Personal Cash Balance Plan™: How 99% Can ‘Avoid’ Mistakes

If you own your own business and don’t have employees, you may wonder how you’ll contribute to or catch up on your retirement accounts. If retirement isn’t too far off, an IRA won’t be enough to keep you afloat during retirement since the contribution limits are so low.

A personal cash balance plan could be a good solution. Here’s how it works and what you must know.

What is a Personal Cash Balance Plan?

Cash balance plans have a predetermined annual contribution or pay credit and a predefined rate. Unlike a 401K, the balance isn’t determined by an investment’s performance. There is a predetermined rate of return that is what drives investment managers’ decisions on what investments to consider.

At retirement, you can choose to take the funds as a lump sum or monthly payments. The limits for personal cash balance contributions are much higher than an IRA or 401K and depend on your age and goes up to $341,000 for 2022.

How it Works

Cash balance plans have hypothetical account balances. It sounds odd, but it’s based on the predetermined contributions and rate of return. They are not based on the actual performance of individual investments like a 401K.

The business carries the risk of making up the difference in the hypothetical account balance at retirement if the investments didn’t reach their full potential. All funds grow tax-free, and withdrawals are taxed at your retirement tax bracket.

If you choose a lump sum payout at retirement, you can roll it over into an IRA to avoid taxation on the full amount and control how much you receive throughout retirement.

The Benefits of a Personal Cash Balance Plan

Business owners greatly benefit from a personal cash balance plan because you can catch up on your retirement contributions quickly. If you didn’t contribute to your retirement accounts for the last few years while you set up your business, you may feel behind. The cash balance plan allows plenty of room to catch up.

As a participant, you don’t have any risk in how much is in your account at retirement, since it’s the business’s responsibility to make up the difference. Even though you are the owner, it won’t come out of your personal pocketbook, but instead, the business’s value.

Another benefit of the cash balance plan is the tax deductions. All contributions are pre-tax. This means your business avoids tax payment on the funds you contribute to your cash balance plan. Like we said earlier, the funds grow tax-free in your account too. You don’t pay taxes until you withdraw the funds.

chart with finance, tax and debt

If you have a pass-through entity such as a sole proprietorship or partnership, it decreases your tax liability personally since all taxes are passed through to you personally.

Finally, cash balance plans, like 401K accounts, are protected from creditors. This means if you or your business must file bankruptcy, your creditors cannot come after your cash balance plan. You’ll still be set up for retirement.

The Downsides of the Cash Balance Plan

It’s important to understand the good and the bad sides of a cash balance plan. While there are plenty of reasons to consider one, there are some disadvantages including:

  • There are strict IRS guidelines and regulations that can get confusing
  • Employers face high administrative costs
  • The plan could require large contributions which could be hard for the business to afford consistently

Who Should Consider a Cash Balance Plan?

Cash balance plans aren’t right for everyone, but here are some things to consider to decide if it’s right for your company.

  • You want to contribute more than $20,500 to your plan. If you need to catch up on retirement contributions, or worry about not having enough for retirement, a traditional 401K plan may not be enough. You can only contribute $20,500 with an additional $6,500 if you’re over age 50 in a 401K. The limits are much higher in a cash balance plan.
  • Your company has consistent cash flow. If your company is established and consistently earns profits, it can likely afford to pay the larger contributions toward your retirement. Not only will you set yourself up for the future, but you’ll also reduce your tax liabilities.
  • You are ‘older.’ Cash balance plan contribution limits are based on your age. The older you are the more you can contribute and like we said above, the limits can get as high as $341,000, which is much more than a 401K plan allows.

The Difference Between a Cash Balance Plan and 401K

You might wonder what the difference between a cash balance plan and 401K is since they sound so similar.

First, the contribution limits are vastly different. You can contribute much less to a 401K than you can a cash balance plan.

Second and most notably, there’s no guarantee on your 401K balance. It’s dependent on the market’s performance which means your balance and fluctuate considerably. There’s no guarantee you’ll have a set amount of money at retirement.

