A Look at Cash Balance Plans

Lower Your Taxes and Accelerate Your Savings With an Innovative Plan Design Called a Cash Balance Plan

By Steve Sansone, J.D., AIF®, CPFA®

I’ve been working in the retirement plan industry since 1986, and at the end of the day, business owners and Firm shareholders really want to know two things: How can I lower my tax liability and increase my savings? Enter the Cash Balance Plan. Cash Balance Plans have become the fastest-growing retirement plan design in the country for several years now for these two specific reasons, addressed in further detail later. When asking whether or not the Cash Balance Plan is right for your Company or Firm, it boils down to a classic cost-benefit analysis, which requires a specialist to help you evaluate your options. I’ve been educating Advisors for nearly 20 years on how to conduct this analysis, and very few of them fully come to understand the numerous moving parts involved in the analysis. Hopefully this article will give you some of that understanding. 

Given the significant benefits a Cash Balance Plan can provide, the question becomes whether or not it’s right for your Company or Firm. Here’s what you need to know about the Cash Balance Plan, what it is, and how to decide if it makes sense for you.

What Is a Cash Balance Plan?

While a Cash Balance Plan is technically considered a defined benefit plan, it has some key characteristics similar to those found in defined contribution plans.

Consequently, it’s commonly called a “hybrid plan” since it lives in the defined benefit world but looks and feels like a 401(k) defined contribution plan. It is often used as a separate plan that gets “bolted onto” a 401(k) profit-sharing plan to maximize the benefit an Owner can receive each year toward retirement. IRS rules ensure that additional contributions need to be made to eligible employees for the Owner(s) to receive these benefits.

The beauty of this plan design is each Shareholder has an account balance that includes a contribution (“pay credit”) and mandatory earnings (“interest credit”) each year. These two annual additions to a participant’s account are the promise the Company or Firm agrees to pay when participants retire or otherwise leave. Not every Owner/Shareholder has to participate in the Cash Balance Plan.

Here’s the best part. The contribution limit is derived from the defined benefit formulas, which allow high-wage earners to receive up to $300,000 in contributions on their behalf each year, above and beyond the 401(k) profit-sharing legal limits! One Owner can accrue over $3,000,000 (indexed for inflation) over their lifetime.

Why Have They Become So Popular?

Why have Cash Balance Plans become the fastest-growing retirement plan design in the country over the last 10 years or so? In a word: taxes. Every dollar contributed to the Cash Balance Plan on behalf of the Owner comes right off the top of the Owner’s annual income and thus lowers their marginal tax rate and ultimate tax liability. Depending on your total household income and the state you live in, those tax savings can be upwards of 50% each year, depending upon your state income taxes and personal income tax situation, not to mention the possibility of other tax benefits that an Owner could avail themselves of with reduced adjusted gross income resulting from the Cash Balance contribution. In a world of shrinking tax deductions for high-wage earners, this above-the-line tax deduction is pure gold.

A second (and equally important) reason is the acceleration of an Owner’s savings. Many Owners have spent their working years building their company, or practice, at the expense of their own retirement savings. With a well-crafted Cash Balance Plan, however, Owners can “squeeze 20 years of savings into 10,” generating a dramatically different retirement lifestyle than would be possible otherwise. Under current law, Owners can have over $3,000,000 contributed on their behalf, beyond the 401(k) profit-sharing limits, over a 10-to-12-year period, depending upon their age and income.

And in case you’re wondering, these assets are not only afforded the same creditor protection that 401(k) plans have under ERISA, but they can also be rolled over to an IRA account or another qualified retirement plan, either once the Owner reaches age 59½ and is still working, or when the Owner retires or leaves the Firm. The assets are completely portable.

How Do They Work?

Each Owner gets to decide, based on their income and age, how much they want to be contributed on their behalf by the Company as opposed to receiving that money in income and being taxed on it at the highest marginal tax rate.

Companies or Firms will then redirect that compensation into the Cash Balance Plan, held by a Custodian, in a pooled account. There is no participant direction in a Cash Balance Plan. It’s “one size fits all.” The contributions are pooled together, and an actuary will track the plan’s funding requirements, keep the records of each participant’s account balance, and provide plan participants a statement each year. A few actuarial firms can also provide a daily valuation for the plan participant.

