What is a cash balance plan?

Theoretically speaking, a cash balance plan is only a type of a defined benefit plan. The difference is in the manner in which the allocations are communicated to the clients or plan participants.

In a cash balance plan, the allocation is communicated as a lump sum dollar amount where as in a defined benefit plan, the allocation is communicated as a dollar amount payable monthly as an annuity starting at some assumed retirement age.

For example, the cash balance plan document can state that the owner of the business receives an allocation of $125,000 each year. This amount is typically referred to as the ‘hypothetical account balance’

In the first year, the company will deposit the $125,000 for the owner in the cash balance plan account and an account balance certificate will be provided that states the allocation amount.

If the same individual were to have a defined benefit plan, the benefit would be stated as a monthly annuity of x dollars, starting at an assumed retirement age of 62/65, with interest rates assumed as a% for the first five years, b% for the next 15 years, and c% thereafter.

For a company with only one participant, the cash balance or defined benefit plan will generate the same retirement benefits. This is an important point to note!

Please discuss with your actuary the appropriate plan design for you. If you do not have an actuary, we can provide some insights in to the appropriate plan design for you. Feel free to email us at info@pensiondeductions.com and we shall be happy to assist you.


To get an approximate estimate of how much you can contribute to a cash balance plan, please use our calculator on the right!


If they are the same, why was the concept of a cash balance plan created?

The answer is simple, to easily fix and communicate the benefits to the participants.

Most companies will have more than one participant in the pension plan. Each participant will also be of a different age and derive a different compensation. Hence, each participant will accrue benefits at a different rate and such situations typically lead to a conflict if it is a small business.

Assume a situation where a company has three partners who are 40, 50 and 60 years old with different compensation amounts. It will be almost impossible to generate the same allocation to each of them year after year. Such situations are easily resolved by utilizing the cash balance plan design.

The partners in the above situation can agree to make a contribution of 80,000 for each so that the amount is the same for each irrespective of their age.

The other possible scenario is that the partners can agree to allocate $80,000 to the youngest partner, and $150,000 and $200,000 to the other two partners based on their proximity to retirement age.

All cash balance plans will have the following components:

  1. An allocation rate,
  2. A crediting rate,

Allocation Rate: The allocation rate is the amount that has to be contributed for each participant each year. This could be stated as a fixed dollar amount, or as a percentage of salary. The $80,000, $150,000 and $200,000 stated in the above example were allocation rates.

Crediting Rate: The cash balance plan will credit fixed interest based on the hypothetical account balance each year. For example, the crediting rate could be 4%, so the participants account balance will grow at the rate of 4% each year in addition to the allocations that are made.

How to set up a cash balance plan?

The first step would be to provide the company demographic information to an actuary. This typically includes the date of birth, date of hire, and approximate compensation for all owners, partners and employees. Once this information is provided, your actuary should design a proposal for you along with recommendations about the appropriate plan design.

If you do not have an actuary, please reach out to us at info@pensiondeductions.com and we can design the proposal for you.

Once you finalize the allocations and the plan design, a plan document will need to be drafted. This plan document will list all assumptions of the plan and ensure compliance with all IRS rules and regulations. This document can be drafted by us before you can set up the investment accounts for the plan. A new TIN may need to be registered for the pension plan as it is a distinct legal entity.

The plan document will be customized based on the contributions allocations that are finalized. You can read more about a pension plan document here.

After the plan document has been drafted, you are all set to open the investment account for the plan. You should reach out to your financial advisor or a broker to set up the accounts. Make sure you tell them to open a ‘qualified account’ so that the investment gains are not taxed at source.

You can start making contributions to the plan as and when free cash flow is available once the investment accounts are open. All deposits need to be made before you file the tax returns for your business.

All qualified plans are required to file annual returns with the IRS. Note that these returns are different from the company tax returns and your personal tax returns. Also note that most CPA’s or financial advisors cannot file these returns since the IRS requires a separate Form 5500 for pension plans.

The penalties for not filing these forms run in to hundreds of dollars and the pension plan could end up getting disqualified.

If you are a small business owner and interested in exploring the idea of a cash balance plan for yourself feel free to email us at info@pensiondeductions.com . We specialize in this area and can provide you with valuable advice and services that could end up saving thousands of dollars and giving a boost to your retirement planning.

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