Cash Balance Plans: A Unique Retirement Savings Plan for Business Owners

The landscape of retirement savings options is broad, offering various strategies for future financial independence in retirement. Many people are familiar with 401(k)s, 457(b) plans, SIMPLE IRAs, Simplified Employee Pension Plans (SEPs), and profit-sharing/stock purchase plans. In addition to these retirement savings plan options, a Cash Balance Plan (CBP), also known as a Cash Balance Pension Plan, is another retirement savings plan that may provide substantial benefits for a business owner. This article covers what business owners need to know about the unique retirement savings plan known as a CBP.


A CBP – What Is It?

A CBP is a tax-advantaged defined benefit pension plan. Like other pension plans, it encourages long-term savings. However, unlike traditional pension plans, CBPs offer individual accounts for each participant and define an individual’s benefit in terms more characteristic of a defined contribution plan.

In a CBP, the participant’s account balance is credited each year with a “pay credit” – typically a percentage of their salary – and an “interest credit.” The interest credit may be either a fixed or variable rate linked to an index such as the one-year Treasury bill rate. The underlying benefit of the CBP is the guarantee that the investment strategies will earn a specific return, reducing the risk for plan participants.


Why CBPs may be attractive to business owners

CBPs may be particularly attractive to business owners for several reasons. For one, they enable more significant, tax-deductible contributions, facilitating effective tax management strategies for companies. Furthermore, the higher contribution levels typically associated with these plans significantly increase the duration at which retirement savings can accumulate.

As plans are age-weighted, older business owners and high-earning employees close to retirement can benefit significantly. Participants can “super-fund” their retirement savings since these plans allow for larger contributions for older workers, thus enabling them to catch up on contributions if necessary. The catch-up feature of CBPs is conducive to rapidly contributing to a retirement savings plan as the participant works toward an independent retirement.

Advantages of CBPs

There are numerous advantages of CBPs that business owners may find appealing:

Asset preservation

Along with the benefits above, CBPs provide excellent asset preservation. The Employee Retirement Income Security Act of 1974 (ERISA), under which these plans fall, offers protection against creditors. Thus, business owners can more effectively protect their retirement savings assets.


Retaining and attracting top talent

CBPs are attractive to business owners and vital in retaining top employees, such as management and employees critical to the company’s success. CBPs are also an effective recruiting tool to attract top talent to the company.


Dual retirement plan participation

If a business owner participates in another retirement savings plan, such as the company’s 401(k) plan, they are also eligible to participate in the company’s CBP. However, the contribution limit for the CBP is often three to four times higher than that for a 401(k). The contributions are tax-deductible to the company, saving thousands of dollars in annual taxes.


CBPs are easy to understand

CBPs are straightforward when calculating benefits since benefits are stated as a balance rather than calculated based on position in the company, years of service, etc.



Another feature of CBPs is that different participant classes with varying contribution levels can be set up – only some receive the same contribution. For example, the business owner, partners, or senior management may receive differing contributions.


Understanding the costs and risks of CBPs

While the CBP has several benefits, business owners must understand the associated costs and risks of this type of retirement plan. CBPs must be managed by a plan administrator, much like a 401(k), which incurs management and fund costs. However, CBPs also must utilize the services of actuaries, which come at an additional cost. Here are other risks business owners must be aware of before considering a CBP retirement savings plan:


Contributions, regardless of company profitability

When having a CBP, the company must commit to making annual contributions irrespective of their profitability, and there can be potential penalties if the plan is terminated early.


Liable for benefits

The company is also liable for ensuring funds to cover all accrued benefits, meaning that if the investments in the CBP underperform, the company is responsible for covering the shortfall. Companies should diversify their CBP investment portfolios or employ a liability-driven investing strategy to mitigate such risks.


Limitations on contribution limits

Like all retirement savings plans, CBPs also have IRS income limitations. Business owners must know the IRS limits, which may change occasionally. Also, the income of plan participants may change yearly based on factors such as company profitability tied to salary. For this reason, a yearly actuarial calculation determines how much each plan participant will contribute to the CBP.

Because CBPs can be complex, business owners must work with a financial professional who works with business owners, understands CBPs, IRS rules on this type of plan, and the various company retirement savings plans available. Because a business owner’s situation differs from others, they must also rely on tax professionals who understand the business owner’s unique situation.

In conclusion, CBPs are a retirement savings option that may provide substantial tax deductions, allow for rapid savings accumulation, offer asset preservation, and provide higher contributions for older workers. However, understanding the cost and potential risks is fundamental when implementing a CBP retirement savings plan. Therefore, before implementing a CBP retirement savings plan, business owners should consult with financial and tax professionals to understand the benefits and risks of CBPs and how to integrate this unique retirement savings plan into their broader retirement savings strategy.







Important Disclosures

This information was developed as a general guide to educate business owners and/or plan sponsors but is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, business owners and/or plan sponsors will be in compliance with ERISA regulations.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

This article was prepared by Fresh Finance.

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