How to Set Up a Cash Balance Plan: 5 Start Up Steps [+ Who Can Manage]

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If you are wondering how to start a retirement plan and setting aside some money, a cash balance pension plan may be for you. In this post, we will examine how to set up a cash balance plan in 5 simple steps.

Cash balance plans have been gaining momentum in the recent years as employers try to lure key talent to their companies. With proper management, a cash balance plan is a great way for small-scale businesses and companies to substantially boost their retirement savings, to lower their tax payable and offer employees better retirement funds.

Who can set up and manage a cash balance plan? We’ll answer this question as well. Let’s dive in!

Who can set up and manage a cash balance plan

Why a Cash Balance Plan?

A cash balance plan is a defined benefit plan but highly resembles a defined contribution plan, gaining the name “hybrid” plan. It was considered extinct some years back until the Pension Protection Act of 2006 was enacted, shading light to what cash balance plan needed to get IRS approval.

Cash balance plan rules allows for high contribution to your retirement, well over $100,000, way higher than roughly $50,000 for 401(k) plans. This is possible for key employees nearing their retirement age, 50 years and above, with cash balance plan, 20-year savings could be done with less than 10 years.

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Another reason to go for the cash balance plan is for the tax deduction. Contributions towards a cash balance plan are deductible for the employers, which could range from $50,000 to $250,000 per year depending on age and income levels of plan participants.

How a Cash Balance Plan Works

An employee’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 your account balance. As pointed out, increases or decreases in a portfolio’s value does not affect the contributions, and the employer is the one bearing this risk.

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A participant under a cash balance plan receives benefits defined in terms of their account balance. Assuming an employee has $100,000 by the age of 65 and decides to retire, they will be entitled to an annuity based on this balance, which is about $8,500 annually for life. The company will be able to manage the plan assets.

How to Set Up a Cash Balance Plan

Starting a cash balance plan may be easier than you thought. We will break out below the 5 steps that are involved in plan set up. The key is to make sure that you have a quality third-party administrator that can help you set the plan up and work with you on plan design.

  • Get a financial advisor and/or a CPA. First, get a financial or tax adviser as they can help you navigate the process. The adviser will collect relevant employee information such as ages and their salaries. This information is used to calculate the amount to be contributed to the plan for business owners and executives, and how much to contribute to the employees. IRS requires that a plan passes non-discriminatory testing in terms of favoring owners and key employees.
  • Draft the plan document. Put together a legal document outlining all the plan details, the contributions to be made and the interest rates. The document is to be signed by the end of a tax year that the company wants to take the deduction.
  • Make required contributions. Make contributions by the due date of your tax returns. If an extension is obtained, contributions should be made not later than eight and a half months after the year ends.
  • Establish a monitoring process. You should have standards to ensure that your business will be able to meet the yearly contributions. Continuous reviews should be done on the returns made by plan assets and make a decision to change the interest rate, to amend or freeze the plan before the plan becomes a liability to the employer. The plan can be terminated in certain situations and the plan assets distributed.
  • Find a quality third-party administrator. Look for a third-party administrator (TPA) to help manage the plan. This is an organization specialized in offering services to other companies on pension plans. Managing all plan activities may be a hard task for you and you must have an actuary involved. Therefore, contract a third-party administrator to handle much of the hefty administrative work so you can concentrate on the remaining investment work.
Pros ✅Cons ✅
Tax deductible fundingPermanent plan structure
Flexible min/max/target contribution levelsMandatory annual funding
Large (sizable) annual contributionsHigher plan fees

Who can set up and manage a cash balance plan?

The cash balance plan is funded by the employer. Depending on your age and business income, a cash balance plan can have contribution levels as high as $3 million.

A cash balance plan is a great pension option for your company. It offers accelerated retirement savings and increased tax deductions. But it might not be the best option unless you make a constant cash flow or profit margins annually.

While changes are allowable along the way, frequent changes may prompt IRS to consider your plan a cash-deferred arrangement rather than a pension plan. A good plan is the one that combines a 401(k) alongside a cash balance plan.

Can I set up cash balance plan myself?

Setting up a cash balance plan involves complex legal and actuarial considerations. While it may be possible for some individuals to establish a cash balance plan on their own, it is generally advisable to seek professional assistance from an actuary or third-party administrator. If you wanted to set one up yourself, you would need to get an IRS approved plan document.

But don’t forget that you have to have an actuary sign off and certify the plan funding each year. This is certainly not something you can do yourself. Completing the required Schedule SB is complex and not something you can complete on your own.

How does the formula work?

Pay credits are typically expressed as a flat percentage of pay or even a flat dollar amount. They are credited to the accounts each year. The sum of these credits will usually differ from the amount the employer contributed to fund the plan.

