Cash Balance Plans: What are They and How do I Know if They are Right for Me?

Updated: Jul 31

There are all kinds of retirement plans available to employers searching for a retirement strategy that will meet their financial goals, as well as those of their employees. One of these strategies is known as a cash balance plan. Let’s explore what this plan is and how it works.

Cash balance plans are a lot like a traditional pension plan, but with a twist. Like pension plans, cash balance plans are calculated based on a lifetime income at age 65, and funding is whatever amount is necessary to provide that benefit. Cash balance plans offer the potential for large savings for older business owners with high incomes, due to the plan requiring high-income levels over a short period of time. But, like a 401(k), the benefit is stated as an account balance, rather than as a monthly income stream. Additionally, these plans are transferable. This twist on a traditional pension plan is what makes cash balance plans easier to comprehend and perceived as more valuable. However, unlike a 401(k), the employee cannot make her own contributions to the plan. It is, after all, a defined benefit plan.



In these plans, the participating employee is promised a certain sum upon retirement which they can take either as regular monthly checks (like a traditional pension) or, more commonly, upfront as a lump sum. Cash balance plans allow employers to make greater contributions to retirement savings—which can make a big difference if large catch-up deposits are needed to prepare for retirement. Additionally, the contribution limits become less restrictive as the employer ages. For example, an employer age 58 or older can save up to $200,000 annually.

Cash balance plans can bring tax benefits to the company as well. Any contributions the employer makes into employee accounts are tax-deductible at the corporate level and the contribution is tax-deferred for the employee. On the employees' end, participants get regular statements explaining the hypothetical value of the retirement account. The account is hypothetical because the money is technically in a pension plan pooled account with the other employees. Think of that money as earmarked for individual employees. Annually this pooled fund is accounted for on an individual basis.



Where cash balance plans are most popular is in a small business with older, higher-income owners who have a tax problem and a need for retirement savings. The cash balance allows the owners to make a large contribution to themselves, as well as smaller contributions to the employees, and defer taxes to a time when hopefully they are in a lower tax bracket. Because a cash balance plan is a type of pension plan, the contributions are not discretionary. Contributions are a promised benefit and must be made on an annual basis. For a highly profitable business, this could be a great solution. It all depends on the unique situation of your company. For more advice, give us a call.





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