Cash Balance Plans Help Some Business Owners Supersize Retirement Savings
Cash balance plans are technically defined benefit plans (or pensions) that share some key characteristics with defined contribution plans such as 401(k)s and 403(b)s. These hybrid plans have generous contribution limits that increase with age, and they are often stacked on top of a 401(k) and/or profit-sharing plan. This combination can help partners in professional service firms and other high-income business owners to maximize or catch up on retirement savings and significantly reduce their taxable incomes.
On top of the $70,000 maximum contribution to a 401(k), a 65-year-old could save as much as $329,000 in a cash balance plan in 2025, while a 55-year-old could save $248,000 on a tax-deferred basis until the account reaches a maximum balance of about $3.6 million (IRS limits adjusted annually for inflation).1–2
Employees benefit too
A cash balance plan can also be a powerful tool for employee recruitment and retention. As with other defined benefit plans, employees are promised a specified retirement benefit, and the employer is responsible for funding the plan and selecting investments. However, each participant has an individual account with a “cash balance” for record-keeping purposes, and the vested account value is portable, which means it can be rolled over to another employer plan or to an IRA.
But unlike a 401(k), the participant’s cash balance when benefit payments begin can never be less than the sum of the contributions made to the participant’s account, even if plan investments result in negative earnings for a particular period. This means the employer bears all the financial risk.
Rising number of employers with cash balance plans
At last count in 2020, U.S. cash balance plans had 9.4 million participants and assets exceeding $1.2 trillion.
Source: FuturePlan National Cash Balance Research Report, 2023 (most recent data available)
Funding the plan
The amount that the employer is required to contribute to the plan each year is actuarially determined based on plan design and participant demographics. Generally, the employer makes two contributions to the cash balance plan for each employee. The first is a pay credit, which is either a fixed amount or a percentage of annual compensation. The second contribution is a fixed or variable interest crediting rate (ICR). The ICR can be set to equal the actual rate of return of the portfolio, if certain diversification requirements are met, which helps reduce the employer’s investment risk and the possibility of having an underfunded plan due to market volatility.
Businesses may take a significant tax deduction for employee contributions, so current-year tax savings may offset some of their contributions. Still, a cash balance plan is typically more cost-effective if you are a sole proprietor or the owner of a small firm with just a few employees.
All investing involves risk, including the possible loss of principal, and there is no guarantee that any investment strategy will be successful. Diversification is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss.
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