Cash Balance Plans: Big Deductions, Big Retirement Savings

A business owner sits back in his desk chair while he smiles and talks on the phone.

(Image credit: Getty Images)

High-current-income business owners can’t afford to sit still with the IRS loading up its audit and IT staff to drive federal tax revenue. Cash benefits plans can help lower tax burdens and build a more affluent retirement and are worth investigating.

As the IRS grows more aggressive with high-net-worth taxpayers — even announcing it’s deploying artificial intelligence audit tools in its pursuit of additional federal revenue — successful business owners need proactive tax strategies that offer big benefits.

One of the most underutilized approaches is also one of the most powerful: cash balance plans, which create the opportunity for both big deductions and big retirement savings.

From just $107.88 $24.99 for Kiplinger Personal Finance

Become a smarter, better informed investor. Subscribe from just ~~$107.88~~ $24.99, plus get up to 4 Special Issues

CLICK FOR FREE ISSUE

https://cdn.mos.cms.futurecdn.net/flexiimages/y99mlvgqmn1763972420.png

Sign up for Kiplinger’s Free Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

What are cash balance plans?

Cash balance plans, sometimes referred to as cash balance pension plans, have elements similar to certain other pension and defined benefits plans. They’re more complex to set up and administer than a standard 401(k), so relatively few advisers fully grasp their implications and benefits.

The U.S. Department of Labor offers a fact sheet on the complex plans, which were created under the federal Employee Retirement Income Security Act (ERISA). The plans come with some regulatory and oversight burdens, as the Department of Labor, the EEOC and the IRS all have roles in the plans’ oversight.

But don’t let the regulatory regime scare you. The premise of cash balance plans is relatively simple. It’s essentially a hybrid pension plan that offers significant benefits to the owner and potentially to other highly compensated people in the company’s management structure.

Who are cash balance plans best for?

The best candidates for cash balance plans are mature businesses with forecasted sustainable profits and a stable number of employees on their books. Cash balance plans require businesses to sign off on putting away a significant amount of money on a perpetual basis, limiting the amount of money businesses have to reinvest in themselves.

But if your business can do that, the deductions are excellent, and the rate of savings accumulation can be terrific.

What’s the benefit of a cash balance plan?

In a traditional 401(k) defined contribution plan, individuals and businesses calculate a contribution amount for themselves that they can afford today. Based on their current salary, lifestyle and 401(k) contribution limits, individuals determine the amount of money they want to contribute to their plan. It’s a straightforward calculation for individuals and their accountants.

Cash balance plans have a significantly higher contribution limit and more flexible time commitments. For individuals with multiple income streams, they also offer the ability to shelter additional income, then roll up those funds into an IRA at the end of the plan.

CBPs also allow for complete freedom for the underlying investment, meaning the individual can decide how it’s structured and who it’s structured with. Investors have access to traditional bonds, stocks, mutual funds, as well as alternative investments. In some cases, it may even be possible to have life insurance funded inside of the plan, effectively paying for insurance on a tax-deductible basis.

Conversely, cash balance plans depend on more in-depth and complex calculations. Rather than defining what you can contribute today, cash balance plans are based on a statistical calculation that factors in age, target retirement benefit and target retirement age. The contribution amount is predetermined based on an actuarial assumption and can differ year to year within a set range.

What are the drawbacks?

First, the complexities make it a less utilized tool, and there are moderate expenses to create and administer it. Second, because it’s less well known and less frequently used than other kinds of tax strategies and retirement plans, there are fewer well-versed cash benefit plan advisers. Check with your financial adviser, CPA or tax attorney, and if they don’t know what they’re doing, you’ll need to find someone who does. Most screening can be done by answering a few simple questions about your business and our employees.

Additionally, unlike a 401(k) — for which almost everyone is a prime candidate — the mandated contribution rate of a cash balance plan means that only individuals with a specific income flow are good candidates. In a cash balance plan, consistency is key. Individuals who are thinking of starting cash balance plans for their companies need to be sure that they have the long-term qualities needed to continue to fund these plans.

And for growing companies that eat cash for breakfast, lunch and dinner, cash balance plans provide too little flexibility, both in terms of available capital, as well as for employee growth; the majority of businesses that utilize cash balance plans have less than 100 employees. Businesses with cash balance plans need to be able to contribute the designated amount, even with variation from year to year.

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.

TOPICS

Tom Ruggie, ChFC®, CFP®, founded Destiny Family Office, a Destiny Wealth Partners firm, to help clients manage the increasing complexities inherent in their business and personal lives. He has identified three key areas where his firm can make a significant difference: presenting a compelling sphere of investments, including alternative, direct and co-investment opportunities; creating a special emphasis on high-end collectors whose collections signify significant alternative investments; and strengthening the firm’s private trust capabilities. Ruggie has become one of the most respected financial advisers in the industry, receiving national recognition and rankings including: 7x Forbes Best-in-State Wealth Advisors (including 2024; #1 N Florida), InvestmentNews Awards RIA Team of the Year (2024), Forbes Top 250 RIA Firms (2023), Forbes Finance Council since 2016, 12x Barron’s Top 1200 Financial Advisors (including 2024), InvestmentNews Top 75 Fastest-Growing Fee-Only RIAs (2023), 12x Financial Advisor Magazine America’s Top RIAs (including 2024), 3x Family Wealth Report Awards Finalist (2024), USA Today Best Financial Advisory Firms (2023).