A cash balance plan has a guaranteed balance which becomes the business’s responsibility to make up the difference if the balance isn’t the promised balance at retirement.

Final Thoughts

A cash balance plan is worth considering if you are self-employed and don’t have a retirement account or even if you do. If you want to catch up your contributions or ensure you have enough for retirement while decreasing your tax liability, talk to your tax advisor about a cash balance plan.

While it has regulations that can be strict and require more work on your end, it can help you have the money needed for retirement, which is most business owner’s goals in owning a business – setting themselves up for the future.

Cash Balance Plan Minimum Contribution Guide [+ IRS Hazards]

The Cash Balance Plan’s minimum annual contribution is set by the employer, and is generally 5% of compensation. The employer may choose to contribute a different amount to each participant than the minimum required for each. The maximum contribution is $100,000 per year, which can be changed for different tax reasons.

The Cash Balance Plan must be amended within two and a half months before the start of the year, before an employee works 1,000 hours. In addition, if an employee does not work 1,000 hours in a plan year, the account must be frozen or terminated.

Cash Balance Plan Minimum Contribution

A cash balance plan requires an employer to contribute a certain amount to the account each year. The minimum contribution is usually $1,000 a year. Some employers make higher or lower contributions than others. The amount may be different for employees and business owners. It is important to understand that these contributions are subject to compliance testing.

The amount of the minimum contribution depends on the age of the participant and the amount of income the participant makes. For example, a business owner may be required to contribute $200,000 per annum.

Contributions are taxed the same as 401(k) plans. Depending on age, a business owner can contribute up to $250,000 per year to fund the maximum benefit limit. The amount of the contribution depends on the employee’s income and age.

How to structure a plan

If the business owner is younger than 50, the minimum contribution will be lower. An owner may make a smaller annual contribution than an employee. The maximum contribution depends on the age of the employee.

The minimum annual contribution in a cash balance plan is 3% of the participant’s annual income. The employer’s contribution is usually determined by the plan’s funding formula, and it varies from plan to plan.

However, the minimum contribution is a good starting point. It is important to remember that the cash balance plan minimum contribution is only the beginning. Once the account is funded, the employee can enjoy retirement without any interruption in his or her salary.

The cash balance plan minimum contribution is 3% of employee income. The employer’s contribution will be determined based on the employee’s age and the company’s size.

Many companies already offer a company retirement plan that offers an employer-paid contribution of 3% to 5% of employees’ annual salaries. As long as it passes the testing requirements, cash balance plans are a great option for business owners. If you have a small business, the minimum contribution is low.

The minimum contribution in a cash balance plan is generally set at 5% of salary. A small business owner can also make a maximum contribution of $100,000. A Cash balance plan is a good option if the employee’s income fluctuates greatly.

This type of plan is a tax-favored retirement plan. The IRS is likely to favor your contributions if they are in the correct tax bracket. If your employees’ earnings don’t increase significantly, the employer’s contribution can be reduced.

Funding the Minimum Contribution

The minimum contribution in a cash balance plan is calculated on a per-capita basis. If your salary is higher, you can make a smaller contribution. The maximum contribution amount in a cash balance plan can be lower than your 401(k) plan.

A minimum contribution is important for retirement planning. The IRS allows you to withdraw money from a savings account in a cash balance plan only when you need it.

Financial planning puzzle piece

A cash balance plan’s minimum contribution is set by the sponsoring company. A cash balance plan participant must pay a minimum amount of taxes to benefit from the tax-deferral provisions. The employer is solely responsible for the investment risk.

For a small business owner, the minimum contribution will increase over time as the profits from the cash balance account increase. This is why a minimum contribution in a cash balanced plan is an important part of the overall retirement plan.

Bottom line

As the minimum contribution in a cash balance plan is set by the employer, you will need to pay taxes on the earnings of your investments. The income tax you pay is paid after the tax-deferral period, which is why the cash balance plan minimum contribution is calculated annually by an actuary.

You must also pay the Medicare surtax, which is 3.8% of investment income. If you are a business owner, a minimum contribution in a cash balance plan is a good idea.

