Combining a cash balance plan with a 401(k) plan can be one of the most powerful retirement strategies for business owners and high-income professionals. However, when the two are paired, the IRS requires a series of compliance tests to ensure that benefits do not unfairly favor owners or highly compensated employees.
For business owners, the complexity of these tests can seem daunting. The testing process ensures that both the 401(k) and cash balance components meet federal fairness standards while allowing employers to maximize tax efficiency.
By understanding how these tests work—and planning contributions accordingly—employers can maintain IRS compliance while enjoying the significant tax deductions. Let’s jump in!
Basic Assumptions
When combining a cash balance plan with a 401(k), we will use some basic assumptions. These assumptions become a starting point for how the tests are completed. These assumptions include:
- Same Definition of Compensation: Both plans must use the same compensation definition when figuring contributions. This ensures consistency in how salary, bonuses, and overtime are treated.
- The 401(k) Must Be a Safe Harbor Plan: This structure automatically satisfies certain IRS testing requirements. It does so by guaranteeing minimum employer contributions—either 3% non-elective or a basic match.
- 6% Profit-Sharing Limitation: Combining the two plans limits profit-sharing to 6% of pay. Specifically, the company contributions (the total of safe harbor non-elective contributions, employer matching contributions, and profit-sharing contributions) that were made during the year cannot exceed 6% of compensation.
These assumptions establish the framework for smooth and compliant operation. Aligning these areas helps maximize tax benefits, ensure fairness, and support long-term stability.
Standard Guidelines
In addition to the basic assumptions, there are some basic guidelines that are used for testing purposes:
IRC §401(a)(17)—Compensation Limits. This provision applies an annual compensation limit for each participant. The compensation limit is applied when calculating a participant’s contributions for the plan year (i.e., deferrals, employer non-elective or match contributions) and in nondiscrimination testing. For 2026, the compensation limit is $360,000.
IRC §402(g)—Limitation on Elective Deferrals. For 2026, the IRS limit on participant contributions is $24,500. If there are 402(g) violations, excess deferrals, and any accrued income must be returned to the participant by April 15th of the year following the year of the excess deferral.
IRC §415—Maximum Annual Additions. For 2026, annual additions to a participant’s account under IRC §415(c) may not exceed the lesser of $72,000 or 100% of the participant’s §415 compensation (excluding catch up). Annual additions include employer and employee contributions to all plans.
IRC §416(i)(1)(a)—Key Employee Definition. A key employee is any employee who, during the current plan year, meets one of the following criteria: owns more than 5% of the employer, owns more than 1% and earns over $150,000, or is an officer earning over $230,000 (for 2025).
Under IRC §416, a plan may be top-heavy next year if key employees have more than 60% of all account balances on the last day of the current year. If a plan is determined to be “top-heavy” for a given plan year, the employer must make a minimum contribution for all non-key employees. This contribution is generally 3% of each non-key employee’s compensation, or, if less, the highest percentage contributed for any key employee.
The top-heavy test can be passed automatically by using a Safe Harbor plan with a 3% non-elective contribution. See the discussion here.
Cash Balance Plan Rules
Compliance testing is essential to keep a cash balance plan tax qualified. The IRS requires all retirement plans to meet nondiscrimination and coverage rules, preventing benefits from concentrating among owners or highly compensated employees. When combined with a 401(k), compliance for both plans becomes even more important.
Two of the most significant compliance tests for cash balance plans are:
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- Meaningful Benefit Rule: This rule requires non-highly compensated employees (NHCEs) to get a real, measurable benefit. This benefit results in a 0.5% of pay benefit amount. This usually translates to 2-4% of compensation.
- 40% Rule (Coverage Requirement): At least 40% of eligible employees must participate and receive a benefit, preventing plans from favoring only owners or key employees. This rule can also be met if at least 50 employees are included in the plan.
Together, the meaningful benefit and 40% rules ensure fairness and flexibility. Passing these tests shows the plan gives real retirement benefits to many employees, not just owners. An actuary or third-party administrator usually handles this testing to keep the plan compliant and on track with the employer’s goals.
New Comparability Profit-Sharing and Cross Testing
Typical profit-sharing rules require that contributions are at the same percentage for each employee. So, if the owner wants to do a 20% profit-sharing contribution, each eligible employee must get this amount. This structure makes traditional profit-sharing allocation too cost prohibitive for employers.
