Cash Balance Plans Under the New Tax Law

By Bill Barks
Director of Employee Benefit Plan Services

The Tax Cuts and Jobs Act (TCJA) was signed into law on December 22, 2017 and generally impacts tax years beginning in 2018. The tax law introduced a new deduction that should provide a substantial tax benefit to individuals with “qualified business income” from a partnership, S corporation, LLC or sole proprietorship. In general, owners of pass-through entities will receive a 20% deduction of “qualified business income.”

However, taxpayers that are owners of a “specified service trade or business” may be limited in the amount of deduction that can be claimed. A “specified service trade or business” is defined as a trade or business involved in the performance of services in the fields of health (i.e., medical services by physicians, nurses, dentists and other similar healthcare professionals, but not services not directly related to healthcare, such as the operation of spas and health clubs), law, accounting, actuarial science, performing arts (but not services by persons other than performing artists, such as promoters or broadcasters), consulting, athletics, financial services, brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities, and any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.

Under the new law, taxpayers that are owners of a specified service business are not entitled to the full 20% deduction if their taxable income exceeds certain thresholds. The applicable threshold levels for 2018 are $315,000 (joint filers) or $157,500 (all other filers), and the deduction is phased out for service business owners with taxable income between the threshold levels plus $100,000 for joint filers or $50,000 for all other filers. In other words, owners of service businesses will receive no deduction if their taxable income exceeds $415,000 (joint filers) or $207,500 (all other filers).

If you are in a specified service trade or business, contributions made to a qualified retirement plan can be a powerful tool to reduce your taxable income sufficient to qualify for the 20% deduction. One type of retirement plan in particular, a cash balance plan, offers significantly higher contribution deduction opportunities.

Simply put, a cash balance plan is a cousin of the defined benefit plan with more flexibility. In some respects it looks somewhat like a 401(k) plan that you probably already have. It’s an additional qualified plan which generally sits side-by-side with a profit sharing/401(k) plan. Because a cash balance plan is a type of defined benefit plan, it greatly favors its older and higher compensated participants. This makes it ideal for many professional practices. Cash balance plans have been around for over 20 years and based on IRS data through 2016:

  1. There are over 20,000 cash balance plans in operation.
  2. Plan assets exceed $1 trillion dollars.
  3. Cash balance plans comprise over 35% of all defined benefit plans.
  4. Over 90% of plans are in place in companies with less than 100 employees.
  5. Over 65% of plans are in place for physicians, dentists, attorneys and other professionals.

Depending on your age, a cash balance plan might allow you to put away an additional $250,000 or more each year into a tax deferred, qualified retirement plan. Below is a comparison of defined contribution and defined benefit plans.

A defined contribution plan sets a formula based on compensation to determine the annual contribution for each participant’s account in the plan. Upon termination or retirement, the benefit is whatever value the account has attained. So, the final value is dependent on deposits, time and rate of return. There is no guarantee of any particular benefit.

On the other hand, a defined benefit plan sets a percentage of compensation as a benefit due at retirement, and then works backward to determine annual contributions. The accrued vested benefit of contributions compounding at 3-5% is a guarantee by the plan and the plan sponsors. In the event of a funding shortfall, the plan sponsor must make up the deficiency.

While the cash balance plan is a defined benefit plan, the participant will see an account much like their 401(k) except that their contributions grow at a guaranteed 3-5%, and the participant does not exercise investment control. It’s all done for the participant.

Let’s see how using a cash balance plan could allow any owners of a specified service trade or business to qualify for the full 20% deduction and the impact on their effective tax rates.

The above 61-year-old married physician with a practice earning $650,000 a year could set up a defined benefit plan to get his taxable income under the $315,000 threshold amount. He could put $268,000 in a cash balance plan, in addition to putting money in his 401(k) and contributing to employee retirement accounts, and get down to an effective tax rate of approximately 20%.

In order to address non-discrimination rules, owners are required to allocate some portion of the cash balance plan funding to the other eligible employees. The rules depend on the age and income levels of the employees. Typically setting up a cash balance plan for a business owner will require a profit-sharing retirement contribution for staff to equal to about 7.5 percent of their salaries. As a result of this, cash balance plans can sometimes be too expensive for larger businesses with many low wage earners.

For small, profitable professional businesses, however, the vast majority of the benefit can usually go to owners, not the employees. In the example above, the physician practice employs four people earning between $25,000 and $50,000 a year. To pass nondiscrimination rules, the four employees would split an annual retirement contribution from the doctor of about $14,000. Therefore, the owner gets over 95% of the total allocation of the contribution amount.

Setting up a cash balance plan isn’t the right strategy for every business. Owners must be sure of stable, consistent profits before they commit to funding several years of cash balance plan contributions.

However, in the right situation, cash balance plans have been an effective tax strategy. Now, under the new tax law, they can be an even more powerful tax reduction tool for specified service business owners that operate as a partnership, S-corporation or sole proprietorship.

If you have questions about your company’s employee benefit plan, please contact Bill Barks at (317) 613-7867 or email

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