How to Use a Cash Balance Plan to Maximize Tax Deductions

How to Use a Cash Balance Plan to Maximize Tax Deductions

May 05, 2017

Back in October, we discussed the surge of growth in cash balance plans (CBPs). One of the reasons they have been growing ten times as fast as 401(k) plans is the tax savings they provide. As your clients recover from tax time, now is a great time to reach out to them to discuss the benefits of a CBP for tax savings.

Qualified Status Of Cash Balance Plans

CBPs are called “qualified” plans because they qualify for special tax treatment under Section 401(a) of the Internal Revenue Code (IRC). Qualified plans are eligible for pre-tax contributions, which means that employers don’t have to pay any taxes on the money they put into the plans. They get to deduct all of their contributions.

With the constant increase in federal, state, and local tax rates, this can be very valuable for your clients. With CBPs, they can maximize their tax-deferred retirement savings while receiving deductions for contributing to their employees’ accounts as well.

Tax Savings

Deductions for CBP contributions are valuable because they directly reduce taxable income. Even with Arizona’s low income tax rates, your clients could easily be paying over a third of their income in taxes. (1) A $100,000 CBP contribution reduces their ordinary income by the same amount. Taxes on that can be over $33,000, so that is a significant savings!

The tax savings not only benefit your clients today, but they provide a greater benefit for the contribution recipients in the future. A $100,000 contribution earning 6% would be worth $574,349 after 30 years. If taxes had been taken out and only $67,000 had been invested, it would only be worth $384,813 (less if the earnings were taxed). That is almost a $190,000 difference.

How Benefits Are Determined

CBPs commonly use class-based benefit formulas, which allow different classes of employees to receive different benefits. That way, business owners can receive higher benefits than their employees. Depending on the benefit formula used, your business-owner clients could set aside up to $250,000 for retirement and take a deduction for it. (2)

Rank-and-file employees must still receive a benefit, but it can be a lot lower than the executives’. Those contributions are also tax-deductible, so in essence, they cost the company a lot less than the benefit that the worker receives.

Benefit Formula Compliance

While there is flexibility in benefit formulas, it is important to follow the rules. Recently, the IRS has directed its agents to review cash balance formulas, especially as they relate to compensation. Agents are tasked with analyzing benefit formulas based on only a portion of annual compensation, a special bonus, or something other than annual compensation, to ensure they comply with the language set forth in Section 401(a).

If a formula allows the employer to vary the compensation as used in the benefit formula, then it violates the rules. Being found in violation can be costly, so it is best not to push things too far. Business owners can reap tremendous tax savings while saving significantly for retirement well within the rules.

How I Can Help

In order to maximize tax deductions without violating the IRC, it is best to work with a retirement plan specialist. I can work with you and your clients to develop a CBP and benefit formula that maximizes tax deductions and retirement contributions while staying within legal bounds. Feel free to forward this article to your clients who may benefit from a CBP. Email me today at so we can discuss how your clients can better utilize the tax deductions allowed to them in their cash benefit plan.

About Kenny Phan

Kenny Phan is a Managing Partner at FinancialFocus Retirement Plan Services, a 3(16) fiduciary. He works as a pension specialist who partners with financial professionals to design and implement pension plans. His area of expertise is customized defined benefit, defined contribution, and 401(k) plans. Serving financial advisors and businesses in the greater Phoenix area, he is supported by FinancialFocus Retirement Plan Services. Together, they provide comprehensive plan design consultation, administration, document installation, compliance testing, as well as IRS and DOL reporting for qualified retirement plans.