The Cash Balance Plan: How to Supercharge Your Tax Savings Beyond the 401(k) Limit
The Cash Balance Plan: How to Supercharge Your Tax Savings Beyond the 401(k) Limit
COACHING POINTS
- The Ceiling: A standard 401(k) caps out around $69,000 (or $76,500 with catch-up). For a surgeon or CEO making $800k, this barely creates a dent in their tax bracket.
- The Solution: You can stack a Cash Balance Plan on top of a 401(k). This is a “Defined Benefit” plan where the limit is based on your age and income. A 60-year-old can often contribute an additional $300,000 tax-deductible.
- The Trade-off: This is a pension, not a savings account. Contributions are mandatory for the life of the plan (usually set up for 3-5 years minimum). It requires an actuary and higher admin fees.
If you are writing a check to the IRS for six figures every year, your 401(k) is not enough.
The Cash Balance Plan is the heavy artillery of tax reduction. It allows successful business owners to compress 20 years of retirement savings into 5-10 years, all while reducing taxable income dollar-for-dollar.
Source: IRS Publication 560 (Defined Benefit Plans)
Unlike 401(k)s, “Defined Benefit” limits rise as you get closer to retirement (shorter time to compound).
- Age 40: Max Contribution ~$85,000.
- Age 50: Max Contribution ~$150,000.
- Age 60: Max Contribution ~$300,000+.
- + 401(k) Profit Sharing: You can typically add another ~$45,000 in a 401(k) alongside this.
- Total Capacity: A 60-year-old owner can often shelter $350,000+ in a single year.
What-If Scenario: Solo Consultant (Age 55, Income $600k)
Goal: Maximize tax deductions.
| Plan Strategy | Total Deduction | Tax Savings (@ 40%) | Take-Home Wealth |
|---|---|---|---|
| Solo 401(k) Only | $76,500 | $30,600 | Higher Tax Bill |
| 401(k) + Cash Balance | $286,500 | $114,600 | Maximized |
Result: By adding the Cash Balance layer, the consultant saves an extra $84,000 in cash taxes. That’s the price of a luxury car, paid for by the IRS.
Visualizing the Savings Stack
| Strategy | 401(k) Deferral ($) | Profit Sharing ($) | Cash Balance Plan ($) |
|---|---|---|---|
| Standard 401(k) | 30500 | 46000 | 0 |
| Combo Strategy | 30500 | 46000 | 210000 |
*The Cash Balance Plan (Red Layer) massively expands the tax-deferred savings capacity on top of the 401(k) foundation.
Execution Protocol
Do not do this if your income fluctuates wildly. You must commit to the contribution amount (e.g., $100k/year) for at least 3-5 years. Missing a payment brings IRS penalties.
You cannot set this up on E*TRADE. You need a Third-Party Administrator (TPA) and an Actuary to calculate the funding limits and file Form 5500 annually. Expect fees of $2k-$5k/year.
The plan will have a guaranteed interest crediting rate (e.g., 4% or 5%). The goal is to hit this number, not beat the S&P 500. If the portfolio grows too fast, you might actually be forced to contribute less next year. Manage for stability.
COACHING DIRECTIVE
- Do This: If you are over 45, earning >$400k consistently, and feel “behind” on retirement savings. It is the fastest catch-up mechanism available.
- Avoid This: If you are young (<35) or have unpredictable income. The administrative costs and mandatory funding rules make it too rigid for early-stage or volatile businesses.
Frequently Asked Questions
What is a Cash Balance Plan?
It is a type of Defined Benefit (Pension) plan. It allows for much higher contribution limits than a 401(k), increasing with age. The money is pooled but tracked in hypothetical individual accounts.
Who is this for?
High-income business owners, partners, or consultants (usually earning $400k+) who want to save more than the ~$69k limit of a 401(k) and reduce their current tax liability.
Is the contribution mandatory?
Yes. Once set up, you are required to fund the plan annually according to the actuary’s calculations. It is a commitment, not a flexible option like a 401(k).