Cash Balance Plan Basics for Practice Owners

What is a cash balance plan?

A cash balance plan is a type of defined benefit pension plan that offers substantial tax and wealth-building opportunities for practice owners. Unlike a 401(k), which is a defined contribution plan, a cash balance plan outlines retirement benefits in terms of a stated account balance. This structure allows business owners to accelerate retirement savings while also providing an additional benefit to employees.

Key benefits of a cash balance plan.

Cash balance plan benefits are determined by a formula outlined in the plan documents and are subject to certain maximums. The annual benefit amount increases as participants get older, meaning business owners can contribute more as they approach retirement. Here are approximate annual benefit limits by age:

• Mid-40s: approximately $167,000.
• Mid-50s: approximately $274,000.
• Age 60 and above: approximately $336,000.

These contribution limits far exceed those of 401(k) plans, making cash balance plans an attractive option for high-income practice owners looking to maximize tax-deferred savings.

Another advantage is that these plans are employer-funded, meaning employees do not contribute. While they are subject to non-discrimination testing, cash balance plans are often structured to provide maximum benefits to owners while keeping employee costs relatively low. This makes them a valuable employee retention tool, complementing a 401(k) plan rather than replacing it.

Understanding plan funding and overfunding.

Unlike a 401(k), where contributions are discretionary, a cash balance plan is a type of pension plan, meaning it comes with an obligation to provide benefits. Each year, participants accrue benefits, and the associated investment account must be maintained within an acceptable range to support those benefits.

• If the account balance falls below the accrued benefits, the plan is underfunded, requiring additional contributions.
• If the account balance exceeds accrued benefits, the plan is overfunded, creating opportunities to amend the plan and increase owner benefits.

When our team designs these plans for our clients, our goal is to strategically target overfunding in the early years to provide flexibility. By pairing this strategy with a conservative, diversified investment portfolio, practice owners can minimize the risk of unexpected funding shortfalls.

Plan permanency and considerations.

Because a cash balance plan is a pension, it is considered a promise of benefits to employees, including the practice owner, who acts as both employer and employee. The IRS requires these plans to meet a permanency standard, though it does not provide strict guidelines on duration. Generally, plans should remain in place for at least three to five years to comply with this standard.

While the benefit formula can be amended over time, adjustments should be made proactively rather than reactively. A cash balance plan is an incredibly effective tool for tax-efficient wealth accumulation, but it’s important to avoid overcommitting to a benefit structure that becomes financially uncomfortable.

Pairing a cash balance plan with a 401(k) plan.

A 401(k) plan is a defined contribution plan where both employees and employers contribute. Employees can defer salary into the plan, while employers may contribute through safe harbor contributions, matching, and discretionary profit sharing.

In contrast, a cash balance plan is entirely employer-funded, meaning employees cannot contribute. Both plans are subject to non-discrimination testing, but in a typical practice setting, these tests often result in the vast majority of benefits going to the practice owner. Across our client base, we frequently see owner retention of more than 90% of total plan balances.

By pairing a cash balance plan with a 401(k), practice owners possibly can create a powerful retirement strategy that maximizes tax savings, accelerates wealth accumulation, and enhances employee benefits — all while maintaining flexibility in plan funding.

For several reasons, a cash balance plan can be a powerful tool for building retirement savings while providing a structured and secure way to grow wealth. Through a unique combination of high contribution limits and predictable benefits, these plans can be an attractive option for high-income practice owners looking to maximize tax-deferred savings. FPW only: If you are considering a cash balance plan or want to explore how it fits into your financial strategy, our team would love to help. Schedule a conversation with a practice integration advisor today! 

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