What Is a Cash Balance Plan?

A Cash Balance Plan is a type of Defined Benefit Plan that operates much differently than other types of retirement plans. This page will provide you with some general information about how the Cash Balance Plans we design operate, and the advantages of using a Cash Balance Plan to help meet your retirement savings objectives.

Most of the Cash Balance Plans we design are established for the primary benefit of the owners or executives of a company. Therefore, the contributions for owners and executives are typically very large with a smaller contribution provided to staff to meet IRS requirements. During the plan design, the sponsoring company selects the amount of contribution for each owner and executive, up to the maximum amount permitted by law.

Only businesses can sponsor a Cash Balance Plan, but any business entity may do so. We provide services for sole proprietorships, partnerships, LLCs, nonprofits, and corporations. You don't even need to have any employees other than yourself.

The number of companies sponsoring Cash Balance Plans is growing rapidly. Among the reasons for such rapid growth are:

  • Higher anticipated tax rates for small business owners and professionals
  • The increased number of small business owners who are getting closer to retirement age
  • The government's desire to have privately funded pension plans help fund the retirement of America's workers
  • The need for larger retirement contributions due to market losses in existing retirement accounts that can't be deducted in Defined Contribution Plans
  • The emergence of Cash Balance Plans as an accepted way of controlling Defined Benefit Plan employee cost while still maximizing deductions for the owners.

Before setting up a Cash Balance Plan, you should have a good idea of how they operate since it works differently than a 401(k) Profit Sharing Plan or a Traditional Defined Benefit Pension Plan. This is why you may hear Cash Balance Plans referred to as "Hybrid" Plans. They generally offer the best of both worlds; the high contribution limits of Defined Benefit Plans with the ease of understanding of Defined Contribution Plans.


Under a Cash Balance Plan, a "Hypothetical Account" is established for each participant. This is not an account within the plan's trust account. Instead, the plan administrator maintains the accounts; thus, they are referred to as Hypothetical Accounts. Contributions are credited to these accounts each year in accordance with formulas in the plan document. The accounts are also credited with interest each year based on a rate selected by the plan sponsor. Typically this rate is a flat percentage between 4% and 5% or it is based on the yield of an index such as the 30 year treasury yield.

When a participant terminates employment, he or she will be eligible to receive the vested portion of their hypothetical account balance. A Participant's vested percentage is determined by the plan document and can be 0% for up to 3 years of service and then must be 100% upon completion of 3 years.

Changes in Participant Contributions

The amounts which can be contributed from year-to-year are subject to complex discrimination testing. That is, we must be sure that contributions made for highly compensated individuals bear a reasonable relationship to the amounts contributed on behalf of individuals who are not highly compensated. In performing the discrimination test, we are permitted to combine the cash balance contributions with the contributions the company is providing in other retirement plans. The amount of the required contribution depends on employee demographics. Therefore, the contributions can fluctuate from year to year, but we do our best to minimize those fluctuations and provide a projection of upcoming contributions free of charge to our clients so you can make a change if the contributions for the year are not meeting your company goals.

Restrictions on Changing Participant Contributions

Once a participant has worked 1,000 hours during a plan year, the employer must make a contribution on his or her behalf and cannot amend the plan to lower the amount of the contribution. This is true even if the participant subsequently terminates employment during the year. For most full time employees, 1,000 hours will be reached for a calendar plan year in June.

Plan Amendments to Change Employee Benefit Accruals

The plan can be amended periodically to permit different contribution levels, but there are some restrictions on this. For example:

  • Contributions cannot be changed to an amount that would cause the discrimination test to fail.
  • The plan can be amended to increase contributions but this must be done prior to the end of the year for Highly Compensated Employees. Non-Highly Compensated Employees can be increased at any time.
  • Plan amendments decreasing contributions must be made 15 days before any affected participants complete 1,000 hours of service in a plan year.
  • The plan is intended to be permanent Defined Benefit Plan and not a deferral plan, so amending the plan to increase and decrease contributions every year is not allowed. A general rule of thumb is that an amendment should be committed to for at least 3 years, but there are exceptions for certain unforeseeable business circumstances.

Plan Investments

Individual participants are not able to direct the investment of their account -- plan assets will be pooled and invested by the trustee (usually the company owner or owners). The hypothetical accounts of the participants will be credited with interest at a rate guaranteed by the plan document. If the actual trust earnings exceed the guaranteed rate, the excess will be used to reduce future employer contributions. This will not affect the amount credited to the participants' accounts. That is, the account will increase according to the plan's schedule and the increase will be funded partially from employer contributions and partially from the excess earnings.

Employer Contribution and the Contributions to Participant Accounts

Typically, the employer contribution will be different from the amounts added to the accounts. This is primarily due to differences between the interest that is credited to the accounts and the return on the plan's investments, but can also be due to vesting or changes in IRS required assumptions.

Payment of Hypothetical Accounts

In general, the hypothetical account in a Cash Balance Plan can be paid as a lump-sum distribution to a participant upon death, disability, retirement, or termination of service. If the value of the account exceeds $5,000, the participant must also be given the option to elect payment of an annuity in lieu of a lump-sum. Payment of a lump-sum distribution may be restricted if plan assets are not sufficient. For this purpose, the accounts are valued using rates of interest and mortality prescribed by the Internal Revenue Service. If assets are not sufficient, the employee may be restricted to receiving only the annuity form of payment or waiting until assets are sufficient to take a lump sum. If the contribution we recommend each year is deposited, such restrictions rarely occur.

PBGC Insurance Premiums

In general, the benefits in Cash Balance Plans are insured by the Pension Benefit Guaranty Corporation ("PBGC"); however, if the company is a professional service firm with fewer than 26 active participants, the plan is not covered by PBGC. Plans that are covered by PBGC insurance must pay a premium to the PBGC each year ($69 per participant starting in 2017). If plan investments do not perform adequately or the plan sponsor chooses to make less than the recommended contribution, the plan could have unfunded benefit liabilities. Unfunded benefit liabilities will increase the amount of premium that must be paid.    

Tax Deductions and Allocation of Plan Contributions

How the tax deduction for the contributions to a Cash Balance Plan is taken depends on the entity of the plan sponsor.  The contributions for non-owners are always a company tax deduction.  The owner contributions are either a company tax deduction or a personal tax deduction depending on whether or not the plan sponsor is a corporation.

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