This article originally appeared in Ed Slott's IRA Advisor Newsletter, July 2025
The Wall Street Journal recently highlighted cash balance plans ("The Retirement-Savings Weapon Doctors and Lawyers Use to Build Wealth," March 8, 2025), emphasizing the substantial tax deductions they offer participants. While valid, any conversation on these cash balance plans should also address the tax implications of eventually unwinding these accumulations — what could be called "the rest of the story."
High-earning professionals seeking to dramatically reduce their income tax burden while supercharging their retirement savings have discovered a powerful alternative to traditional 401(k) plans. While most companies have abandoned costly defined benefit (DB) plans for simpler defined contribution plans that shift investment risk to employees, savvy business owners and high-earning partners and shareholders are turning to cash balance retirement plans. This "hybrid" plan design allows participants to shelter significantly more income from taxes annually and accelerate wealth accumulation beyond conventional retirement plan limits, making cash balance plans an increasingly attractive choice for those earning substantial income.
Mixing Both Worlds
A cash balance plan is "hybrid" in the sense that it looks and feels like a 401(k) plan, with each participant having an account balance. However, these plans are centered in the DB world, with the powerful pension calculation formulas that come with DB plans allowing significant annual contributions beyond the legal limits of 401(k) profit sharing plans. Cash balance plans have become especially popular among companies with under 100 employees, particularly groups with multiple shareholders.
Cash balance plans structure participants into separate classes, permitting business owners to redirect substantial compensation into tax-deferred contributions while non-shareholding employees receive benefits through profit sharing allocations (averaging 5%-7.5%) and coverage benefits in the cash balance plan. Each participant's "hypothetical" account grows through annual pay credits and interest credits using a mandatory interest crediting rate (ICR) embedded in the plan. Older cash balance plans might use fixed rates or Treasury-tied rates that can create funding shortfalls when the investment returns do not match the ICR, but modern plans often employ a market-rate-of-return ICR, matching actual investment performance.
The cash balance plan’s popularity stems from two key drivers: (1) high-earning owners can dramatically slash tax liability through contributions far exceeding 401(k) limits while (2) simultaneously accelerating wealth accumulation by compressing twenty years of typical retirement savings into ten years.
Key Q&A
When high earners hear about massive tax deductions in cash balance plans, they tend to ask three key questions. Is this legal? Why haven't I heard of this? Why isn't everyone doing this?
The 2006 Pension Protection Act and final IRS Cash Balance Regulations of 2014 validate the cash balance plan design. Despite their advantages, these plans remain unknown to many CPAs and advisors because cash balance plans do not work universally. Success for these age-weighted plans require the right employee demographics and consistent cash flow, at a minimum, along with sufficient earnings by the owner(s) to justify the higher administrative and operational costs.
When these criteria are met, cash balance plans can deliver extraordinary results. At maximum contribution levels, high earners can accumulate enough assets over their careers to generate a maximum lifetime benefit of $280,000 per year. This represents the actuarial equivalent of a $3.7 million lump sum (indexed for inflation), effectively squeezing twenty years of normal retirement savings into ten years of accelerated contributions.
The Other Side of the Coin
Cash balance plans offer compelling benefits, but success demands careful navigation of complex implementation and ongoing management challenges inherent in all DB-type plans. The cash balance plan design requires actuarial firms to design and administer the plan and avoid regulatory pitfalls, along with an experienced advisor to assist in that endeavor as well as investing the plan assets in alignment with the unique investment protocol that’s required.
Perhaps the biggest issue that is rarely discussed in the cash balance arrangement is the growing tax liability awaiting these assets when it comes to required minimum distributions (RMDs) at age 73 or 75. High-earning owners often are blinded by the massive allowable contributions and tax deductions on the front end, but have little understanding of how cash balance plan assets will combine with other qualified plan assets and IRAs to create a "ticking tax time bomb" when eventual distributions occur.
In reality, cash balance plans can be both a blessing and a potential curse. They are a blessing during high-income, high-tax rate years, particularly for shareholders living in high-tax states such as California or New York. However, without proper tax planning, they can be a tax curse; when combined with RMDs from other qualified plan/IRA assets, they could bring the owner back into the high tax brackets they avoided during the contribution years. Worse, an unsuspecting 50-year-old shareholder might pay no attention to what the future impact could be on Medicare premiums (IRMAA), taxes on Social Security benefits, capital gains tax and other “stealth” taxes throughout retirement when combined RMDs begin at age 73 or 75 — or when the taxpayer passes away and the “widow’s tax” kicks in.
Defusing the Tax Time Bomb
A knowledgeable advisor can help cash balance plan participants take advantage of the "retirement tax-planning window," the period of time between retirement and the onset of RMDs. During this window, possibly from a normal retirement age of 65 to RMDs beginning at age 75, there is a period of time with no requirements for retirement account distributions. Retirees can leave these accounts to compound, take distributions and pay tax, or convert them to a Roth account. It is the Roth conversion strategy that holds the magic.
A ten-year Roth conversion plan can substantially reduce or eliminate the income tax liability accrued through cash balance plan participation. Over that 10-year period, up to approximately $395,000 of 24% tax bracket capacity per year can be harvested for those married, filing jointly.
Assuming a net $350,000 in bracket capacity after Social Security and other income, a skilled retirement planner could harvest $3.5 million or more in the 24% tax bracket during a 10-year retirement tax-planning window.
This tax-reduction success does not factor in state income taxes, but cash balance plan participants who move to one of the eight income tax-free states can escape the state tax they would have paid had they taken this compensation in income. For professionals who save 40%-50% in taxes during their working years, converting those cash balance IOUs at the marginal tax rate of 24% or less during the retirement tax-planning window is a game changer.
Lemons into Lemonade
Example: Dr. Will earns $350,000 per year and joined his medical group's cash balance plan because state and federal taxes are eating over 45% of his income. He enrolls at age 55, contributing $150,000 per year. After a decade of contributions at a 4% crediting rate, he accumulates approximately $1.8 million in the plan.
If Dr. Will then rolls these assets into an IRA and earns 4% from ages 65 to 75, when RMDs begin, doing no planning, he could end up with $2.6 million in pre-tax assets in the IRA. Combined with other retirement assets, the total could exceed $4.5 million by the time RMDs begin.
Dr. Will's estimated RMD at age 75 is nearly $183,000 per year, increasing to over $200,000 by age 78 and almost $300,000 per year by age 90. If Dr. Will and his spouse pass away by age 90, they will leave over $3,000,000 to their children, who must drain this amount within 10 years at ordinary tax rates. The resulting RMDs would be added to their household income when they might be in their highest earning years, facing tax rates that could be higher than today’s.
Effective tax planning between ages 65-75 could dramatically change the outcome. Assuming Dr. Will had $300,000 of 24% tax bracket capacity, he could convert the $1.8 million of cash balance assets to Roth accounts with partial annual conversions in 7 years and begin using the remaining pre-tax assets.
Brace for Impact
In a recent conversation with a cash balance participant, I asked about his plan for retirement. He told me, "I'm going to save as much as I can and brace for impact." Many cash balance participants and their CPAs are focused on today, cutting taxes, with little understanding of the delayed, impending wave of direct and indirect taxes coming their way in retirement. Bracing for this impact can be financially devastating.
The point is not that high earners should avoid cash balance plans — they should participate when it makes sense. For many, it is truly the only game in town for dramatically lowering taxes. Rather, here is the message: There is a clear need for the second chapter of the cash balance story — the tax planning sequel that should be initiated immediately upon retirement during the calm before the RMD tax storm.