Understanding Cash Balance Pension Plans

What is a Cash Balance Pension Plan?

A cash balance pension plan is a retirement benefit account sponsored by a company for the benefit of their employees. This defined benefit plan is a pooled investment account that incorporates the elements of both a 401(k) and a traditional pension. Within this defined benefit pension account, each employee has a hypothetical account rather than an individual account. An annual tax deductible contribution is funded to the pension account by the employer. The employer also agrees to a minimum annual interest credit to the pension account. This guarantees a steady and predictable growth rate for the pension plan. Business owner(s) can use a cash balance pension plan in their favor to maximize their tax savings while also helping their employees save for retirement. 

Why should you create a cash balance pension plan for yourself as a business owner?

By creating a cash balance pension plan, not only does an employer help their employees save for retirement, but they maximize their corporate funded tax savings as a business owner. Cash balance pension plans can be skewed to favor the business owner while also helping the employees. Business owners can defer a portion of their net business profit by funding a tax deductible pension benefit for themselves. The tax deductible pension contribution reduces the amount of net business profit taxable to the business owner in any given tax year. The business owner can invest and grow their pension benefit in the tax-deferred pension account until they retire. Provided that a business owner is the right type of taxpayer, these plans can be designed to unlock maximum tax benefits for the business owner. 

How Does a Cash Balance Pension Plan Differ from a 401(k)?

The main distinction between a cash balance pension plan and a 401(k) is who bears the investment risk. The employee’s retirement income is determined by the success of the investments in their 401(k)—either investments they choose or investments their advisor chooses. The employee is responsible for making these decisions. Under a cash balance plan, the employer will guarantee their employees the benefits from the plan but also by providing a minimum rate of return. Most successful business owners hire professional money managers and use guaranteed insurance contracts to produce an efficient minimum rate of return.