Cash Balance Plans: A Strategic Retirement & Tax Planning Tool for Business Owners

Avail Investment Partners
Jul 23, 2025
4 min read

Executive Summary

Cash balance plans are an underutilized yet highly effective tool for business owners seeking to reduce their tax burden and accelerate retirement savings. These plans offer the high contribution limits of defined benefit plans while retaining some of the flexibility and portability of defined contribution plans like 401(k)s. This whitepaper explores what cash balance plans are, how they work, who they are ideal for, and how they compare to other retirement vehicles. We also include a real-world case study to illustrate their tax efficiency in action.

What Is a Cash Balance Plan?

A cash balance plan is a type of IRS-qualified retirement plan that combines features of both defined benefit and defined contribution plans. Legally categorized as a defined benefit plan, it provides participants with a hypothetical account balance, which grows annually with employer contributions and an interest credit. Unlike traditional pensions, the account balance is visible to the participant and can typically be rolled over into an IRA or another retirement plan upon leaving the company.(1)

How Cash Balance Plans Work

Each participant has a “hypothetical account” that is credited annually with:

A pay credit (a percentage of salary or a fixed dollar amount), and
An interest credit (either fixed or based on an index like the 30-year Treasury rate).

The employer is responsible for ensuring the plan is adequately funded. Contributions are calculated annually by an actuary, and the employer receives a tax deduction for each contribution. Investment earnings grow tax deferred. The employer also bears the investment risk, as they must ensure enough is contributed to meet future plan obligations.

Who Should Consider a Cash Balance Plan?

Cash balance plans are best suited for high-income business owners and professionals who:

Have consistent earnings of $250,000+ annually
Have already maxed out 401(k) and profit-sharing contributions
Want to reduce current tax liability
Are age 40+ and looking to catch up on retirement savings
Can commit to annual contributions for at least 3–5 years

These plans are especially common among:

Physicians in private practice
Attorneys and law firm partners
Consultants and freelancers with 1099 income
Owners of professional services firms

Advantages of a Cash Balance Plan

High Contribution Limits: Up to $100,000–$300,000+ annually depending on age

Significant Tax Deductions: Contributions are fully deductible to the business
Tax-Deferred Growth: Investments grow without current taxation
Asset Protection: ERISA protection from creditors
Flexible Rollovers: Funds can be rolled into IRAs or other retirement accounts
Pairs with 401(k)s: Used alongside 401(k) for maximum savings

Risks and Considerations

Requires annual funding and long-term commitment

Actuarial and administrative complexity
Contributions become a company liability on the books
Investment performance must match the interest credit rate to avoid underfunding
Subject to IRS nondiscrimination testing and funding rules

It is recommended to commit to a cash balance plan for at least three consecutive years to meet IRS expectations and make setup costs worthwhile.

Participation Requirements & Strategic Considerations

Cash balance plans are subject to IRS nondiscrimination rules, which require that the plan does not disproportionately benefit highly compensated employees. A key rule to be aware of is that at least 40% of employees must be covered by the plan, or the plan must cover 50 employees, whichever is less.(2)

This does not mean that 40% of employees must receive large contributions. Instead, the plan must simply include them as participants receiving a benefit, which can be modest.

Strategic Approaches to Meeting the 40% Rule:

Include Partners and Owners: Start by including all owners and partners in the plan, since they are usually the primary beneficiaries and key to plan design.
Add Younger, Lower-Salaried Employees: Employers can often meet the 40% threshold by including younger or lower-paid staff. Since cash balance plan contributions are based on salary and age, these participants require relatively low funding amounts, helping the plan stay cost-effective.
Use as a Retention Incentive: Participation can also be targeted to key employees as a retention and recruitment tool. Because vesting typically follows a three-year cliff schedule, employees must remain with the company for three years to receive the full value of employer contributions—aligning their interests with long-term company success.

This flexibility allows business owners to meet IRS requirements while tailoring the plan to suit their financial objectives, staff structure, and budget.

Cash Balance Plans vs. Other Retirement Plans

Case Study: Tax Savings for a Business Owner

Scenario: A 58-year-old consulting firm owner earns $700,000 annually. He already contributes the maximum to a 401(k) with profit sharing ($70,000 in 2025). His advisor recommends layering a cash balance plan into his strategy.

Solution: Based on his age and income, he contributes an additional $250,000 annually to the cash balance plan. At a federal and state marginal tax rate of 35%, this reduces his current tax bill by $87,500 per year.

Results Over 5 Years:

Total contributions: $1,250,000
Total tax savings: $437,500

Outcome: He accelerates retirement readiness while drastically reducing taxable income during peak earning years.

Implementation & Timeline

Setting up a cash balance plan involves several key steps:

Feasibility Study: Work with an advisor to determine if your income and business structure are suitable.
Plan Design: A third-party administrator (TPA) and actuary develop the plan document.
Coordination: Work with your CPA and financial advisor to ensure the plan integrates with your other retirement strategies.
Funding: Contributions are due by the tax filing deadline (plus extensions).
Investment Management: The employer manages investments to target the plan’s interest credit rate.

Timeline: Allow 2–3 months from plan design to initial funding. Most plans are established by year-end to allow for current-year deductions.

Conclusion

For business owners in their peak earning years, cash balance plans offer a powerful combination of tax savings and retirement security. While more complex than other retirement vehicles, their benefits, particularly when paired with a 401(k), can be substantial. With professional implementation and the right income profile, a cash balance plan may be one of the most valuable tools available in a comprehensive wealth management strategy.