What is a cash balance plan and is it worth it for a practice owner?
A cash balance plan is a defined benefit plan, which is a type of pension, that a practice sets up for its owners and employees. Each participant has an account that grows by a set pay credit each year plus an interest credit, so on a statement it looks a lot like a 401(k). Behind the scenes it follows pension rules, and that is what allows much larger contributions.
The main benefit is the size of the deduction. A 401(k) with profit sharing tops out around $70,000 a year for most owners. A cash balance plan sits on top of that. An actuary sets your maximum based mainly on your age and compensation, and the older you are, the more you can put in. An owner in their mid-40s might be able to contribute around $100,000 a year. Someone in their late 50s or early 60s can often contribute $250,000 to $300,000 or more. All of it is deductible, so an owner in the top bracket can lower their tax bill by tens of thousands of dollars a year.
If you have employees, the plan has to pass nondiscrimination testing. That usually means contributing roughly 5% to 7.5% of pay for eligible staff, often through a mix of the cash balance plan and 401(k) profit sharing. Say you have six eligible employees averaging $50,000 a year. At 6%, that comes to about $18,000 for your staff. If the plan lets you put away $150,000 for yourself, the math usually works out well in your favor. Practices with a large staff compared to the number of owners, or with older and well-paid staff, need a closer look before committing.
The tradeoff is flexibility. Contributions are not optional the way profit sharing is. The actuary gives you a range each year and you have to fund at least the minimum. The IRS also expects the plan to be permanent, which in practice means planning to keep it running for at least three to five years. Opening it for one big deduction and closing it the next year can create problems. Expect a few thousand dollars a year in actuary and administration fees as well.
It tends to make sense for owners in their 40s to 60s who already max out their 401(k), have consistent profits, and want to catch up on retirement savings. It is usually a poor fit for a new practice with uneven cash flow, a younger owner with lower limits, or a practice expecting a big drop in income. When we provide tax services for physicians, this is one of the first things we look at once a practice’s profits have leveled out.
How your practice is structured also matters. If you’re taxed as an S corporation, your contribution limit is based on your W-2 salary, not total profit, so owner pay and plan design need to be decided together. The lower taxable income can also help with the qualified business income deduction. Medical practices lose that deduction as income rises past certain thresholds, so if you’re close to the phase-out range, a large contribution may recover some or all of it.
Before signing up, get an actuary’s proposal showing your contribution range and staff cost, then run it against your actual tax projection. That comparison is a core part of our tax planning work, and it tells you whether the deduction is worth the long-term commitment for your situation.
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