Defined Benefit Plan for the Self Employed: How to ‘Legally’ Structure

There are several benefits of a defined benefit plan for the self-employed. Benefits are guaranteed, contributions are fixed and employer responsibilities are clearly defined. It can be an effective tool for recruiting and retaining key employees.

It requires a steady cash flow to support high contributions and administrative expenses, such as consulting fees. But it isn’t for everyone. Read on to learn how defined benefit plans work and why self-employed should consider one.

One of the benefits of a defined benefit plan for the self-employed is its ability to allow you to make large deductible contributions. Whether you choose to front-load your contribution stream depends on your income and business. If you have a strong year, you may opt for a higher contribution amount than you expected to earn.

Can a self-employed person have a defined benefit plan?

You can also front-load your contribution stream to match tax deductions with your expected income. You can also vary your contributions based on your business income to minimize taxable income.

Another benefit of a defined benefit plan for the self-employed is its ability to provide substantial tax savings. Because payroll taxes are based on wages paid, a higher amount of money can go into the plan. Because of these advantages, a defined benefit plan may be a worthwhile investment for a business owner.

Another benefit is that contributions to a defined benefit plan can be tax-deductible as business expenses. Combined with other retirement options, a defined benefit plan can provide a higher annual retirement income while reducing the risk of lawsuits.

A defined benefit plan for the self-employed is a great way to maximize your retirement savings. Unlike a traditional retirement plan, a defined benefit plan can be more complicated to set up and administer.

But if you make a lot of money, a defined benefit plan may be the best option for you. It has the benefit of allowing you to catch up on your retirement savings. When you start to plan for your future, the benefits can be great.

Defined benefit plan providers

A defined benefit plan for the self-employed is an excellent way to provide your employees with a solid retirement income. Self-employed physicians typically set up defined benefit plans to protect their incomes.

In most cases, the monthly benefit is fixed, but most of these plans do not include cost-of-living adjustments. Therefore, it is important to understand the details of the plan before signing up for a defined benefit plan for the self-employed.

Final thoughts

Unlike a pension plan, defined benefit plans do not fail and cannot retroactively decrease benefit amounts. In fact, one type of defined benefit plan pays a monthly income equal to 25% of the average compensation of the individual.

For example, an employee earning $60,000 a year would receive $15,000 in annual benefits. Monthly benefits would equal $1,250. The benefits begin when the employee reaches a specific age or dies.

Is a Cash Balance Plan Reported to the IRS? Surprising Answer

Cash balance plans have been a favorite retirement structure for many years. But many people wonder if a cash balance plan is reported to the IRS?

This is an important question. While on its face it might not sound that important, people often think these plans can get them audited. They are sometimes very surprised that they can make such a large tax-deductible contribution.

In this post, we will take a look at 4 specific ways that the IRS is notified of your cash balance plan. Let’s get started.

Is a Cash Balance Plan Reported to the IRS?

But the truth is that they’re only tax deferrals. At some point down the road, you’re going to pay tax on the money. So, the IRS is going to get paid, but it’s just going to have to wait a while.

Your third-party administrator isn’t going to directly notify the IRS that your plan is set up. But there will be several ways in which the IRS is notified.

When the administrator gets the EIN

When you set up your plan, you gave the administrator likely a limited power of attorney. This was enabled on form SS-4 them to go directly to the IRS and obtain a tax ID number for the plan. This is also called a plan EIN

The administrator submitted an online application for the EIN. They told the IRS the name of the plan, the company that is sponsoring the plan (you), the company address, and also the fact that you were setting up a tax-exempt retirement trust.

So, in theory the IRS is aware of the plan. I’m just not so sure they do a good job of reconciling EINs back to tax returns filed or other information they may have. Remember that if a balance in a cash balance plan (or combined plans) is less than $250,000 they’re not required to file a form 5500-EZ with the IRS. So, the IRS doesn’t really do a good job of reconciling EINs to plan tax returns filed.

Preapproval document

Some people believe that the IRS is notified when the actual cash balance plan is established. This is often the assumption because during the set-up process, they may have received an IRS preapproved plan document letter.

