Cash Balance Plan Illustration: Our #1 Design [+ IRS Red Flags❌]

What if you were able to get an extra $189k into retirement and get a tax deduction? Well, we can show you how one client did it with our cash balance plan illustration and example.

We speak with both small and large business owners (including independent contractors) on how they can improve their retirement situation and save a bit on taxes. I strive to help them with both goals.

So, with that said – let’s look at one cash balance plan example and the financial benefits.

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Some background

When I look at retirement examples, there is no one size fits all. There are many plans with different pros and cons. But one thing is for sure – the cash balance plan is an often-overlooked solution. If a business owner has no employees (or just a few) then there are a couple great solutions.

Typically, I would do a 401k plan (with a basic profit-sharing component) in addition to a cash balance plan. Most folks can grasp the details of the of the 401k, but the cash balance plan is a different animal. Let’s examine a real life cash balance plan example.

  • There is often confusion surrounding cash balance plans. They are technically a type of defined benefit plan. Annual contributions are based on a variety of factors. This includes yearly compensation, age, length of service, and potential employment factors.
  • Cash balance plans are qualified plans. As such, they will qualify for tax deferral status. So you can contribute to the plan, take a tax deduction, and defer any account appreciation into the future.
  • They are not subject to the traditional contribution limits associated with 401k plans.
  • Creditor protection is afforded to qualified plans. This protection comes under ERISA. This comes in handy when subject to bankruptcy and lawsuits.
  • They work great for sole proprietors, S-corps and C-corps. It also works similarly for a partnership.
  • Ability to combine with other retirement structures, such as a 401k, profit-sharing plan, or even an IRA.
  • Solo cash balance plans can use the Mega Backdoor Roth.
  • They allow for portability. If employees leave the company, they are able to take their vested assets to another plan or roll them into an IRA.
cash balance plan illustration

In most cases, business owners make a cash balance plan contribution to lower their taxable income. For example, a 55-year-old physician earning $450,000 annually might have a salary of $250,000 and contribute $200,000 to a cash balance planlan contribution.

The contractor

This example is not that uncommon. The client is a 54 year old contractor with a thriving construction business. As I have said before, it doesn’t really matter what business the client is in as long as the circumstances make sense.

He is married with two children in college. He has accumulated $425,000 in retirement, which is short of his needs based on his spending level and expected retirement age.  Like a lot of self employed folks, he lives a modest but comfortable lifestyle and understands that he needs to buckle down and start maximizing his retirement contributions.

The contractor had no full-time employees since he acted as a general contractor and only used independent subcontractors. Since he was the only qualifying employee, the cash balance plan was a great solution.

His business is structured as an S corporation and he was paid officer compensation of $180,000. He was already contributing to a solo 401k and his retirement holding were divided between the 401k and a rollover IRA.

Cash balance plan illustration

The plan example

There is no need to touch the solo 401k. Because he is over age 50, he can contribute up to $24,000 annually. With the profit sharing, he can contribute an additional 25% of his W2 income. The profit sharing will be limited to 6% though when combined with a cash balance plan. But in any case, I would just leave this in place as is.

So, the goal was to supplement the solo 401k with the cash balance plan. You are allowed to have both plans in place, subject to the profit-sharing contribution limitations previously discussed.

One little known fact is that most cash balance plans have a 401k plan attached. Let’s take a look at what the combined plans look like.

The cash balance plan illustration

A cash balance plan is technically a defined benefit plan. But it acts somewhat like a defined contribution plan ( i.e. 401k).  This is why many refer to it as a hybrid plan.

A cash balance plan will create individual accounts for each employee, and it will also specify a lump sum account balance. But for the owner, it allows for substantially higher contributions than any 401k plan.

This is a great benefit to many business owners who have either fallen behind in retirement contributions or have increased income and are looking for a tax deferral. Contribution limitations are based on income and age and can be in excess of $250,000 for certain highly compensated, older employees.

Sample Illustration #1

Sample Illustration #2

Sample Illustration #3

The illustration result

Now let’s get back to the example. We started off by contributing $24,000 into the 401k plan and an additional $10,800 as a profit-sharing contribution. This part is straightforward, considering the 6% limitation on the profit sharing.

But that is just a start. We were then able to contribute $154,000 into the cash balance plan. The combined total for the two plans was $189,000. Assuming a combined federal and state tax rate of 40%, the result was $75,000 in tax savings. Good news for a business owner looking to maximize retirement contributions.

