Cash Balance Plans: How to Hide $300,000 from the IRS Legally
Cash Balance Plans: How to Hide $300,000 from the IRS Legally
๐ WHO THIS IS FOR
- Target Profile: Business Owners, Doctors, Partners with annual net income > $500,000.
- Primary Objective: Massive Tax Deduction (Reducing taxable income by $200kโ$400k annually).
- Not Suitable For: W-2 Employees (unless you own the company) or businesses with unpredictable cash flow.
EXECUTIVE SUMMARY
- The Problem: A SEP-IRA or Solo 401(k) caps out around $69,000/year. If you earn $1M, you are still paying tax on $931,000. You need a bigger bucket.
- The Solution: A Cash Balance Plan is a type of Defined Benefit (Pension) plan. Instead of being limited by a fixed dollar amount, the limit is based on creating a future annuity stream (e.g., $275k/year at retirement).
- The Scale: For a 55-year-old business owner, this actuarial math allows annual tax-deductible contributions of $200,000 to $400,000. When combined with a 401(k), total deductions can exceed half a million dollars.
- Authority Baseline: This strategy is strictly regulated by IRC ยง 412 (Minimum Funding Standards) and requires an Actuary to certify annual contributions.
Most people think the 401(k) is the ceiling. For the wealthy, it is just the floor. The Cash Balance Plan is the “Secret Weapon” of high-income professionals. It allows you to squeeze a decade’s worth of 401(k) contributions into a single year. According to Team BMT Analysis, this is the only reliable way to drop from the 37% tax bracket to the 24% bracket while retaining 100% of the asset. Source: Schwab / Kravitz (Cash Balance Consultants)
Scenario: 60-Year-Old Cardiologist earning $800k/year.
- Strategy A (401k Only):
Contribution: $30,500 (Employee) + $46,000 (Profit Sharing) = $76,500.
Taxable Income: $723,500. Tax Bill: ~$240k. - Strategy B (Combo Plan):
401(k) Profit Sharing: $46,000.
Cash Balance Plan: $320,000 (Actuarially calculated).
Total Deduction: $366,000.
Taxable Income: $434,000. Tax Bill: ~$120k.
Verdict: You saved $120,000 in cash taxes this year alone.
BMT Verdict: If you are a business owner over age 50 earning more than $500k and you do not have a Cash Balance Plan, you are effectively choosing to pay a 40% voluntary penalty on your income. The administrative cost ($2k-$5k/year) is a rounding error compared to the six-figure tax savings.
Maximum Contribution Limits (2024 Estimates)
| Age of Owner | 401(k) + Profit Sharing Max | Cash Balance Plan Max | Total Tax Shelter |
|---|---|---|---|
| 40 | 69000 | 105000 | 174000 |
| 50 | 76500 | 189000 | 265500 |
| 60 | 76500 | 328000 | 404500 |
*Chart Note: The older you are, the more you can contribute. The IRS allows you to “catch up” on retirement savings rapidly because you have fewer years left to compound. This makes it the ultimate late-career accelerator.
Mandatory Funding Warning: Unlike a 401(k) where contributions are discretionary (you can stop if business is bad), a Cash Balance Plan is a pension obligation. You must fund it every year, usually for a minimum of 3-5 years. In 2008, many business owners struggled because they were legally required to fund the plan despite plummeting revenues.
โ BOUNDARY CLAUSE: This Structure Breaks Down If:
- You Have Many Employees: You must contribute to employees’ accounts too (typically 5-7.5% of their salary) to pass “Non-Discrimination Testing.” If staff costs are too high, the owner’s benefit is diluted. Ideal for Solo owners or small teams.
- Short Horizon: If you plan to sell the business or retire in < 3 years, the IRS may disqualify the plan as not being "permanent."
Execution Protocol
You cannot open this at Fidelity/Vanguard with a click. You need an actuary to draft the plan document and file Form 5500 annually. Fees range from $2,000 to $5,000 per year.
The plan guarantees a specific growth rate (e.g., 4% or “30-Year Treasury”). Strategy: Invest conservatively. If the portfolio earns more than the guaranteed rate, it reduces your allowable contribution next year (bad for tax deduction). If it earns less, you have to put more money in (good for tax deduction, bad for cash flow).
When you retire or close the plan (after 5+ years), you do not take an annuity. You roll the massive balance ($2M-$3M) into a Traditional IRA. Then, you can Roth convert it slowly over time.
This is the heavy artillery of tax planning. It requires consistent cash flow and professional administration. Do not attempt this DIY.
WEALTH STRATEGY DIRECTIVE
- Do This: Combine a Cash Balance Plan with a “Safe Harbor 401(k).” This combo maximizes the owner’s allocation while satisfying employee testing requirements with the minimum mandatory cost.
- Avoid This: Investing the plan assets in high-volatility stocks (Bitcoin/TSLA). Large losses force you to make massive “makeup contributions” unexpectedly, which can bankrupt the business in a downturn.
Frequently Asked Questions
Is the money locked up?
Yes, like any pension or 401(k). You generally cannot touch it until age 59ยฝ or plan termination without penalty. However, it is fully protected from creditors under ERISA.
What if I have employees?
You usually have to give them a “Profit Sharing” contribution of ~5-7% of their salary. The math works if the owner’s tax savings ($100k+) outweigh the cost of employee contributions ($20k).
Can I do a Backdoor Roth too?
Yes. The Cash Balance Plan and 401(k) do not interfere with the Backdoor Roth IRA strategy. You can (and should) do all three.