A different kind of plan
Most owners are familiar with defined contribution plans, where an amount goes in each year and the participant bears the investment outcome. Annual additions are capped at a figure that, for a high earner, is modest relative to income.
A cash balance plan is a defined benefit plan wearing familiar clothes. Each participant has a hypothetical account credited with a pay credit and an interest credit, so it reads like an account balance. Legally it is a promise of a future benefit, and the contribution required to fund that promise is determined actuarially.
The census decides it
The plan must satisfy coverage and nondiscrimination requirements, which in practice means the owner cannot be the only meaningful beneficiary. Contributions must be made for eligible employees, and the testing looks at benefits as a proportion of pay across the workforce.
The arithmetic therefore depends almost entirely on who works there.
| Business profile | Typical outcome |
|---|---|
| Owner-only, or owner and spouse | The strongest case. No coverage problem and the whole contribution benefits the household |
| Owner plus a few long-tenured, well-paid staff | Usually workable. The employee cost is real and proportionate |
| Owner materially older than a small, younger workforce | Often very favorable, because the actuarial requirement is concentrated on the owner |
| Large workforce of comparable age to the owner | Frequently uneconomic. The required employee contributions can exceed the value of the owner's deduction |
| High staff turnover | Complicates administration and testing; eligibility and vesting design become the whole exercise |
These plans are commonly paired with a profit-sharing plan so that the two are tested together, which can improve the result considerably. That is a design question for an actuary and a plan consultant, and it is where most of the value is created or lost.
The commitment is the real constraint
A defined benefit plan is a funding obligation, not an annual election. Once adopted, minimum required contributions must be made, and failure carries excise taxes.
- 01Income volatility is the principal risk. An owner whose income swings substantially may face a required contribution in a poor year. Plan design can build in flexibility through the benefit formula and the interest crediting rate, and the flexibility is bounded.
- 02The investment return matters to the sponsor, not only the participant. Returns above the crediting rate create surplus and reduce future contributions; returns below create shortfall and increase them. A conservatively invested plan is usually the point.
- 03Termination is possible and is not costless. Overfunding on termination is subject to substantial excise tax on any reversion to the employer, which is why the funding target is managed towards the end of the plan's life rather than at the end of it.
- 04Administration is ongoing. An actuary, an annual valuation, a separate filing, and in some cases insurance premiums. This is a real cost and it is proportionate to the deduction obtained.
General information only. This article describes law and practice as we understand them at the time of writing. It is not tax, legal, accounting, or investment advice, it does not consider your circumstances, and it does not create an advisor-client or attorney-client relationship. Odyssey Strategic Advisors LLC is not a law firm and is not a CPA firm. Confirm any position with your own tax professional before acting on it. See our disclosures.