Cash Balance Plan for Business Owners: Save Past the 401(k)

A cash balance plan for business owners is a company pension that sits beside a 401(k) and can take much larger yearly contributions than a 401(k) can.

The price is commitment. The business must meet annual funding requirements, provide benefits for eligible staff, and keep the plan running for several years, so it fits owners with steady, high profits who are older than most of their employees.

How does a cash balance plan work?

A cash balance plan is a defined benefit plan, the same legal family as a traditional pension. A traditional pension states its promise as a monthly check at retirement. A cash balance plan states it as an account balance.

Each year, each participant's account gets a pay credit (an amount or a percentage of pay) and an interest credit (a fixed or variable rate). The plan sets both, and the law caps the interest credit at a market rate of return.

The account is a bookkeeping figure. The real money sits in a plan trust, invested by the business or a manager it appoints. Gains and losses in that trust do not directly change what participants were promised, so the investment risk sits with the business. Every year, an enrolled actuary measures how well funded the plan is, calculates the required minimum contribution, and signs Schedule SB of the plan's Form 5500, so the contribution normally changes from year to year.

The account balance is the business's promise. When the plan's investments fall short of it, the gap generally comes back as a larger required contribution.

Defined benefit plan

A plan that promises a benefit, with the employer responsible for funding it. In a defined contribution plan like a 401(k), the benefit depends on what goes in and how it is invested.

Enrolled actuary

A pension actuary qualified to sign the plan's yearly funding report (Schedule SB of Form 5500).

Highly compensated employee

For plan testing, this group includes anyone who owned more than 5 percent of the business at any time during the year or the year before.

How does a cash balance plan work alongside a 401(k)?

The two plans can run side by side: the IRS notes that an employer with a defined benefit plan can also have other retirement plans. They are measured differently. A 401(k) caps what goes in each year. A defined benefit plan caps what comes out: the yearly benefit at retirement, stated as a life annuity.

The benefit limit is adjusted when benefits start before 62 or after 65, and it shrinks when you have fewer than 10 years in the plan: the dollar cap is multiplied by your years of participation divided by 10.

When the same people are covered by both plans, section 404(a)(7) caps deductible contributions to the two together at the greater of 25 percent of covered pay or the cash balance plan's minimum funding amount, which for a single-employer plan is never less than its funding target minus the value of plan assets. Salary deferrals are not counted, employer contributions to the 401(k) up to 6 percent of pay are not counted, and a cash balance plan insured by the Pension Benefit Guaranty Corporation (PBGC) is not counted at all. That makes the profit-sharing percentage a design choice to settle with the actuary.

If you are still choosing the defined contribution side, our SEP IRA vs. Solo 401(k) comparison walks through it. A cash balance plan is the next layer once that side is full.

A 401(k) limits what goes in. A cash balance plan limits what comes out, and for an older owner that difference is where the extra room comes from.

When does a cash balance plan for business owners make sense?

Steady, high profits

The funding requirement applies in good years and lean ones, and the IRS applies an excise tax when the minimum contribution requirement is not met. A business whose profits swing widely can find that duty hard to carry.

An owner older than most of the staff

The tax rules let these plans be tested on projected benefits: each person's credits are converted into the retirement annuity they would buy at a set testing age. A dollar credited to a 32-year-old has decades longer to grow than a dollar credited to a 58-year-old, so a modest credit for a younger employee can test as large, as a share of pay, as a much bigger credit for an older owner. Generally, the wider the age gap, the more of the plan's dollars can go to the owner.

Several years of runway

Treasury regulations treat a qualified plan as a permanent program. Abandoning one within a few years, for a reason other than business necessity, is evidence it was never a bona fide plan for employees. Add the 10-year phase-in of the benefit limit, and starting early matters. If a sale is on the horizon, our pre-exit tax checklist explains why the plan belongs in the conversation before a letter of intent.

It usually does not fit owners with uneven profits, a workforce older or better paid than the owner, or a horizon of a year or two.

