Supercharging retirement: Tax benefits and planning opportunities with cash balance plans

Editors: Brian Hagene, CPA, CGMA (CPAmerica), and Susan M. Grais, CPA, J.D., LL.M. (Ernst & Young LLP)

For high–income clients, especially those already maxing out 401(k) and profit–sharing contributions, the tax–deferred retirement space can feel frustratingly limited. Enter the cash balance plan — a powerful hybrid retirement vehicle that can dramatically increase deductible contributions while building long–term retirement wealth.

With rising tax rates possibly on the horizon and a growing appetite for creative retirement solutions, cash balance plans are making a comeback among small businesses, professional service firms, and even sole proprietors. This item explores the tax benefits, mechanics, and strategic opportunities of these often–overlooked plans.

What is a cash balance plan?

A cash balance plan is a type of defined benefit plan that behaves like a defined contribution plan. Each participant has a hypothetical account (not an actual separate account as in a 401(k)) that grows annually based on:

1. Pay credit — typically, a percentage of compensation (e.g., 5% to 8%); and
2. Interest credit — either a fixed rate or a variable rate tied to an index (such as the 30-year Treasury bond).

Unlike traditional defined benefit plans that show benefits as a series of monthly payments for life beginning with retirement, cash balance plans show benefits as a lump–sum account balance, which is easier for participants to understand.

The tax angle: Massive deductibility potential

The headline benefit is this: Cash balance contributions can be three to five times larger than 401(k) limits — especially for older participants. For 2025, the maximum 401(k) employee deferral is $23,500 (plus a $7,500 catch–up contribution for participants 50 or older or $11,250 catch–up contribution for individuals who attain age 60 through 63 in 2025), and total defined contribution limits by employee and employer combined top out at $70,000 (before any catch–up contributions). But with a cash balance plan, business owners in their 50s or 60s may contribute $150,000 to $300,000 or more annually, fully deductible.

These contributions:

• Are above and beyond 401(k) and profit-sharing limits;
• Reduce adjusted gross income for high earners (great for Sec. 199A planning or mitigation of net investment income tax);
• Shelter income from federal and state tax, including at top marginal brackets; and
• Grow tax-deferred until distribution or conversion.

Who are the best candidates?

Cash balance plans are not one–size–fits–all, but when the fit is right, the benefits are enormous. Ideal candidates include:

• Partners and owners earning more than $300,000 who want additional tax sheltering;
• Professional services firms (law, medical, dental, engineering) with relatively stable income;
• Sole proprietors or S corporations with a handful of employees or none; and
• Late-career individuals looking to rapidly build retirement savings.

A firm with predictable profitability, owner–centric demographics, and the willingness to commit to several years of funding is typically a strong fit.

Design flexibility = strategic planning opportunities

Cash balance plans can be tailored to favor key employees or owners — within IRS nondiscrimination rules. When combined with a 401(k)/profit–sharing plan, they form a combo plan structure where owners can:

• Max out 401(k) deferrals;
• Receive a 25% of compensation profit-sharing contribution; and
• Stack a six-figure cash balance contribution on top.

Plans can also be custom–graded to skew benefits toward older owners or partners, especially in professional firms with younger staff. Careful actuarial design is key.

Compliance and pitfalls

Cash balance plans are pension plans, and with that come rules, filings, and responsibilities. Key points include:

• Minimum funding is required each year — this is not “optional like a SEP” (simplified employee pension plan);
• Plans require actuarial certification and annual Form 5500 series filings;
• Pension Benefit Guaranty Corporation coverage may apply (but there are small-plan exemptions); and
• Contributions must meet nondiscrimination testing, though creative plan design can mitigate this.

Under the Setting Every Community Up for Retirement Enhancement (SECURE) Act, Division O of the Further Consolidated Appropriations Act, 2020, P.L. 116–94, a cash balance plan can be adopted after year end up to the tax filing deadline, including extensions, for the plan’s first year.

Exit strategy: What happens later?

Cash balance plans are not forever. But with planning, they can be transitioned or terminated cleanly:

• After three to five years of funding, many owners choose to terminate and roll over the balance to an individual retirement account (IRA);
• If income drops, the plan can be amended to reduce credits or be frozen; and
• At retirement, balances can be rolled into IRAs or annuitized, depending on the participant’s goals.

Be mindful that lump–sum payouts must consider the Sec. 417(e) interest rate assumptions, which may create funding shortfalls if rates move rapidly.

Practitioner tips and best practices

• Work with a qualified third-party administrator/actuary. Cookie-cutter plans lead to nondiscrimination failures or angry employees.
• Run illustrations early. Get a sense of contribution levels and costs before pitching to clients.
• Stack with a 401(k)/profit-sharing plan for maximum impact.
• Educate the client. This is not a DIY setup; they need to understand the commitment.
• Review annually. Income changes, staffing shifts, or retirement dates all affect funding strategies.

A turbocharged tool in the right hands

Cash balance plans are not for everyone, but for the right client, they can be a tax–deferral powerhouse. CPAs and advisers who understand their mechanics can help high–income clients dramatically lower tax burdens while rapidly accelerating retirement wealth.

In a world where most tax planning feels like nibbling around the edges, this is one of the few strategies that still packs a punch.

Editors

Brian Hagene, CPA, CGMA, is partner/owner at Mathieson, Moyski, Austin & Co. LLP in Lisle, Ill., with CPAmerica. Susan M. Grais, CPA, J.D., LL.M., is a managing director at Ernst & Young LLP in Washington, D.C.

For additional information about these items, contact thetaxadviser@aicpa.org.

Contributors are members of or associated with CPAmerica or Ernst & Young LLP, as designated.