5 Brilliant Cash Balance Plan Strategies for the Sole Proprietor

What if you could boost your retirement savings by an extra $1 million? Not a bad deal.

Cash balance plans allow significant retirement contributions for sole proprietors. They are technically defined benefit plans. But they have some characteristics that are similar to a defined contribution plan. Accordingly, they are often called hybrid plans.

But questions arise. What type of companies are good candidates for cash balance plans? What professions make the most sense for cash balance plans? Will a cash balance plan make sense for my business?

The truth is that many business types and professionals are ideal candidates for cash balance plans. The following are the top 5 candidates for cash balance plans:

  1. Companies with consistent profits (historically and forward-looking)
  2. Professional service businesses (doctors, lawyers, CPAs, etc.) and service proprietorships
  3. Companies looking to improve morale and employee retention
  4. Owners trying to “catch-up” on retirement savings
  5. Owners looking to maximize tax deductions

Consistently Profitable

The truth is that you don’t have to have high profits for a cash balance plan to make sense for you. But of course, it helps.

Companies who have consistent profits are excellent candidates. If your business is very cyclical and subject to boom years as well as bust years, it can be more challenging. In reality, even a company with inconsistent cash flows can do very well with cash balance plans, but it just becomes more difficult when times are challenging.

Ideally, consistently high cash flows and the assumption of decent cash flows over the foreseeable future make the most sense under the rules. We have seen companies in manufacturing, distribution, real estate and a variety of service businesses. If a business owner makes more than $200,000 a year, it might make sense to consider.

A cash balance plan falls under define benefits plan rules, but maintains individual employee accounts like a defined contribution plan. A cash balance plan for a sole proprietorship is meant for an individual with stable surplus income or recurring consulting income, who is interested with making sizable retirement contributions. A cash balance plan allows one to save over $2.9 million towards retirement.

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A sole proprietor cash balance plan is commonly classified as a hybrid plan as it resembles a 401 (k) plan. A participant’s account earns a pay credit, normally 5% of their salary each year, plus an interest credit, at a fixed rate or variable rate on the account balance. If a plan is terminated, one can move their funds to another tax-advantaged account in order to defer tax until they formally take a distribution.

Qualification for a Sole Proprietor Cash Balance Plan

To qualify for a sole proprietor cash balance plan, the following criteria should also be met:

  • Owner of an unincorporated business that employs only the owner and spouse.
  • Partner in a partnership that employs only partners or partners and their spouses.
  • Sole owner of a corporation (or an LLC taxed as a corporation) that employs only the owner and spouse.
  • Owner of the company who meets the above requirements and employs part-time employees, but all of them have not met the 1,000 hour requirement during the year.

How to Start a Sole Proprietorship Cash Balance Plan

  • Adopt the Plan. Have the administrator draft a legal document outlining all the plan details, the contributions to be made and the interest rates.
  • Establish a Plan Account. Open a sole proprietorship cash balance plan account. If the plan accommodates the spouse or partners and their spouses, one account will be used to pool the contributions.
  • Get the Numbers. Determine the amount of plan funding considering the age, compensation, plan document, actuarial assumption, and IRS regulations. Your plan actuary will assist you with this.
  • Fund the Plan. After determining the contributions by the plan actuary, you can deposit fund into the sole proprietor cash balance plan account. Please note that your contributions must be made by your business tax filing deadline, including extensions. The deadline is April 15, for unincorporated businesses including extensions, and March 15, including extensions for corporations and LLCs, organized as corporations.
  • Look for a third-party administrator (TPA) to administer the plan. This is an organization specialized in offering services on pension plans. Managing the plan activities can be challenging, so the third-party administrator can handle much of the hefty administrative work so you can concentrate on the investments.
Cash Balance Plan Sole Proprietorship

Maintain the Plan

Your plan will be funded annually. Ensure that you consult with the actuary before making contributions and ensure that he or she approves the numbers. Give him or her the earnings information and any changes to earnings. The IRS will require that you file Form 5500 annually and an Actuarial Certification.

Paul Sundin

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4 thoughts on “5 Brilliant Cash Balance Plan Strategies for the Sole Proprietor”

  1. What happens if I can’t fund the plan? How many years do I have to fund it? I am a consultant and my income should be consistent over the next several years but after that I am not sure. I am just not sure how much flexibility I have.

    Reply
    • The plan is permanent but that doesn’t mean it has to stay open forever. You can terminate it and roll it out into an IRA if you like, but you should at least try to keep the plan open for a few years. Our plans will provide some flexibility. You have a targeted amount, but you can always fund at a minimum level if you like. You also can control your contribution a bit by controlling your compensation or business income (if you are a sole proprietor) or even your interest crediting rate. So you do have options. Take a look at this article for a few ideas https://emparion.com/cash-balance-plan-minimum-contribution/

      Reply
  2. Hi Paul,

    I have W2 income through an employer as well as 1099 income on the side ($150k). I am planning on opening a solo 401k for my 1099 income but have been reading more about cash-balance plans. Question – at what 1099 income level would it make sense to try and open a cash balance plan? I imagine this may depend on age, etc, but is there a general sense/level of income where one could truly derive benefit in a scenario such as this? I am hoping to combine a solo 401k and CBP for my side income, but not sure if it makes sense if there is an income/percentage limit. Thanks for your time.

    Reply
    • Great question Red. The older you are and the higher your income the more a cash balance plan makes sense. For example, let’s assume you have high W2 income. With your $150k of 1099 side income you could probably contribute $100k or so with a combo plan if you were say 55 years old plus. But if you were 35 years old the number is probably half that. You have to also consider heavily your tax bracket. People in high taxing states like California and New York are in much higher overall brackets so the plans can make more sense. But our average client probably saves 40% in taxes. You can always have us run a free illustration for you and you can see what your numbers would like like. You can use this link https://emparion.com/free-cash-balance-plan-design/

      Reply

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