Cash Balance Plan: Six-Figure Deductions for Older Owners

A cash balance plan is a defined benefit pension plan that appears as if participants have individual accounts. Each year the company will credit each participant a pay credit, a set percentage of the employee's earnings or a flat dollar amount, along with an interest credit at a guaranteed rate. An enrolled actuary must certify the funding annually. Because the amount of contribution room increases as age increases, older high earning owners who are in their fifties and sixties use this type of plan to claim deductibility of six figure amounts that a 401(k) could never hold.

The hypothetical accounts account for each worker's promised benefit, not a pot of the employee's own money (i.e., this is a "pension obligation" as opposed to a "discretionary account"). That distinction decides whether it fits your business.

What is a cash balance plan?

The label represents how accounts are tracked, not how the plan is funded. Employees see the hypothetical accounts as if they were their "own" account, much like a 401(k) statement, with a growing value over time for years to come. The hypothetical accounts represent a promise (that the company will pay out at retirement), not a pot of the worker's own money. The actual money backing them is held within one pooled trust created through the employer's contributions and valued by an actuary, placing the plan into the defined benefit category of the small-business retirement plans family rather than the account based category of plans that contain 401(k)s and SIMPLE IRA accounts.

The account contains no investment options for employees. Instead the employer, not the worker, bears the investment risks associated with the pooled trust that underlies the plan.

How does a cash balance plan work?

The plan credits both amounts (a pay credit and an interest credit) to each participant's account, and funds the promise through one employer trust. The Pay Credit represents either the contribution amount based on a percent of compensation (for example 5% of pay) or a flat dollar amount which may be significantly higher for owner participants. The Interest Credit is a guaranteed growth rate and is typically either a set percentage as defined in the plan document or a bond-linked rate capped by IRS regulation. Each year an enrolled actuary must certify the funding and sign the plan's Form 5500 Schedule SB. Under the statute, if desired, a plan may provide for benefits based on the hypothetical account balance under Internal Revenue Code Section 411(a)(13).^[1]

In most cases, once you have developed your plan design, your annual contributions are a mandatory requirement based on the calculations made by the Actuary under the minimum funding rules of Internal Revenue Code Sections 412 and 430. Regardless of whether there is an increase or decrease in earnings from operations during the year, your company will be obligated to make a required contribution annually. If you fail to contribute enough to meet these requirements, there will be a 10% excise tax imposed pursuant to Internal Revenue Code Section 4971.^[2] You may elect to limit future pay credit amounts or freeze the plan. However, you can never reduce the amount already owed during the current year.

How much can you contribute to a cash balance plan?

The contribution limit is driven by age, not a fixed amount per year. This is why the program is attractive to business owners who are older. The program will provide a target retirement benefit, with an upper limit set by IRS Publication 560 (the lesser of 100% of the participant's highest three-year average compensation or $290,000 for 2026).^[3] As there are many fewer years remaining to contribute as you grow older, your yearly contributions would be significantly greater than those of a younger person.

A defined contribution plan caps the account, while a cash balance plan caps the benefit and lets age drive the contribution, which is how owners past 50 reach deduction levels no SIMPLE IRA versus 401(k) comparison can match.

Cash balance plan vs 401(k)

A cash balance plan is not simply a larger 401(k). With a 401(k) you can fund one year and stop for the next year, but with a cash balance plan you are establishing an annual funding target that your actuary certifies and that must be met. One obligation many small practices avoid is PBGC insurance. The Pension Benefit Guaranty Corporation exempts a Professional Service Employer, a practice owned by physicians, attorneys, or accountants, that has never had more than 25 active participants.^[6] Therefore most solo and small-practice cash balance plans pay no PBGC premium. The differences that decide the choice line up like this:

Who should set up a cash balance plan?

A cash balance plan is usually best suited to a steadily profitable business, such as a professional practice that has an owner who is 45 years old (or older) and has already made maximum contributions to a 401(k), and wants to make a much higher deductible contribution. Most cash balance plans do not stand alone. Rather they are paired with a safe-harbor 401(k) and a profit-sharing plan. This allows the owners to defer their own salaries while allowing them to contribute to the cash balance plan in addition to both of those plans. However, this pair does create a deduction trap. In general, when a plan is not covered by the PBGC, the deductibility cap of Internal Revenue Code Section 404(a)(7) limits the deductible employer profit-sharing contribution to 6% of covered payroll once the two plans share employees.^[5] You will also be required to fund the benefits of any non-owner employees. A discretionary profit-sharing 401(k) fits better if you experience large fluctuations in earnings.

The Bottom Line

A cash balance plan is a type of defined benefit plan described in terms of hypothetical account balances, where an employer provides employees both a "pay" credit and a guaranteed "interest" credit certified by an actuary each year. Cash balance plans are subject to largely mandatory funding requirements, which means they are typically suited to owners over 45 of steadily profitable businesses, who have already maximized their contributions under a 401(k), and wish to take a much larger deduction. Usually a 401(k) profit-sharing plan is also provided in conjunction with a cash balance plan, and it rewards commitment. Price it with an actuary before you sign.

This guide is educational and summarizes IRS and ERISA rules for cash balance plans. It is not investment, legal, or tax advice. Your plan documents, your actuary, and current IRS limits control. Talk to your tax advisor about your business's circumstances.