The contributions allowed in cash balance plans are great, but the tax savings are even better. When high income business owners and independent contractors are looking for a tax shelter this can be a great solution.

But this is only one cash balance plan example. Every client has different retirement needs and goals. But the end result is to listen carefully to your client and design a retirement strategy that fits.

Let’s look at the details

There are a few deadlines of the cash balance plan illustration that you will want to keep in mind.  For tax deduction purposes, any contributions to the cash balance plan must be made by the employer by the tax due date or by the extended due date of the employers tax return.

The required minimum funding contributions of a cash balance plan must be made at least within 8 ½ months following the plan year end. This cannot be any later than the last day of the tax year.

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Can you rollover a cash balance plan? Yes. Cash balance plans can be rolled over into an IRA upon certain qualifications. The most common circumstance that this may happen will be when terminating the plan. Just like a 401(k), when you switch employers, you have the ability to rollover your plan balance into an IRA (Individual Retirement Account).

Age = 50Cash Balance Structure
W2 Compensation$100,000
Maximum Contribution$243,000
Base Contribution$98,000

How to complete a cash balance plan illustration

The following are five steps to consider when completing an illustration:

  1. Interview the client

    Determine the client’s financial goals and requirements. Client needs can vary significantly. A good prospect is one who has high, consistent income and can commit to funding a plan for 3 to 7 years. But each client situation is unique. So make sure that the client understands the pros and cons of the plan structure once they review the examples.

  2. Consider combining with a 401k plan

    Most cash balance pension plans are combined with a 401k plan. This will provide funding flexibility. But be careful because these plans do not combine well with SEPs or SIMPLE plan structures.

  3. Consult actuary on examples

    The actuary will provide the necessary benefit information based on interest credit rate, age and compensation. As a guide, the employer can exclude part-time employees and certain other employees but will need to contribute approximately 5 to 7% for the remaining employees to pass the rules.

  4. Verify that funding requirements are met

    Once the actuary has provided input, ensure that funding goals are met, and illustration is consistent with client expectations. Remember that a hypothetical cash balance account is established for each employee when they participate in the plan. Generally, the account balance starts at zero. Each year pay credits and interest credits are added to the beginning of the year hypothetical account balance.

  5. Review with client.

    Make sure to answer all client questions and determine if modifications to the illustration are required. It is best to also discuss the examples with the CPA and financial advisor. Remember that the vast majority of financial professionals know very little about these plans. So an onboarding call can ensure that everybody understands how the plans work.

Large tax deductible fundingHigher fee structure
$100k plus contributionsPlan combination limitations
Flexible funding rangeRequired funding
Custom plan structureBest for owner-only

Bottom line

This example shows what can be done with cash balance plans. Whether you are a large company or a small independent contractor, all it takes is a little planning and right team.

Paul Sundin

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4 thoughts on “Cash Balance Plan Illustration: Our #1 Design [+ IRS Red Flags❌]”

  1. I currently am the owner of a management company in which my wife and I are considering dissolving and or retiring from. My desire is to transfer (Custodian to Custodian)the cash balance assets into a Roth IRA or our Company’s Roth 401k. I think paying the tax now may be better than tax increases being proposed. We don’t need the money now and would like the growth to be tax free. Is this the right strategy?

    • Hi Charles – you can do this but is it the correct option? It just depends on how much you have in total in your retirement plans as well as your other investments. Of course, you do pay the tax immediately which is big downside. But the money will grow tax-free and is not subject to RMDs. So it does make sense in certain situations. I would have your CPA look at your tax bracket and run a few scenarios.

  2. Paul,

    Considering a Cash Balance plan for my 1099 business. CPA mentioned it as option for our tax stucture.
    Question: What type funds is it usually invested in? I don’t understand the
    employer 4% rule.

    • Hi Cynthia – As far as investments are concerned, you have the flexibility to invest your funds as you see fit. You can invest in basically anything you want. Most people will do stocks, bonds, mutual funds, CDs etc. But you can also do real estate, etc. The big issue is that if you do real estate, you need to make sure that you can give our actuary a value at the end of the year. We need to have a fair market value of all assets in the plan as of the end of the year in order to run our calculations.

      I am not exactly sure what you mean by the 4% rule. Are you talking about a safe harbor match of 4% for employees? Possibly you are talking about the 6% rule whereby your profit sharing contribution is limited to 6% when you combine a solo 401k plan with a cash balance plan.


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