Well, most cash balance plan administrators use a preapproved prototype plan. In essence, this plan has been approved by the IRS as an acceptable template to create a cash balance plan. But the IRS is not approving information input into the form like pay credits, interest credits and other technical aspects of the plan design.

So even though you may have a custom, tailored plan. It is still generated on the IRS approved template. The IRS will typically issue the document provider a preapproval form which is then often distributed to companies they set up plans for.

chart with finance, tax and debt

As such, many companies confuse this IRS approval letter with the actual filing of the cash balance plan document. But this is simply not the case. The TPA and the company are not required to notify the IRS when the cash balance plan is established.

Of course, the company is required to maintain all applicable documents, forms, and supporting documents in case of an audit. So of course, there needs to be an actual legal document. 

On the tax return

When the tax return is filed there is an IRS prescribed category called pensions, profit-sharing and other qualified plans. As such, if there is a number on this line (on the Schedule C, S-corp, Partnership or C Corp tax return) you would assume the IRS is notified.

But this line encompasses a lot of other retirement plans. In fact, most of which are defined contribution plans.

So, the IRS isn’t really able to break out the components of this line and tie it directly to a cash balance plan. Presumably, the higher the deduction is the more likely it is for a defined benefit plan or cash balance plan structure.

When a 5500 is filed

As we’ve stated before, a plan is required to have a 5500 filed each year if it is a group plan. But if it is a solo plan it only needs to be filed if it meets the $250,000 threshold.

Even though you have a plan EIN, it is not actually reported on the form 5500. However, you’re required to report the EIN for the business itself. So the IRS is being told that this specific company has a cash balance plan.

Bottom line

So there you have it. We have outlined 4 specific ways that a cash balance plan is reported to the IRS.

Don’t feel like the IRS is going to audit you because you have set up a plan. The reality is that the plans are a tax deferral and not tax avoidance. The IRS will get it’s tax revenue at some point. They may just have to wait awhile.

Cash Balance Plan Rules & Requirements

A cash balance plan is like a pension, but with a few differences. It’s an employer-sponsored plan like a pension, and it provides employees with the option for a lump sum payment upon retirement or a lifetime annuity.

Each eligible employee has an individual account with the projected lump sum amount that they should receive upon retirement with the option to select lump sum payment (if there are sufficient assets) or a lifetime annuity payment.

All contributions grow tax-free, but like a traditional retirement plan, withdrawals are taxed at the current tax rate.

The Hypothetical Account

Each cash balance plan has a hypothetical account for each eligible employee. The cash balance plan administrator oversees the accounts. The employer pays a ‘pay credit’ which is a percentage of the employee’s salary plus a predetermined interest rate.

The employer sets the interest credit rate. An employer can choose a fixed interest rate or variable. If they choose a variable rate, it’s tied to an index and varies along with the chosen interest rate.

The main difference between a 401K and a cash balance plan is that the interest credit is guaranteed. In a 401K account, the balance is dependent on the investment’s performance which can mean gains and losses throughout the time you have the account.

The Maximum Amount

The maximum amount allowed for cash balance plans varies by year. In 2022, the limit is $3.15 million. The goal of an employer should be to fund accounts to the maximum in 10 to 12 years to meet the maximum limit.

Most cash balance plans are fully funded by the time the owner or employee is 62-years old and the withdrawals can be a lump sum or an annuity payment each year.

In some cases, though, the cash balance plan is in addition to a 401K plan so it may not have as high of a balance.

Employers must meet the funding requirements to qualify for the tax deduction. They are required to make a minimum contribution amount each year and can have an age limit of 21. Some plans can exclude some employees, so it is important to determine which employees are eligible before you start the process.

However, you should remember that a cash balance plan can only be funded if the owner and employees are both eligible. So, if you’re considering a cash balance plan for your business, you should make sure you understand what you’re signing up for.

Can Employers Offer a 401K Plan and a Cash Balance Plan?

Yes, employers can offer multiple retirement account options including a 401K plan with a cash balance plan add-on.

