payment of their accrued benefits, which can then be rolled into an IRA or 401 (k), whereas most traditional defined benefit plans are designed to pay out if the employee stays through retirement age.

Disadvantages of a Cash Balance Plan

  • Higher set-up fees
  • Higher administrative costs
  • Strict funding and distribution rules
  • Requires positive cash flow forecast for years

So, I’ve mentioned the many benefits of a cash balance plan, but what about its disadvantages? Cash balance plans have higher set-up and administrative costs than other plans. These plans are complex and require the services of an actuary to calculate the plan and provide an annual valuation. Still, these plans are less complex and easier to calculate than traditional pension plans. If you are a small business owner and cannot afford the necessary fees, you may need to look at other options.

You will also find that while cash balance plans offer greater contribution limits, they have strict rules regarding contributions and require a steady stream of contributions to fund the plan. Unlike other plans, this type of plan has strict distribution rules that may limit access to the funds, except for specific situations such as an employee leaving.

One last thing to consider is that to properly fund a cash balance plan will require a significant financial commitment. Yes, you can temporarily freeze or amend a cash balance plan, but it is designed to be funded consistently over several years. If you are not able to make the necessary contributions to a cash balance plan, that can result in penalties and other financial liabilities. In this case, a simpler and more affordable retirement plan, such as a SEP IRA or a SIMPLE IRA, may be a better option for your

In conclusion, cash balance plans offer many benefits to both employers and employees. If you are a business owner looking for ways to attract and retain talented employees while also securing your own financial future, a cash balance plan may be worth considering.

Deadlines for Establishing a Cash Balance Plan

If you want to set up a cash balance plan this year, the deadline to establish a new plan is up until your tax filing deadline, including extensions, for the plan’s first year.

I hope this article has provided you with some helpful information that you can consider for improving your and your family’s financial outlook. Stay tuned as next month I will be focusing on profit-sharing plans in detail and how they can be a good option for business owners that would like to increase the number of tax deductions they have and to save more money for themselves for retirement.

Chris Zeches is a Certified Financial Planner® and Managing Partner at Zeches Wealth Management. Zeches Wealth Management has one singular focus: To financial planning and tax expertise to help multi-generational families and business owners achieve more of what they love.

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