It’s not all a bed of roses. Cash Balance Plans do not have the same flexibility as 401(k) plans. While 401(k) plan contributions can be adjusted every pay period, Cash Balance Plan participants must select an amount to contribute according to a “definitely determinable” formula, for a certain time frame. And contributions for a participant are locked in after the participant reaches 1,000 hours of work each year. However, with the right team of experts in place, these restrictions can be mitigated.

Investing the Assets

Before the plan design is finalized, it’s critical to meet with an experienced Advisor to review the plan’s interest credit rate (“ICR”) and the unique investment protocol of Cash Balance Plans. These two issues are deeply connected to each other, and to the long-term success of the plan, as well as the Company or Firm cash-flow requirements. At the heart of every traditional Cash Balance Plan are “guaranteed” earnings (by the Company or Firm) each year the plan is in place, regardless of how the underlying pooled plan assets actually perform. Most plans historically have been designed using a fixed-interest crediting rate, such as 4%-6%, or a floating interest such as the yield on the 30-year Treasury Bond, recalibrated each year.

Both rate structures are flawed in that they create potentially significant cash-flow pain to the Company or Firm by coming up short of the “guaranteed” ICR each year. That shortfall typically is made up each year by the Company or Firm, since departing Shareholders get to leave their share of any shortfall behind. A 5% credit rate, for example, that suffers a 10% investment decline in 2022, now is faced with a 15% shortfall, and depending upon the size of the assets, could result in significant dollars that the Plan Sponsor (aka Shareholders) has to fund.


Market Rate of Return 

However, there is a newer, more innovative interest crediting rate available, called a Market Rate of Return, that effectively neutralizes that pain, and allows CB Plan Sponsors to use whatever the investment return is for the year in question as the crediting rate for the plan. And shortfalls only potentially surface at the participant level (a) when the participant leaves and (b) their account balance is less than their total contributions made on their behalf. Since the MRR approach looks at the participant account cumulatively, it dramatically reduces the “threat to cash flow” that Cash Balance plans with traditional ICRs face.

Once the crediting rate is finalized, the pooled Cash Balance Plan assets should be actively managed to achieve the desired outcome for your plan’s interest crediting rate. The investment strategy should consider many factors, including the plan’s funding liability, the company’s risk tolerance level, and current market conditions, among others.

Performance is measured annually, and, as mentioned above, the plan’s funding requirements and potential shortfall liability are determined accordingly. When participants terminate their employment, they receive their contributions plus earnings credits under the traditional crediting method. The type of interest credit rate used in the plan can dramatically affect what amount, if any, is owed to a departing participant. This is where expertise comes into play.

Who is Best-Suited for This Plan Design?

While Cash Balance Plans are open to any entity, regardless of structure or size, great candidates contain the following five key qualities:

  1. Owners are over the age of 40 and the majority of employees are younger.
  2. Owners have an annual earned income of $300,000 or more.
  3. Owners want and can consistently contribute more than $61,000 each year toward their retirement objectives.
  4. Companies or Firms that are already contributing 3%-5% to employees in a current plan design or bonus structure
  5. Companies that have consistent profitability


Is it Right for your Company?

The only clear way to understand whether or not a Cash Balance Plan makes sense for you is to have an experienced professional conduct an in-depth review of your Company or Firm. At SageView Advisory Group, we have years of experience helping clients navigate decisions about their retirement plans.

Send a census of your Company or Firm to ssansone@sageviewadvisory.com, and I’ll have that analysis completed and back to you in 72 hours. Let SageView Advisory Group help you determine if this multimillion-dollar plan design is right for your Owners.


About Steve

About Steve

Steve Sansone has over 30 years of experience in the retirement plan industry and is the Managing Director of the Valencia office at SageView Advisory Group, one of the largest Registered Investment Advisor firms specializing in retirement plans. As an Accredited Investment Fiduciary® and Certified Plan Fiduciary Advisor practitioner, Steve works with professional service groups and companies of all sizes seeking to create a world-class retirement plan experience for their plan participants. He serves as an ERISA 3(21) or 3(38) Advisor, bringing independent, conflict-free services to both Plan Sponsor Committees and retirement plan participants. Steve’s expertise in Cash Balance Plans spans nearly 20 years and is one of the few Advisors in the industry that understands both sides of the Cash Balance equation: Actuarial and Investments. He considers his work to be the greatest financial rescue mission of this time, helping people retire on time, sufficiently prepared to write the next best chapter of their life. To learn more about Steve, connect with him on LinkedIn.

Learn more