Cash Balance Plans for Business Owners

What Is a Cash Balance Plan?

The IRS describes a cash balance plan as a defined benefit pension plan. It is also called a hybrid plan because it borrows from both plan types. Like a traditional pension, it promises a defined benefit. Like a 401(k), each participant sees a simple account balance.

How a Cash Balance Plan Works

Each participant has a “hypothetical account” that tracks their benefit. Two things build that balance each year:

• Pay credits. The plan sets a formula for what is credited to each participant, often tied to a percentage of pay or a flat amount.
• Interest credits. The plan also credits interest to each account at a rate set out in the plan document.

The IRS notes that the formula and the interest rate must be clearly stated in the plan and applied the same way to every participant. These plans are usually set up to pay a lump sum equal to the account balance. The account is “hypothetical”: it is a bookkeeping balance that tracks each participant’s benefit.

Why Business Owners Look at Cash Balance Plans

PlanPerfect works with owners of closely held businesses, family offices, CPA firms, medical groups, and professional service organizations. These groups often look at a cash balance plan for these reasons:

• Tax treatment. Employer contributions are generally deductible, and benefits grow tax-deferred. Your tax advisor can tell you how that applies to your situation.
• Higher contribution levels. Contribution amounts generally rise with age, which is why the plan often draws owners who are closer to retirement.
• It can sit alongside other plans. A cash balance plan can be paired with a 401(k) profit sharing plan.

What to Weigh Before You Adopt One

A cash balance plan is not right for every business. Consider these tradeoffs:

• Contributions are required. As with traditional defined benefit plans, the company has to fund the plan each year, whether or not it is a strong year.
• Employee costs. PlanPerfect advises owners to budget about 5 to 8 percent for employee cost.
• Actuarial work. An actuary has to certify the plan every year.
• Cost to set up and run. A cash balance plan costs more to set up and maintain than a 401(k) alone.
• Age and timing. It generally makes less sense for younger owners, since contribution levels start lower at younger ages.

Is a Cash Balance Plan a Fit for You?

A cash balance plan tends to fit a profitable business with steady cash flow, an owner who wants to save more than a 401(k) allows, and a team whose cost can be planned for in advance. It may not fit a business with uneven income, since the contribution is not optional. An early look at your numbers helps.

How PlanPerfect Can Help

We help you compare plan types and see how a cash balance plan would work for your business before you commit. Learn more about our retirement plan options, review our yearly contribution limits, or see all of our services.

Frequently Asked Questions

Is a cash balance plan a pension?

Yes. The IRS classifies it as a defined benefit pension plan with a hybrid design.

Can I have a cash balance plan and a 401(k)?

Yes. A cash balance plan can be combined with other plans, such as a 401(k) profit sharing plan.

Are contributions optional?

No. Contributions are required, similar to a traditional defined benefit plan.