A Smart Retirement Strategy for Business Owners Using Cash Balance Plans

How is a cash balance retirement plan like a Kardashian? Everybody’s talking about them, and nobody seems to know why. Cash balance retirement plans, on the other hand, have also emerged as an especially hot topic, but with good reason.

Is Your Business Your Retirement Plan?

Commonly, business owners consider their business to be their main asset for funding their personal retirement. After all, they have spent their career building it and ensuring its proper running and value. Why wouldn’t a great business sell, and sell for a great price, allowing the business owner to enjoy the fruits of their labor during their retirement years?

Unfortunately, the reality is that this strategy is fraught with risk. The biggest problem with selling a business is that most of them never sell. Estimates range widely, with some stating that as many as 90% of business listings never result in a sale. Business listing sites seem to have very wide ranging standards for asking prices, financial information disclosed, and details included, and many of the inquiries made on such sites go unanswered. Without a carefully groomed buyer in place, hopes of selling are grim.

And those who do sell may not get the asking price they were hoping for, giving them a less comfortable retirement than they imagined. Or, they may discover that the business is difficult or impossible to run without them personally involved, leaving them with complicated relationships and responsibilities.

So while selling a business may be an excellent path to a generous and enjoyable retirement, smart owners are backing up their business sale plans with more structured preparation.

Step One: Get a 401(k)

A company 401(k) plan is a cliche for a reason. They serve as a strong foundation for tax-advantaged investing, and they give real benefits to everyone employed at the company.

Successful business owners can save the maximum contribution limit each year, and pair it with a company match. 401(k) plans have much larger limits than other plan types, about 10x larger than an IRA (Individual Retirement Account), when the company contribution is included.

To take full advantage of what a 401(k) has to offer, use a profit-sharing plan. Rather than taking  a large portion of profits in wages, and suffering the accompanying tax burdens, business owners can consider the profit-sharing plan to be part of their compensation, giving them tax advantages now and wealth that grows for the future.

Step Two: Pair It with a Cash Balance Plan

Cash balance retirement plans are increasingly popular with successful business owners, especially those who are already maxing-out a profit-sharing 401(k) and want to save even more. These plans allow for much larger contributions than are available in a 401(k) while providing significant tax deductions to the business.

And, they give businesses some flexibility in terms of which employees can receive the benefit, making them particularly attractive for family businesses or those with a few high-paid or key employees.

Take a look at the basics of how these plans are structured to understand why they are becoming such a valuable option for many professionals who are nearing retirement age.

Cash Balance Plans are Unique

Understanding the key differences between a traditional 401(k) and cash balance plans is essential.

First, a cash balance (CB) plan is a defined-benefit (DB) plan. Instead of defining what can be contributed during working years, they define what will be distributed upon retirement. The contributions are made by the employer, not the employee, and the funds are pooled and professionally managed.

Because of this structure, employees do not have individual accounts, and in fact, their account balances are only hypothetical until they retire. This means participants don’t select their investments, and they can’t take loans or early withdrawals. Payouts happen at only one time: at normal retirement age.

Second, unlike many other types of DB plans and pensions, cash balance plans allow for participants to receive a lump sum when they retire. They can also move it into an annuity or other option. This makes them uniquely attractive, giving the participants maximum flexibility for how to handle their money post-employment.

To expand your understanding of cash balance plans even farther, and to receive CE credit, sign up for our free April 2, 2025 Webinar: Cash Balance Plans 201.

Here’s How CB Plans Grow

Cash balance plans operate through a combination of credits. Employers make annual contributions, called “pay credit.” The plan establishes a guaranteed rate of return, often between 4% and 5%, which is called an “interest credit.”

The pay credit requires a complex calculation based on time to retirement for each employee, the promised benefit amount, market performance and related factors. An actuary performs the calculation and tells the business how much their pay credit will be that year. It’s important that businesses have a track record of high revenues in order to cover this amount, which will vary from year to year, but will always be required.

The interest credit is set to ensure steady growth and minimize volatility. It is not intended to take advantage of market performance. If the plan accumulates a large amount due to investment performance, it will reduce the pay credit for that year. Businesses that count on the pay credit to help offset tax burdens may find themselves less advantaged during bull market periods.

Strong Candidates for a Cash Balance Plan

While any business can establish a cash balance plan, they only make sense for a very specific type of saver:

• High-income professionals, dentists, doctors, attorneys, and high-end contractors or consultants
• Successful small business owners with stable cash flow, high profits, and owners nearing retirement age
• Self-employed individuals, especially when a spouse wants to be included

It is vital that businesses considering cash balance plans prepare for ongoing, high annual contributions. Those already maximizing their profit-sharing 401(k) plans and able to commit to the plan for at least three years make the best candidates.

You should specifically avoid a cash balance plan if the business does not have a stable cash flow, since plans require guaranteed contributions. This makes them unsuitable to sectors with high seasonality, sensitivity to economic fluctuations or with otherwise volatile earnings. Additionally, young business owners should avoid this retirement plan type, since distant time horizons will make it unlikely that they maximize their benefits. Instead, focus on clients closer to retirement age.

How Effective are Cash Balance Plans?

To see how much more powerful a retirement planning strategy can be when a cash balance plan is included, imagine a dental practice with one dentist and one hygienist, each with their very different incomes.

Example 1: 401(k) with Profit Sharing Only

In this scenario, the practice utilizes a 401(k) safe harbor non-elective plan with profit sharing. The dentist, with a salary of $345,000, receives a total employer contribution of $46,000, which is 13.3% of their compensation. The hygienist receives contributions totaling 4.4% of their compensation. At this rate, each can look forward to a nice lump sum at retirement.

As far as tax savings, those are notable but not substantial, for both participants.

Example 2: 401(k) with Profit Sharing, Cash Balance and Match

By offering a 401(k) plan with safe harbor match and a cash balance plan, the dentist receives total additions of $303,462 with cash balance contributions of $260,887. The result is a three-fold increase in retirement savings for the dentist and about a 40% increase for the hygienist.

Additionally, the tax savings for both the dentist and hygienist jump between 400% and 500%.

Note that the addition of the cash balance plan provides a much larger sum for the dentist at the time of retirement, as well as a substantial sum for the hygienist, and both receive nice tax benefits.

Select a Smart Cash Balance Plan Provider

Successful business owners can prepare a large sum for retirement by using the strategy suggested above. In the event the business does not sell, takes a long time to sell, or sells for an amount that is lower than expected, the prepared funds will provide a safety net of funds to fall back on.

Having a reputable plan provider is crucial. 401GO offers both profit-sharing 401(k) plans and cash balance plans, giving business owners a single point of contact at an affordable cost. This ease of coordination between the two plans is especially valuable when annual testing is performed to ensure the plans are administered fairly. With an unmatched 4.8 G2 approval rating, 401GO is built on a foundation of strong financial advisor partnerships.

To expand your understanding of cash balance plans even farther, and to receive CE credit, sign up for our free April 2, 2025 Webinar: Cash Balance Plans 201.