What is a Cash Balance Plan? Your Top Questions Answered
A Cash Balance Plan is a type of Defined Benefit Plan that allows large tax-deductible retirement contributions that are tax-deferred and protected from creditors. Specifically, a Cash Balance Plan is a Defined Benefit Pension Plan, IRS § 401(a), often used by small business owners. It allows for significant tax-deductible contributions and retirement asset accumulation. In short, it’s an excellent tool for tax planning, asset accumulation, and asset protection.
Key Benefits of a Cash Balance Plan
Most business owners adopt a Cash Balance Plan to supercharge their retirement savings while taking advantage of generous tax deductions. Unlike 401(k) Profit Sharing Plans, these plans offer higher annual contribution limits, which means you can put away more for retirement and defer more taxes. These plans are ideal for business owners and self-employed individuals who want to ramp up their retirement savings while reducing their tax burden. Typically, Cash Balance plans work best for people 50 and older, with stable, predictable, high income.
Who Should Consider a Cash Balance Plan?
A Cash Balance Plan may be a good fit for you and your business if:
- Your company has fewer than 10 employees.
- The owners are typically older than the employees.
- You have a stable, high income with some predictability.
If you’re self-employed, a Cash Balance Plan can be a powerful retirement tool. You can combine it with other plans to significantly increase your retirement contributions. Cash Balance Plans aren’t designed to replace your 401(k) or IRA – they’re meant to complement them.
How Does a Cash Balance Plan Work?
Each participant in a Cash Balance Plan gets a “pay credit” every year, which is the amount the employer contributes on their behalf. The contribution can be a flat dollar amount or a percentage of income and may vary between employees and owners, as long as it passes compliance testing. For example, $1,000 annually per participant or 3% of a participant’s annual income. Additionally, accounts earn interest on accumulated contributions each year, called interest credit. Usually, this is a fixed rate like 5% or tied to an index, such as the 30-year Treasury yield.
What is the Difference Between a Cash Balance Plan and a 401(k) Plan?
Both Cash Balance and 401(k) Plans are considered “qualified plans” under IRS § 401, but there’s a key difference regarding who bears the investment risk and how benefits are defined.
| Feature | Cash Balance Plan | 401(k) Plan |
|---|---|---|
| Plan Type | Defined Benefit Plan | Defined Contribution Plan |
| Defined Element | The retirement benefit is defined | The contribution is defined |
| Investment Risk | Employer bears responsibility | Employee assumes the risk |
| Insurance | Typically backed by the PBGC | Not insured by PBGC |
Plus, Cash Balance Plans must offer a lifetime annuity option and are typically backed by the Pension Benefit Guaranty Corporation (PBGC), which provides insurance for such benefits.
Maximum Contribution and Benefit Limits
As noted above, a Cash Balance Plan is a defined benefit plan, so there are limits on the maximum benefit that may be paid. IRS § 415(b) limits the benefit that may be paid from a defined benefit plan ($280,000 annually at Normal Retirement Date for 2025 and indexed). This amount is reduced if the participant has less than 10 years of participation in the plan, as well as for retirement before the Normal Retirement Date. Assuming that the participant is at least age 62 with a minimum of 10 years of participation in the plan, the maximum lifetime lump sum payable from a Cash Balance plan is approximately $3.5 million for 2025.