The best candidates have steady profits, a few years before the exit, and a staff younger than the owner.

What does a cash balance plan cost, and what must employees get?

The IRS calls a defined benefit plan the most costly and most administratively complex type of plan: a plan document, an enrolled actuary every year, the annual Form 5500 with Schedule SB, and nondiscrimination testing.

Most cash balance plans are insured by the PBGC, and a covered plan pays PBGC premiums. Two exemptions matter for smaller businesses: a plan maintained only for substantial owners (generally owners of more than 10 percent), and a plan of a professional service employer, such as a medical, law or accounting practice, that has not had more than 25 active participants at any time. Coverage cuts both ways: it adds premiums, and it takes the plan out of the combined deduction limit above.

A plan generally cannot make an employee wait past age 21 and one year of service (a 12-month period with at least 1,000 hours), though it can choose looser rules. Three tests then decide how many employees must benefit, and how much:

• Minimum participation. A defined benefit plan must benefit at least the lesser of 50 employees or the greater of 40 percent of employees or 2 employees (or the only employee, if there is just one).
• Coverage. The plan generally must benefit at least 70 percent of employees who are not highly compensated, or pass an alternative ratio or average benefit test.
• The gateway. When the cash balance plan and the 401(k) are tested together, each rank-and-file employee's combined rate (profit sharing plus the actuarial value of the cash balance accrual, not the stated pay credit) must generally be at least one third of the highest rate among highly compensated employees, or 5 percent of pay if that is less, and the minimum rises once that top rate passes 25 percent of pay. A rate of 7.5 percent of pay is deemed to satisfy it.

Employees must be fully vested in their cash balance credits once they finish three years of service.

What the staff receive is part of the price of the owner's pension.

A hypothetical illustration

The numbers below are invented and round, the cash balance credit is an assumed design choice, and a real plan's figures come from its actuary. Assume an S-Corp owner, age 56, on a $300,000 W-2 salary, with two employees ages 32 and 41 who each earn $60,000. Profit sharing is 6 percent of pay for everyone, and each employee also gets a small hypothetical cash balance pay credit.

For the two employees, that is $7,200 of profit-sharing contributions plus $1,800 of hypothetical cash balance credits. Credits are not deposits: actual cash balance funding comes from the actuary, who also tests whether each employee's combined rate clears the gateway. Holding profit sharing at 6 percent keeps the combined deduction limit out of play even without PBGC coverage.

How does an S-Corp salary affect a cash balance plan?

For an S-Corp owner, the plan sees only W-2 salary. The IRS states that retirement plan contributions can only be made from compensation, and S corporation distributions are not earned income for retirement plan purposes.

Three limits run off that salary: the benefit cannot exceed 100 percent of your average pay over your highest three consecutive years, pay above $360,000 is ignored for 2026, and the combined deduction limit, where it applies, is a percentage of pay. A salary kept low for years keeps the first limit low until three higher years build up.

That pulls against the S-Corp strategy of saving payroll tax on profit taken as distributions (our S-Corp vs LLC breakdown works through that math). One detail helps: for 2026, wages above the $184,500 Social Security wage base owe Medicare tax but no Social Security tax, so salary above that line costs less payroll tax per dollar than salary below it. Model the balance with your CPA before payroll is set for the year.

In an S-Corp, the salary you set also sets a ceiling on the pension.

What are the risks and tradeoffs?

• The money is locked up. A defined benefit plan generally cannot pay in-service distributions before age 59 1/2.
• Earned benefits stay earned. The business can amend the plan to lower future credits, with advance notice to participants if the cut is significant, but it generally cannot reduce benefits already earned.
• Overfunding has a cost too. The deduction is capped by a formula the actuary runs each year, and the IRS applies an excise tax to excess contributions.
• A sale changes the math. If the plan ends, every affected employee becomes fully vested in benefits earned to that date, to the extent funded.
• The tax is deferred. Plan payouts are taxable in the year they are distributed. At separation, many plans allow a lump sum (with spousal consent, if married) that can be rolled to an IRA, where it later feeds required minimum distributions. Our guides to RMD tax planning and tax-efficient retirement income cover that stage.

