Cash balance plans are technically defined benefit plans (or pensions) that share key characteristics with defined contribution plans such as 401(k)s and 403(b)s. These hybrid plans have generous contribution limits that increase with age, and they are often stacked on top of a 401(k) and/or profit-sharing plan. This can help partners in professional firms and other business owners to maximize or catch up on retirement savings and reduce their taxable incomes.
On top of the $70,000 maximum contribution to a 401(k), a 65-year-old could save as much as $329,000 in a cash balance plan in 2025, while a 55-year-old could save $248,000 on a tax-deferred basis until the account reaches a maximum balance of about $3.6 million (IRS limits adjusted annually for inflation).1–2
Employees benefit too
A cash balance plan can also be a powerful tool for employee recruitment and retention. As with other defined benefit plans, employees are promised a specified retirement benefit, and the employer funds the plan and selects investments. However, each participant has an account with a “cash balance” for record-keeping purposes, and the vested account value is portable, which means it can be rolled over to another employer plan or to an IRA.
But unlike a 401(k), the participant’s cash balance when benefit payments begin can never be less than the sum of the contributions made to the participant’s account, even if plan investments result in negative earnings for a particular period. This means the employer bears all the financial risk.
Funding the plan
The employer’s annual contribution amount is actuarially determined based on plan design and participant demographics. Generally, there are two types of contributions made for each employee. The first is a pay credit, which is either a fixed amount or a percentage of annual compensation, and the second is a fixed or variable interest crediting rate (ICR). The ICR can be set to equal the actual rate of return of the portfolio if certain diversification requirements are met, which helps reduce the employer’s investment risk and the possibility of having an underfunded plan due to market volatility.
Businesses may deduct employee contributions, so current-year tax savings may offset some of their contributions. Still, a cash balance plan is typically more cost-effective for a sole proprietor or the owner of a small firm with few employees.
All investing involves risk, including the possible loss of principal, and there is no guarantee that any investment strategy will be successful. Diversification is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss.
If you have questions, contact the experts at Henssler Financial:
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- Email: experts@henssler.com
- Phone: 770-429-9166