The limits for the 401K versus the cash balance plan vary greatly.

In 2022, the maximum 401K contributions are $20,500 with an additional $6,500 catch-up contribution allowed for employees over 50-years old.

The limits for the cash balance plan are based on the total lump sum limit allowed for withdrawal, which is $3.15 million or $245,000 annuity payments.

Cash Balance Plan Vesting

Cash balance plans can have a vesting period of up to 3 years. This means employers can require 3 years of employment before an employee is vested. At the end of the 3 years, the employee is then 100% vested.

If an employee leaves the company before the 3 years is up, he/she completely forfeits the cash balance plan, and the employer uses the accumulated funds to offset future cash balance account requirements.

Employers aren’t required to instill a 3-year vesting schedule, though. It us up to each employer.

Cash Balance Deadlines

Cash balance contributions by an employer are due by the earlier of the following:

  • Business tax return due date with extensions
  • 8 ½ months after the end of the plan year

Contributions are required annually and typically stay the same unless there are major fluctuations in your annual income and/or the investment performance.

Investing the Assets

As an employer, you can choose where to invest the assets, keeping in mind the typical interest rate credit. Most cash balance plans pay an interest rate credit of 4% – 6%. This means your returns must equal at least that much. If they don’t, you must make up the difference with your contributions.

It’s important to understand that employees don’t have individual investment accounts with a say in where the assets get invested. All funds are in a ‘pooled’ account in the name of the cash balance plan.

The employer funds the account annually to ensure there are enough contributions to meet the hypothetical account balance. The plan advisor manages the investments to ensure the return is at least as much as the interest credit promised to each employee.

Most plan advisors use the following guidelines:

  • Keep a conservative portfolio to prevent large losses from occurring, putting the responsibility on the employer to make up the difference for the promised amounts
  • Don’t overgrow the account so that the balance is higher than the necessary balance for eligible employees

The target return is 5% for most cash balance plan investment accounts.

Terminating the Cash Balance Plan

The cash balance plan is a defined benefit plan which means that it’s permanent. Typically, you cannot terminate the plan unless you have a major change in your business including:

  • Restructuring your business
  • Changes in the law
  • Financial issues
  • Replacement with another benefit plan

Tax Benefits

Business owners reap the tax benefits of a cash balance plan because they make the contributions. The contributions are made pre-tax, and any contributions made for employees (not owners or partners) can be deducted. However, if the company is owned as a corporation, even the contributions for owners and partners can be deducted.

All contributions grow tax-free while they remain in the account. Once withdrawn, they become taxable though.

Final Thoughts

The cash balance plan is an alternative to the defined contribution plans, or it can be used in conjunction with it. The cash balance plan has replaced traditional pension plans in most cases and gives employers a little more leeway when preparing themselves or their employees for retirement.

There are vesting requirements, deadlines, and contribution limits you must abide by along with rules regarding what you must offer your employees once you commit to the cash balance plan.

Cash Balance Plan Withdrawal Options: Mistakes to ‘Avoid’ [+ Pitfalls]

Most people with cash balance plans are excited to make the contributions. They want the large tax deductions. But how much do you know about the cash balance plan withdrawal options?

If you have a cash balance plan, you have a few options for withdrawal. Like a 401K, you must be of retirement age according to the plan documents and you must be vested, which by law can be no longer than 3 years.

With a cash balance plan, you get paid a ‘pay credit’ which is a percentage of your salary that remains the same each year. You also receive an interest credit which is predetermined by your employer and also doesn’t change.

The employer takes the risk of the investment performance. You don’t have to worry about whether an investment performs or not. The employer takes that risk and must make up the difference if there is an imbalance.

But how do you withdraw your funds? We discuss your options in this post.

Early Withdrawal Options

While the goal is for you to stay at the same company through retirement, we rarely see that anymore. Unlike traditional pension plans, though, cash balance plans can move with you.

If you make a withdrawal and keep the money, you will pay tax on the distribution. In addition, you will have a 10% early distribution penalty. While 20% of your funds are withheld, you still owe taxes and penalties, which will likely be more than the 20% withholding.

