Cash Balance Plan Overview for Tax Professionals
Maximized Contributions, Significant Tax Savings
A Cash Balance Plan offers small business owners the opportunity to make substantial contributions to a qualified plan, potentially reaching or exceeding hundreds of thousands of dollars annually. This program combines a Defined Benefit plan with a Defined Contribution Plan, into a hybrid plan, enabling highly profitable small businesses and partnerships to maximize tax deductions for themselves while managing employee retirement benefit costs. These plans are IRS-approved and designed to meet compliance requirements.
“Choosing the right retirement plan for your small business can be a $2 million decision. If you are highly compensated and your financial goals include saving as much as you can for retirement, the cash balance/401(k) plan combo might be the solution for you.”
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-Forbes, February 2020
Tax Benefits for Business Owners
A significant, if not the most important, element of cash balance plans is the tax deduction they provide. When federal income tax rates top out at 37% as they do now, cash balance contributions can reduce taxes substantially for key earners — very often tens of thousands of dollars in annual tax savings. In addition to federal tax savings, plan contributions can lower state and local taxes, which range from zero to as much as 13.3% in California.
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In all the following ways, contributing to a cash balance plan may reduce or eliminate taxes:
Collaborative Partnerships
Cash balance contributions are a deduction against business income.
Personal Federal Taxes
If a shareholder or partner receives a Schedule K-1 as a result of corporation or partnership profits, the individual’s personal federal taxes can be reduced by a cash balance contribution.
Top Marginal Income
The top marginal tax rate is 37% for individuals earning over $578,125 ($693,750 for married couples in 2023). A cash balance contribution that reduces income for a married couple below $693,750 will result in tax savings plus a reduction in the marginal income tax rate.
Personal State Taxes
As noted above, state tax rates can range widely from zero to 13.3%. Plan contributions can reduce the amount of tax owed.
Personal Investment Tax
A cash balance plan deduction may put a household under the net investment income tax threshold, eliminating the need to pay the 3.8% net investment income tax on unearned net income imposed on individual earnings over $200,000 ($250,000 for married couples). This surtax applies to investment income such as capital gains, dividends, and rental property income.
Medicare Tax
There is an additional 0.9% Medicare payroll tax on wages and self-employment income above $200,000 ($250,000 for married couples). Cash balance contributions can lower income to reduce this tax.
Qualified Business Income (QBI) deduction
For some business owners and professionals, a cash balance plan contribution could result in eligibility for the QBI deduction. This deduction is provided to companies that are structured as passthrough entities — sole proprietorships, partnerships, and S corporations. Taxpayers who qualify receive a 20% deduction of the income on their tax return. Many professional businesses (doctors, attorneys, consultants, actuaries, CPAs, etc.) do not qualify for the QBI deduction unless their income is below certain levels ($182,100 for a single return and $464,200 for a married couple filing a joint return for 2023).
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