  • Beginning of the year balance is $10,000
  • The interest crediting rate is 5%
  • Pay is $50,000Pay credit is 4% of pay
  • End of year account balance is ($10,000 × 1.05) + ($50,000 × 4%) = $12,500

If a cash balance defined benefit plan is a conversion by amendment of an existing defined benefit plan, the participant’s account balance is the sum of the former accrued benefit plus any benefit earned from post-conversion service under the cash balance formula. Conversions must preserve the accrued benefit with all future services creating cash balance account additions.

While it is easy to compare, for example, a 1% of final average pay plan to a 2% of final average pay plan (the 2% plan is twice as generous, all other things being equal), it becomes more complicated to compare different benefit formulas against each other.

Who can set up and manage a cash balance plan
Who can set up and manage a cash balance plan

For example, consider 1% of the final three-year average pay plan times years of service versus 1.25% of the final five-year average pay plan times years of service. Looking at compensation history, it is easier to determine the extent of the differences in benefits under these two formulas.

Projecting benefits from one year to the next is a tool for the administrator and comes in handy in many different situations. For example, a comparison can be made between an integrated formula and a career average pay plan or between a cash balance plan and a profit-sharing plan. In any comparison, the concept of projecting benefits is helpful when determining who can set up and manage a cash balance plan.

An average career plan is less sensitive to pay changes than a final three-year average plan. The smaller the period over which pay is averaged, the more significant the impact on the benefit level and the more wide-ranging, the cost can be from year to year.

Conservative Cash Balance Plan Investment Allocation

The initial mix of stocks and bonds will depend on your risk tolerance and return goals. Conservative dividend investments can help you find the right balance between diversification and income safety. Here are some tips to get started:

The best conservative dividend investments tend to be well-established, stable businesses with a history of increasing dividend payments. These stocks offer a low-stress place to park your cash during market downturns. If the dividend yield is high, you’ll have even more incentive to invest in them. But be sure to check for other characteristics.

These companies are likely to be stable and grow over time. While the return on investments may be lower than that of start-ups, large-cap companies usually have a sound financial condition and consistently pay dividends. These companies have weathered several economic cycles.

They could account for fifteen to twenty percent of your portfolio. Mid-cap companies have a higher growth potential than large-cap companies but also carry more risk. Mid-cap companies have more significant growth potential. While they may outperform the broader market, they’re only a good place to place your money if you’re looking for a low-risk portfolio with minimal volatility.

Inflation concerns aren’t new. But they are especially prominent during this market cycle, which started in early 2020 with the pandemic outbreak. This article addresses some of the most common questions regarding this period and clarifies how historically responding asset classes are faring. We’ll also discuss why inflation worries are a good thing. The following sections will help you navigate this volatile market environment. But first, let’s look at how inflation has historically affected asset classes.

Paul Sundin

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6 thoughts on “How to Set Up a Cash Balance Plan: 5 Start Up Steps [+ Who Can Manage]”

  1. Doing some research for my small business.
    Couple of questions:
    1. Can the initial balance be funded with UNQUALIFIED money, say my personal savings account?
    2. Is there a requirement to fund the plan every year.
    3. Is there a minimum time period the plan has to stay open?

    • Hi George – You ask some good questions. Here you go:
      1) These are business sponsored plans, so the funds should be contributed by the business. If you have a process to loan money to the business or make capital contributions that should be fine as long as other rules are met.
      2) Since these plans are non-elective, you will generally have to fund the plan while it is open. But you are given a range and you can fund the low end in a bad year and the high end in a good year. They can be structured to mitigate funding issues.
      3) The IRS says that they should be open at least a few years. So 3 years is a good estimate on the low side. But you need to have long-term intent.

    • Hi Nancy – No, you do not need to have a 401k plan in order to set up a cash balance plan. I would guess that 90% of our plans are combined with a 401k. This just allows for funding flexibility, but it is not required.

  2. Hi Paul, I came across your website while looking into cash balance plans. I think it’s a wise thing to reduce tax. And I have a few questions:
    1. is it possible to self manage this? I am curious on how the calculation is done. Wife is 47 with an income ~$350K on 1099, and limited expenses. If she wants to retire at 60, how much can we save each year? Would love to see an illustration on the calculation.
    2. Give the limited growth, I wonder whether it’s possible to invest for few years (let’s say 3 or 5) and set up a new LLC and start a new plan while rolling over the existing plan to another retirement account, and hopefully get a higher return. Does this get frown by IRS?

    Thank you so much,


    • Hi Erik – you can self manage the accounts. Most people will have the money at Vanguard, Fidelity or Schwab. The calculation is a little challenging (that’s why it is done by our actuary). But at age 47, your wife can get $150k or even a higher amount into a plan. The plans are permanent but you can terminate for reasonable cause. It is an option for clients to terminate the plan and roll it into an IRA to avoid the volatility and get a higher return.


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