Cash Balance Plans
When a 401(k) stops being enough
For an owner in their fifties with a profitable company and a maxed-out 401(k), this is usually the answer. It is underused because it is misunderstood.
In short
A cash balance plan is a defined benefit plan that looks like an account with a balance to participants. Paired with a 401(k), it lets business owners in peak earning years make deductible contributions well beyond 401(k) limits, in exchange for a multi-year funding commitment that includes employees. MTP Private Wealth at Farther helps owners decide whether one fits their company.
What it is
A pension wearing a savings account
Technically a cash balance plan is a defined benefit pension. To a participant it looks like an account with a balance that grows by two credits each year: a contribution credit, set as a percentage of pay or a flat dollar amount, and an interest credit at a rate written into the plan document.
That framing is the whole reason these took off. People understand a balance. They do not engage with a pension formula expressed as a monthly benefit at age sixty-five, even though it is the same promise in different clothing.
Why the limits are higher
Defined benefit math runs in the other direction
A 401(k) caps what goes in. A defined benefit plan starts from a benefit promised at retirement and permits whatever contribution funds that promise. Fewer years remaining means a larger annual number.
Which is why age drives everything here. A fifty-five-year-old owner can often contribute a multiple of what a thirty-five-year-old can, and in most closely held businesses the owner is the oldest and best-paid person on the payroll.
Who it suits
Six conditions that make this worth exploring
You do not need all six. The first two matter most, and if neither is true the answer is usually no.
- A business with consistent, dependable profit. The contribution is a commitment, not a bonus.
- Owners over roughly forty-five, where the age-based math produces a number worth the trouble.
- Owners already maxing a 401(k) with profit sharing and still wanting to shelter more.
- Professional practices with a few high earners and a broader staff.
- Owners a few years from selling, looking to shelter income in their final high-income years.
- Partnerships where the partners want different contribution levels from one another.
The trade
What you are signing up for
The tax effect gets all the attention. The commitment is the part worth understanding before you adopt one.
- Funding is largely mandatory
- Once the plan exists, contributions are an obligation rather than a choice. A weak year still requires funding, which is why these suit businesses with predictable profit.
- It is meant to last
- Plans are expected to be maintained for a period of years rather than opened and closed opportunistically. Terminating one early invites questions about whether it was ever a real retirement plan.
- Employees are included
- The plan generally has to cover staff, not only owners, to pass coverage and nondiscrimination testing. That contribution is a genuine expense and belongs in the decision.
- An actuary is required
- These plans need annual actuarial valuation and a separate filing. A real recurring administrative cost, though modest next to the tax effect for an owner sheltering a large sum.
- It sits on top of the 401(k)
- You keep the 401(k) and profit sharing plan. The two are designed together so that the combined structure passes testing, which is most of the design work.
How the decision gets made
It is arithmetic, and it is specific to your payroll
An actuary runs an illustration from your real census: every employee’s age, salary, and tenure. Out of that comes the owner contribution, the staff cost, and the administrative cost. You set that total against the tax effect and the answer is usually obvious.
For some owners the number is compelling enough that they adopt a plan within the quarter. For others the staff cost eats the benefit and the answer is no. Nobody can tell which you are without running it, and running it does not cost much.
Contribution limits, testing rules, and filing requirements change. Any illustration should be prepared for your business by a qualified actuary and reviewed with your tax advisor.
Common questions
Cash balance questions
It depends on your age, your compensation, and your employee census, because the permitted contribution is whatever funds a promised retirement benefit. Older owners can generally contribute several times what a 401(k) alone allows. An actuarial illustration run on your own data gives the real number.
A defined benefit plan works backward from a benefit promised at retirement. An older participant has fewer years left to fund that promise, so the permitted annual contribution is larger. This usually works in an owner's favor, since the owner is often the oldest and highest-paid person in the company.
Generally yes. The plan has to satisfy coverage and nondiscrimination testing, which requires meaningful staff contributions. Good design finds a structure that passes while keeping that cost predictable, and the staff cost is part of deciding whether the plan is worth it.
Contributions are largely mandatory once the plan is in place. There is some flexibility in how the plan is designed and in funding ranges, but a cash balance plan is not something you skip in a lean year. That is the main reason not to adopt one.
Yes, and pairing them is the standard approach. The 401(k) with profit sharing handles one layer and the cash balance plan sits above it. They are designed together so the combined arrangement passes testing.
An actuary runs an illustration from your actual census: ages, salaries, and tenure. That produces the owner contribution, the staff cost, and the administrative cost, which you weigh against the tax effect. Running it is inexpensive and it is the only way to know.
Next step
Find out what your census supports
Send us your headcount, ages, and salaries and we will have an illustration prepared. It tells you the owner contribution, the staff cost, and whether this is worth doing.