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Cash Balance Plans: Key Deduction and Funding Considerations for CPAs

Because cash balance plans are defined benefit plans, annual contribution requirements can vary based on participant demographics, compensation, plan design, investment performance, and the plan’s funded status. Understanding a few key rules can help CPAs better advise clients who sponsor these plans.

The IRC §404(a)(7) 6% Rule.

A common issue arises when an employer sponsors both a PBGC-exempt cash balance plan and a defined contribution plan, such as a 401(k) profit-sharing plan.

IRC §404(a)(7) imposes a combined deduction limitation for employers maintaining both types of plans. However, employer contributions to the defined contribution plan that do not exceed 6% of participant compensation generally receive favorable treatment under the rule. Importantly, this is primarily a deduction limitation, not a contribution limitation. In many cases, contributions greater than 6% may still be permitted under the plan document, but deductibility must be evaluated separately.

Employee elective deferrals are not included in the 6% calculation.

For sole proprietors, the compensation base is earned income from self-employment rather than W-2 wages. Because earned income calculations can be more complex than expected, accurately determining the compensation base is critical when calculating deductible contributions.

Funding Considerations by Entity Type.

As discussed above, entity structure can affect how cash balance plan contributions are funded and deducted.

For corporations and S corporations, required contributions are generally based on actuarial funding requirements rather than current-year profitability. Consequently, a business may still have a funding obligation even during a year with little or no income.

For sole proprietors, deductible contributions are limited by earned income. If the business generates little or no net income, the deductibility of contributions may be significantly reduced or unavailable. This can create challenges when a cash balance plan has actuarially determined funding requirements that exceed available earned income.

The Importance of Actuarial Coordination.

Cash balance plans may require contributions even when business income declines. Investment losses, changes in actuarial assumptions, or existing funding shortfalls can create minimum funding obligations that must be satisfied to maintain plan compliance.

Because contribution requirements and deduction limits are determined actuarially, CPAs should encourage clients to coordinate with their actuary and third-party administrator before year-end. Early planning can help identify funding obligations, maximize available deductions, and avoid unexpected contribution requirements.

Jesse St. Cyr, Partner, Poyner Spruill
Jesse is a member of the Employee Benefits and Executive Compensation team at Poyner Spruill LLP. He represents clients before the IRS and DOL in matters involving employee benefits. Jesse has experience working with a diverse range of benefits and compensation matters and has extensive experience working with a variety of employers. Jesse is recognized by Chambers USA as a leading lawyer for Business (Employee Benefits & Executive Compensation).