When you think of cash balance pension plans you tend to think of IBM and other large companies that have used them to reduce their employee benefit costs. What many people do not realize is that in the right situation, these plans can provide a number of benefits to small business owners as well.

Traditionally, when a small business owner wanted to install a retirement plan for their business they had two options: Defined contribution plans like 401k’s, profit sharing, money purchase, SEP, SIMPLE, etc. or defined benefit plans. Defined contribution plans limit the cost of contributions for employees but also limit the tax deductible contribution for the business owner ($44,000 in 2006). Defined benefit plans allow a large contribution for the owner but can also mandate large contributions for employees. Now, cash balance offer another option, potentially large tax deductible contributions for the business owner with low contributions for employees.

Cash balance plans are a hybrid retirement plan designed to combine the best features of defined contribution and defined benefit plans. Like a defined contribution plan, employees have their own accounts with contributions based on compensation and interest which is credited each year based on a formula specified in the plan document. Like defined benefit plans, the retirement benefit is the greater of the benefit that can be provided by the employees account or a minimum benefit as described in the plan document.

Below is an example of the benefits of a cash balance plan. XYZ Company has two owners, age 45 and 48. They also have 5 staff people of varying ages and incomes. XYZ wants a retirement plan that allows the maximum benefit to the owners while minimizing employee costs. The example below compares the tax deductible contribution for a profit sharing plan, a defined benefit plan, and a cash balance plan:

Employee Age Salary Profit Sharing Defined Benefit Cash Balance
Owner A 45 $220,000 $44,000 $92,970 $92,970
Owner B 48 $220,000 $44,000 $119,870 $94,364
Employee A 46 $80,000 $16,000 $49,614 $9,317
Employee B 47 $35,000 $7,000 $21,695 $4,461
Employee C 31 $30,000 $6,000 $10,106 $1,460
Employee D 22 $25,000 $5,000 $6,188 $1,207
Employee E 21 $25,000 $,5000 $6,002 $1,208
Totals $127,000 $306,445 $204,987
% to Owners 69% 69% 91%

In this example, the cash balance plan allowed the owners a tax deductible retirement plan contribution of over $90,000 each and low contributions for employees. In fact, 91% of all contributions to the plan went to the two owners, as opposed to 69% in the other plan designs.

Cash balance plans will typically work well for the following:

 Professional practices and profitable small businesses with stable earnings.
 Companies with 2-25 employees
 Companies where there is a spread between either the ages of the owners and the employees or the salary of the owners and employees.

Because of the benefits these plans provide they are sure to become more popular as more and more small business owners and their advisors begin to understand them.