Explore when a cash balance plan may fit your business. Compare deductions, employee costs, funding obligations and ongoing employer oversight.
May 13, 2024 · Financial Forte Staff
Historical article: prepared retrospectively using information available as of May 13, 2024.
A profitable year can make an owner wonder whether the business should be saving more for retirement. A cash balance plan may enter the discussion when a 401(k) contribution no longer seems to meet that goal. The potential deduction gets attention quickly. The funding commitment deserves at least as much attention.
A cash balance plan can be worth examining when the employer has dependable cash flow, understands the cost of covering the workforce and is willing to maintain a pension arrangement over time. It is a poor decision to make solely from a large contribution illustration that leaves out what happens in a less profitable year.
Understand the promise before the account format
A cash balance plan is a defined benefit pension plan. Its benefit is expressed in an account-like form, often using pay credits and interest credits, but that does not make it an individual investment account like a typical 401(k). The employer bears the funding and investment risk associated with the promised benefit.[1]
An actuary evaluates required contributions and other funding measures using the plan's design, participant information, assets and assumptions. A credit shown in a participant's hypothetical account is not simply the investment return earned by a separate account owned by that participant.
That distinction changes the employer's decision. With a discretionary profit-sharing contribution, the employer may have flexibility under the plan's terms about future contributions. A pension promise cannot be treated as an annual savings choice that is switched off whenever cash is tight. Changes and termination involve rules, costs and accrued benefits that need their own analysis.[1][2]
Compare a tax deduction with the cash required
Suppose a professional practice is evaluating a plan illustration with a $150,000 employer contribution. Assume its tax professionals determine that the full contribution would be deductible and use an illustrative 30% combined tax effect for the comparison.
Under those assumptions, the deduction would reduce tax by $45,000. The net cost after that assumed tax effect is $105,000, before administrative expenses, timing differences and other consequences. The business still needs to make the $150,000 contribution. A deduction reduces a cost; it does not turn the contribution into free money.
Now suppose $100,000 of the illustrated funding is associated with owners and $50,000 with employees. The workforce amount belongs in the decision from the beginning. It is not an incidental fee that can be ignored when discussing the owners' tax benefit. These numbers are invented for explanation, not an actuarial estimate or a permissible allocation recommendation.
The practice has $220,000 available after its ordinary operating requirements and working-capital target. At first glance, the contribution leaves $70,000. If the owners also want to distribute $100,000 personally, the combined plan would require $250,000 and exceed that available amount by $30,000 before administration. A later reduction in tax does not resolve a contribution due before that tax saving becomes available.
The decision therefore needs a coordinated budget. The owners could reduce distributions, explore a different lawful design, use a different retirement arrangement or wait. They should not ask the actuary to justify a contribution amount chosen without regard to the employees or the business's cash needs.
Test more than the profitable year
Ask for projections that show a weaker business year, different investment results and anticipated staffing changes. Request both the expected contribution range and the conditions that could move required funding outside it. The point is not to forecast precisely. It is to understand which factors could increase the cash the business needs to supply and which levers are actually available.
For example, a practice expecting an owner to retire soon should examine how that departure affects administration, funding and the continuing workforce. A business planning a substantial acquisition should include related ownership and the additional employees in its analysis before relying on the current census.
There is also an opportunity-cost question. Money committed to a retirement plan is not available in the same way as working capital for equipment, hiring or a downturn. Owners who value liquidity may prefer a smaller commitment even when a larger contribution is technically available and potentially deductible.
The benefit for employees deserves a clear explanation too. A pension can add value to compensation, but an account-like statement may be misunderstood as a participant-directed 401(k). Communications should explain what is promised, how vesting works and where employees can obtain accurate information about their benefits.
Set up the oversight alongside the benefit
Deciding whether to establish the plan is an employer business decision. For an ERISA-covered arrangement, operating the plan and managing its assets bring fiduciary responsibilities. Provider selection, investment oversight and reasonable expenses need a prudent process focused on participants.[3]
Assign responsibility for supplying a complete census, reviewing actuarial reports, monitoring contribution deadlines and comparing provider services with the agreement. Name the employer representative who confirms that an assigned task was completed, not just that a provider accepted it. The actuary, administrator and investment professional do different work. The employer should know who communicates when one person's finding affects another person's task.
A useful annual review compares actual funding with the prior projection and explains material differences. Track whether required information and contributions arrived on time and whether employee questions reveal a misunderstanding of the benefit. Those measures help identify administrative weaknesses without promising to eliminate liability or guarantee retention.
Before requesting a final proposal, write down the amount the business can sustain through a range of conditions, the owners' liquidity needs and likely workforce changes. A cash balance plan deserves consideration when that complete picture supports it. The contribution illustration should help answer the business question, rather than define the question by itself.
Related reading
- Combining a 401(k) and Cash Balance Plan
- Cash Balance Funding: A Tax Deduction Is Only Part of the Decision
Have more questions about cash balance plan funding and employer responsibilities? Email Dave at dave@financialforte.com to discuss your questions and next steps.
The contact invitation is current; it does not imply this contact path existed on the historical reference date.
Educational information, not personalized investment, tax, legal or benefits advice. Examples use hypothetical assumptions. Verify current rules and your circumstances before acting.
