The fiscal cliff debate culminated in the passage of the American Taxpayer Relief Act of 2012. The Act extended certain tax provisions that expired at the end of 2012, including the tax rate for individuals, except for those with taxable income over $400,000 ($450,000 for a married couple on a joint tax return).

The increase in taxes for these high income filers has many small business owners scrambling for relief. And one increasingly popular solution is the cash balance pension plan.

A cash balance plan is a qualified retirement plan that contains some of the best features of the defined contribution plan (e.g. 401(k) profit sharing) and the defined benefit pension plan. A hybrid of the two, it allows for larger, tax-deferred contributions but still requires minimum funding standards and a promise to pay benefits, like a defined contribution plan.

But how do they work? With a cash balance plan, the employer makes annual contributions to a participant's hypothetical account. In addition, participants are credited with interest on the account. Employer contributions to the plan are invested in a single, commingled, trustee-directed investment account.

The employer/plan trustee is responsible for investing plan assets and utilizing an investment strategy meant to achieve a return equivalent to the earnings rate set forth in the plan document.

To produce larger contributions, especially for business principals and owners, cash balance plans are usually combined with 401(k) profit sharing plans.

For example, under a cross-tested 401(k) profit sharing plan, an owner would be able to maximize the amount on his behalf to $56,500 for 2013.


Who is a good candidate?

Cash balance plans work best for business owners who fit any of the following scenarios:

* Currently provide a 401(k) profit sharing plan or other qualified retirement plan. Although not necessary prior to establishing a cash balance plan, it can help employees understand how employer-sponsored retirement plans work.

* Looking to increase the deductible amount of employer contributions. Currently, the maximum amount allowable under a 401(k) profit sharing plan is $51,000 ($56,500 for those over age 50). A cash balance plan may allow for a deduction on behalf of an owner or principal of over $250,000, depending on age and the organization's demographics.

* Strong company cash flows and profits. These plans are meant to be around for at least five years and not act as a tax shelter. This is based on facts and circumstances so the ability to make contributions annually is important.

* Willing to give a little extra to employees. Depending on the demographics of the organization, extra cash contributions may be needed on behalf of the employees to pass all of the IRS compliance testing.

Small to mid-sized businesses have been the driving force behind the prevalence of this retirement plan option because it can help accelerate their savings and reduce year-end tax liability.

Jackson is an enrolled actuary with Cornerstone Retirement Plan Administrators in Rhode Island. For more information, call Cornerstone at (800) 678-1700 or visit

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