What Employers Need to Know About Cash Balance Plans

Employers who have maximized their 401(k) profit-sharing plans and are seeking additional contributions to reduce their tax liabilities should consider the advantages of cash balance plans. Offering a cash balance plan along with a 401(k) can help employers maximize their retirement contributions and gain valuable tax benefits. Here is what employers should know about cash balance plans and how they can enhance retirement strategies. 

What Is a Cash Balance Plan? 

A cash balance plan (CBP) is a defined benefit plan that looks and feels more like a profit-sharing plan. Employers who sponsor cash balance plans can generally deduct much higher contributions than with a 401(k) profit-sharing plan alone. Any type of business can set up a cash balance plan, including corporations, sole proprietorships, and partnerships, and there is no minimum or maximum employee threshold.  

How Much Can You Contribute to a Cash Balance Plan? 

Annual contributions to cash balance plans are determined based on age, income, and investment performance in the plan, and contribution limits are much higher than those of a 401(k) plan. The IRS has set up benefit limits so that an individual can accumulate $3.5 million in a cash balance plan by age 62.

Below are the maximum contribution limits for individuals in 2024: 

*The CBP contributions above are based on a normal retirement age of 62. Actual contribution amounts may vary.  

Maximizing 401(k) Contributions Alongside a Cash Balance Plan  

Cash balance plan contributions are made on a pre-tax basis, and the funds grow tax-deferred until an individual distributes the money in retirement. Employer contributions to cash balance plans are deductible as business expenses, resulting in significant savings for employers.  

Owner's spouses can also be included in the 401(k) profit-sharing and cash balance plans if they work in the organization and earn a salary, which may allow them to contribute even more income on a tax-deferred basis. 

How Does a Cash Balance Plan Work?  

Cash balance plan participants are required to make annual contributions, which are determined by an actuary and based on the participant’s income. Once the participant’s yearly income is known, an actuarial team calculates a deductible contribution range, and plan participants have a “hypothetical account” credited with a pay credit and an interest credit each year. The pay credit is typically a percentage of the participant’s income, and the interest credit is generally between 4% and 6%.  

Plan trustees work with their investment advisors to determine their best investment strategy. Remember that the account should earn a moderate rate of return to match the interest credit in the plan (4%-6% annually in most years), as widely fluctuating investment returns will impact annual contributions. Contributions should not fluctuate much yearly if there are no significant fluctuations in investment performance and annual income. 

Terminating a Cash Balance Plan 

Cash balance plans are defined benefit plans that are required to follow a permanency requirement. However, the IRS guidance states that a plan may be terminated for a legitimate business reason, including business restructuring, a change in law affecting qualified plans, the substitution of another plan, and financial hardship. 

Addressing Risks and Underfunded Plans 

Cash balance plan assets are qualified plan assets that are eligible for annuity payouts at retirement or lump sum distributions that can be rolled over to an IRA or 401(k) profit-sharing plan. If the plan is underfunded at plan termination, employers will typically have two options: 

1. Make an additional contribution to cover the shortfall, or  
2. Waive their benefits to the extent that the plan is underfunded.  

Contributions to a cash balance plan are usually required each year until the plan is terminated. The IRS requires the plan to be established with “permanency” in mind, and contributions may fluctuate from year-to-year based on the plan’s investment return. It is important to work closely with your investment advisor to set up the proper mix of investments to avoid any unwanted fluctuations in contribution levels. 

Adding a cash balance plan along with a 401(k) plan does add administrative complexity. As with a 401(k) plan, organizations must work with a third-party administrator to set up a cash balance plan to prepare the documentation, provide ongoing administration, and advise on ideal employer contribution levels to make the most of their plans. It’s essential to work with an administrator you’re comfortable communicating with as questions arise and help you understand how your cash balance plan works to reap all the benefits it offers.