If you leave your job after the vesting period (usually 3 years), you can roll over the balance into an IRA or a 401K at your new job if they’ll allow it. Unlike a 401K, most companies don’t allow you to withdraw funds early for personal use, aka not roll them over into a qualified plan.

The nice thing about rolling the funds over is you don’t have to worry about taxes. You don’t owe any taxes on the contributions or earnings until you withdraw them for personal use during retirement.

If you are eligible for any early withdrawals that you don’t roll over, you will pay taxes at your current tax rate on the earnings.

Getting Around the Early Withdrawal Rules

If your cash balance plan doesn’t allow for early withdrawals but you need one, there is a way around it.

If you transfer the funds to an IRA or 401K when you change jobs, you have more access to the funds. While it’s not recommended, you can take an early withdrawal before age 59 ½ from either an IRA or 401K.

cash balance plan withdrawal options

You’ll pay a 10% penalty charge plus you’ll pay taxes at your current tax rate. Since most people are at a higher tax rate now than they would be during retirement, you’ll likely pay higher taxes taking this route so only withdraw funds early if it’s absolutely necessary.

Lump Sum Withdrawal at Retirement

The lump sum withdrawal is often the most common method for the cash balance plan and sometimes it’s the only option employers allow.

A lump sum withdrawal means you can take the entire balance of the account at retirement and invest it how you want.

The Risks of Lump Sum Withdrawal

It’s important to consider the risks of the lump sum withdrawal. Because you’re receiving the entire amount at once, you could blow through it and have nothing left during retirement. That’s something you have to be able to manage and know that you won’t overspend.

You also have the option to reinvest the funds. That has its pros and cons as well. The benefits, obviously are that you can increase your earnings, ensuring you have enough for retirement. The downside, though, is that you could make poor investment choices and lose more money, decreasing the amount you have for retirement.

Annuity Payments

If your employer allows it, you may also elect annuity payments. This means you’ll receive equal payments monthly for the remainder of your life.

With an annuity payment, there is less risk of using the money incorrectly because you won’t receive it all at once. Instead, you’ll receive level payments that help you cover your monthly cost of living.

The Risks of Annuity Payments

Even annuity payments have their downsides. Even though the payments are guaranteed for life, there isn’t a guarantee the company will stay in business. While cash balance plans are covered by the Pension Benefit Guarantee Corp, they limit their coverage to a specific monthly amount which might mean you don’t receive the full payments you’re entitled to receive.

Cash Balance Plan Withdrawal Options

If your employer doesn’t have an annuity option, you can work around it. First, take the lump sum distribution and roll it into an IRA.

Next, you’ll buy an immediate annuity. This product, which you get from an insurance agency, begins paying you monthly payouts immediately. You get guaranteed income monthly, which is much like what the annuity would have done for you if your employer offered it.

Keep in mind, the immediate annuity is not a tax-sheltered investment, though.

If you don’t use the entire amount to buy the annuity, you give yourself the best of both worlds. You get the traditional monthly payment, so you have some guaranteed income plus you have a cushion.

You can invest the remaining funds either in an IRA or other type of investment, however, an IRA would be tax sheltered, triggering a tax liability only when you withdraw funds.

Taxable WithdrawalTax-Free Withdrawal
Conversion to RothRollover to IRA
Distribution Upon RetirementQualified Plan Rollover
Reversion for OverfundingRollover to 401(k)

Final Thoughts

You have options when withdrawing money from your cash balance plan. Ideally, you’d leave the funds until you retire and take either a lump sum or annuity payment.

How you take the funds depends on how you plan to manage your money. If you’re good at managing investments, you may consider rolling it over to an IRA and taking withdrawals as needed. This way your money can still grow while you have enough money to live off of monthly.

If you aren’t good at managing funds or want a guaranteed monthly payment, the annuity option can be a better choice. Either way, make sure you understand the tax liabilities of taking the funds and try to avoid withdrawing funds before retirement age, so you don’t lose 10% of your balance to the penalty charges.