New comparability profit-sharing allows business owners to make higher retirement contributions to select employees that are typically older and higher paid. Unlike traditional allocations, employers can assign higher contribution rates to specific employee groups.
Cross Testing
New comparability plans use “cross-testing” for compliance. Instead of looking at each employee’s current contribution, the plan will “cross-test” by looking out at each employee’s retirement benefit at retirement age. Cross-testing equalizes group benefits by considering future value, not just immediate contributions.
The process groups employees by age and compares their projected benefits, based on the year’s allocation, ensuring contributions aren’t biased to HCEs. Whether this setup is right for you depends on your staff’s ages and pay.
Owners who are close in age or pay to their employees might not see much savings. That’s because new comparability maximizes contributions for older, higher-paid HCEs or employees, especially those eligible for catch-up contributions.
In essence, new comparability treats profit-sharing contributions similar to cash balance plan contributions. The contributions are weighted based on age and compensation, which will typically favor the owner.
Is a Cash Balance or Defined Benefit Plan Right For You?
Here is a table that is an example of how new comparability might look:
| Employee | Age | Wage | Allocation Group | Profit-Sharing % | Employer Contribution |
|---|---|---|---|---|---|
| Dr. Lee (Owner) | 58 | $300,000 | Owner / Principals | 20% | $60,000 |
| Jordan | 30 | $60,000 | Staff | 5% | $3,000 |
| Casey | 28 | $50,000 | Staff | 5% | $2,500 |
| Riley | 35 | $55,000 | Staff | 5% | $2,750 |
| Total Employer Contribution | $68,250 | ||||
Note: The above is for illustrative purposes only. Actual allocations must pass nondiscrimination and observe IRS limits.
New comparability profit-sharing can be a great option if:
- You’d like to maximize contributions made to the owner or HCEs.
- The HCEs are typically older than most NHCEs.
- The HCEs have higher salaries compared to NHCEs.
- There is a limited number of employees (typically fewer than 20)
Gateway Requirements
To qualify for new comparability profit sharing and cross-testing, a minimum gateway must be met. Employers must make a minimum contribution to all NHCEs of at least:
- One-third of the highest contribution rate given to any HCE, or
- 5% of the participant’s gross compensation.
Employers with a Safe Harbor 401(k) who contribute at least 3% of pay to all eligible accounts can count these nonelective contributions toward the gateway minimum. Safe Harbor contributions also allow the plan to skip certain nondiscrimination tests.
Combining a 3% non-elective Safe Harbor contribution with new comparability profit-sharing helps business owners maximize contributions for themselves while meeting gateway requirements for most NHCEs. Some NHCEs may still require additional contributions to meet the Average Benefits or coverage tests.
Once you satisfy these requirements, you can now make individualized profit-sharing contributions, based on the individual’s benefit accrual rate–potentially increasing employer contributions for certain employees.
The Benefit of Providing a 3% Non-Elective Safe Harbor
To efficiently pass testing, it’s typically better not to make Safe Harbor contributions for the owner (or HCEs), so that there is a “cushion” within the 6% limit to meet the gateway requirements for NHCEs.
In addition, to meet the gateway requirements, a Safe Harbor contribution is best accomplished by a 3% non-elective Safe Harbor if there is a combined deduction limit. This is because the 3% non-elective Safe Harbor contribution serves triple duty – it contributes towards the 5% Top Heavy dual plan contribution, the combined Gateway requirement, and is also used for non-discrimination testing.
As a result, in most situations the owner will have a minimal profit-sharing contribution (say $500 to $1,000). The good news is that even though profit-sharing is limited, the vast majority of the cash balance plan contribution will go to the owner.
Final Thoughts
Combining a cash balance plan with a 401(k) offers powerful opportunities for higher retirement savings and major tax advantages. Yet those benefits depend on meeting IRS compliance and testing requirements. Failing the meaningful benefit rule, 40% rule, or cross-testing standards can lead to penalties, disqualification, or restricted owner contributions.
Success depends on careful plan design and annual review. Working with actuaries and third-party administrators ensures proper compensation definitions, Safe Harbor status, and profit-sharing limits. With these in place, compliance testing becomes straightforward and predictable.
The goal is a balanced plan that benefits both owners and employees. When designed and monitored correctly, a combined cash balance and 401(k) structure provides sustainable, compliant, and efficient retirement savings for years to come.