A cash balance plan is a multi-year funding promise, so treat each year's contribution as a commitment rather than a choice.

Anchor provides tax strategy, planning and coordination, not tax filing or legal advice. The plan document, actuarial work and returns belong with the plan's actuary, your CPA and your attorney.

The IRS dollar limits above are for the 2026 tax year and are adjusted annually. Confirm the current-year numbers before acting.

Frequently asked questions

What is the cash balance plan limit for 2026?

For the 2026 tax year, a defined benefit plan can pay an annual benefit of up to $290,000, stated as a life annuity, or 100 percent of your average pay over your highest three consecutive years, if less. The yearly contribution that funds it is set by the plan's actuary and depends on your age and years in the plan.

Can I have a cash balance plan and a 401(k) at the same time?

Yes, and the two have separate limits. When the same employees are in both, a combined deduction limit can apply, with exceptions for salary deferrals, for 401(k) employer contributions up to 6 percent of pay, and for plans insured by the PBGC.

Do I have to contribute for my employees?

Generally, yes. Participation and coverage tests apply, and when the plan is tested together with a 401(k), a combined rate of 7.5 percent of pay for each rank-and-file employee, counting the cash balance part at its actuarial value, is deemed to meet the gateway minimum. Employees are fully vested after three years of service.

Can I stop contributing if profits drop?

Not freely. Missing the required minimum contribution triggers an excise tax. You can amend the plan to lower future credits, with notice to participants, but benefits already earned generally cannot be reduced, and ending a plan within a few years without a business reason is evidence it was never a bona fide plan.

Do S-Corp distributions count toward a cash balance plan?

No. For retirement plan purposes, only your W-2 salary counts. Distributions do not, so the salary you set limits both your contributions and your benefit.

What happens to the plan if I sell the business?

If the plan ends, affected employees become fully vested in benefits earned to that date, to the extent funded, and many plans allow lump sums that can be rolled to an IRA. Settle the plan's future with your CPA, attorney and actuary before deal terms are signed.

Sources

1. IRS, Internal Revenue Bulletin 2025-49 (Notice 2025-67), the 2026 defined benefit limit of $290,000.
2. IRS, 401(k) and profit-sharing plan contribution limits, the 2026 deferral, catch-up, annual additions and compensation limits.
3. U.S. Department of Labor, Fact Sheet: Cash Balance Pension Plans, pay and interest credits, investment risk, lump sums and PBGC coverage.
4. IRS, Defined benefit plan, Form 5500 and Schedule SB, cost, excise taxes and in-service distributions.
5. IRS, Choosing a defined benefit plan, looser eligibility rules and the required minimum contribution.
6. 26 U.S.C. 415, the benefit and contribution limits, the high-three-years rule and the 10-year phase-in.
7. 26 U.S.C. 401, minimum participation (401(a)(26)) and the compensation limit (401(a)(17)).
8. 26 U.S.C. 410, minimum age and service, and minimum coverage.
9. 26 CFR 1.401(a)(4)-9 and 26 CFR 1.401(a)(4)-12, the gateway for combined plans and testing on projected benefits.
10. 26 U.S.C. 411, three-year vesting, the market-rate cap on interest credits, and full vesting when a plan ends.
11. 26 U.S.C. 404, the deduction limits for defined benefit and combined plans.
12. 29 U.S.C. 1321 and 29 U.S.C. 1307, PBGC coverage, its exemptions, and premiums.
13. 26 CFR 1.401-1, a qualified plan as a permanent program.
14. 26 U.S.C. 414 and 26 U.S.C. 416, highly compensated employees and 5-percent owners.
15. 26 U.S.C. 402, taxation of plan distributions.
16. IRS, Retirement plan FAQs regarding contributions: S corporation, why distributions do not count.
17. Social Security Administration, Contribution and benefit base, the 2026 wage base of $184,500.