How To Maximize Tax Savings with the Cash Balance Pension Plans
When it comes to retirement planning, most people think about traditional pension plans, IRAs, or 401(k)s. But there’s another option that can help you save even more for retirement while lowering your tax bill: a cash balance pension plan.
It’s an employer-sponsored retirement plan that works like a traditional pension but with more flexibility. While it’s available to employees, it can also be a great option for high-earning individuals, especially business owners and self-employed people. These plans allow you to put aside much larger amounts each year compared to a 401(k). This can help you grow your retirement savings while cutting down your taxable income.
In this guide, we’ll break down how these plans work, their tax advantages, and how you can leverage them to save more for retirement while lowering your U.S. tax bill.
What Is a Cash Balance Pension Plan?
It is a type of defined benefit plan that combines features of a traditional pension and a 401(k)-style retirement account. Unlike defined contribution plans, where contributions depend on market performance, a cash balance plan provides a set benefit amount, which makes it more predictable for retirement planning.
In simple terms, a cash balance plan guarantees a certain amount of money at retirement, based on a formula that considers both employer contributions and an interest credit rate.
How Does a Cash Balance Pension Plan Work?
Each year, your employer (or your own business, if you’re self-employed) puts in a set amount of money, usually around 5% to 10% of your salary. Depending on how much you make and how old you are, that percentage can be much higher.
On top of that, the plan adds interest every year, often around 4% to 5%. These two things, the yearly contribution and the interest, help your balance grow steadily over time.
When it’s time to retire, you have choices. You can take all the money in one lump sum, or you can turn it into monthly payments that last for the rest of your life.
The best part?
You don’t have to worry about investment ups and downs, as that risk stays with the employer. Your benefit is guaranteed, no matter how the market does.
The plan itself is managed in a trust, with the funds typically invested in stocks and bonds. The goal is to earn steady returns and keep the plan well-funded (usually between 100% and 110%) to make sure it can meet future payouts.
At retirement, if your projected benefit is, say, $300,000, the plan contributions and investment growth are designed to get you there, and you’ll receive that benefit regardless of market fluctuations.
Cash Balance Pension Plan vs. 401(k): What’s the Difference?
You might wonder, “I already have a 401(k), so why bother with a cash balance plan?”
Great question. The main difference lies in how much you can save and the tax benefits tied to it.
- 401(k) Limits: You can contribute up to $23,500 to a 401(k) or $31,000 if you’re over 50. When you include employer profit-sharing, the total contribution limit can reach up to $70,000.
- Cash Balance Limits: A cash balance pension plan lets you save way more than a 401(k). Depending on your age and earned income, you could contribute $100,000, $200,000, or even over $300,000 per year.
Why the huge gap?
Cash balance plans are designed to get you to a specific retirement balance (up to about $3.5 million), and the older you are, the more you can sock away each year to hit that target. Plus, unlike a 401(k), where you’re limited to employee and employer contributions, a cash balance pension is fully employer-funded, and every penny is a tax write-off for the business.
| Feature | Cash Balance Pension Plan | 401(k) Plan |
| Contribution Limits | Higher (based on age and salary) | Lower ($23,500 or $31,000 for 50+) |
| Employer Contributions | Required | Optional |
| Investment Risk | The employer bears the risk | The employee bears the risk |
| Payout Options | Lump sum or annuity | Lump sum or periodic withdrawals |
| Tax Deductibility | Contributions are deductible | Contributions reduce taxable income |
Maximizing Tax Savings with a Cash Balance Plan
Cash balance plans offer substantial tax advantages, particularly for high-income business owners and self-employed individuals. Here’s how they help reduce your taxable income:
1. Higher Contribution Limits
Unlike 401(k)s, which have stricter annual contribution limits, cash balance pension plans allow significantly higher pre-tax contributions. The exact amount depends on factors like age and income, but these plans offer much more room to save for retirement while lowering taxable income. This makes them especially attractive for individuals looking to build their retirement fund faster while maximizing tax savings.
2. Significant Tax Deductions for Business Owners
Employers who set up cash balance plans can deduct contributions as a business expense, which helps reduce their overall taxable income. This is particularly beneficial for sole proprietors, S-Corps, and partnerships looking to minimize taxes while increasing retirement savings.
3. Tax-Deferred Growth
Since funds grow tax-deferred, you won’t owe taxes on earnings until you withdraw money in retirement. This allows for compounded growth over time, similar to traditional retirement accounts.\
4. Sheltering Income for High Earners
A cash balance plan is ideal for high-income professionals such as doctors, lawyers, and business owners who may already max out their 401(k) and IRA contributions. The ability to contribute larger amounts pre-tax significantly reduces adjusted gross income (AGI), which lowers the overall tax burden.
So, Which Plan Should You Choose?
For maximum tax savings, combining both a 401(k) and a cash balance plan is often the best strategy. This allows high earners to save beyond 401(k) limits while securing guaranteed retirement income.
Who Should Consider a Cash Balance Plan?
Cash balance plans are ideal for:
- High-income professionals (doctors, attorneys, consultants, etc.)
- Business owners with steady profits
- Employers looking for additional tax deductions
- Individuals looking to accelerate retirement savings
Setting Up a Cash Balance Pension Plan
Starting a cash balance plan isn’t as complicated as it might sound, but you do need the right help and a good plan in place. Here’s what the process usually looks like:
1. Talk to a tax pro or financial advisor.
Before anything else, find a tax professional or advisor who knows both tax rules and retirement plans. They’ll help figure out if this plan makes sense for you and gather.
2. Work with a plan administrator.
You’ll need a third-party administrator (TPA) who can help design the plan and handle the paperwork. They’ll draft the official plan documents, set contribution formulas, and make sure the plan is compliant with all IRS rules.
3. Sign and finalize the plan by year-end.
To get the tax deduction for the year, the plan documents need to be signed before the end of that tax year. So don’t wait until the last minute.
4. Make your contributions on time.
Contributions usually need to be made by your tax filing deadline (including extensions). Your advisor and TPA will help calculate exactly how much to contribute.
5. Keep an eye on the plan each year.
Once the plan is set up, you’ll need to review it every year. You may need to adjust contributions, review investment returns, or even freeze or end the plan if it no longer fits your business goals.
Final Thoughts
A cash balance pension plan is one of the best strategies for high-income earners and business owners looking to reduce taxes and accelerate retirement savings. With high contribution limits, tax-deferred growth, and employer deductions, it’s an excellent addition to traditional retirement planning.
If you’re considering setting up a cash balance plan, consult with a tax or retirement planning expert to customize a strategy that fits your financial goals.
Need Expert Advice?
At Tax Samaritan, we specialize in tax-saving strategies for high-income professionals and small business owners. If you’re looking to maximize tax savings while securing your financial future, schedule a consultation today by contacting us at 775-305-1040 or help@TaxSamaritan.com.
