The landscape · Self employed and owners
Defined benefit and cash balance plans at high income
A defined benefit plan promises a yearly pension at retirement, and the business deducts whatever an actuary says is needed to fund it, which for an older owner can run to six figures a year.
Who this exists for. This exists for a business owner or self employed professional with high, steady income who has already filled a 401(k) and wants a much larger deductible contribution. Ticks that show it: I own a business with revenue; I earn money on my own (freelance, gig, side work); My household income is well above average; I am 50 or older.
How it works
The plan document promises a benefit, up to a yearly pension cap of this year's official defined benefit annual limit (not yet verified here; see the official source below) at retirement age, and an actuary calculates each year's required contribution from the owner's age, pay, and the years left to fund it. An older owner has fewer years to fund the same promise, so the required contribution is larger, which is the point for a person in their fifties. A cash balance plan is a defined benefit plan that states the benefit as a hypothetical account balance with a yearly pay credit and interest credit. The contribution is required, not optional, within a range the actuary sets, so the business needs steady profit. Employees who meet the plan's eligibility rules must be covered, and the plan files Form 5500 and pays for an actuarial report every year.
What it gives
Deductible contributions can be several times the 401(k) cap for an owner over 50.
The deduction can move a high earner down a bracket or two in a strong year.
A cash balance design shows each person a plain account balance rather than a pension formula.
What it costs, or where the catch is
The contribution is required each year and the plan is costly to unwind in a bad year.
Actuarial and filing fees run into the thousands every year.
Employees have to be covered, which raises the cost well beyond the owner's own benefit.
A worked example
Astrid, age 56, is a consultant with $400,000 of steady net income. Her actuary sets this year's required cash balance contribution at $150,000, on top of her 401(k) deferral. At a 35 percent marginal rate the deduction saves about $150,000 times 0.35, or $52,500 in federal tax this year. The plan costs her about $3,500 in actuarial and filing fees, so the net tax saving is near $49,000.
Where it goes wrong
The common miss is adopting the plan on one strong year's income, then being unable to make the required contribution when income drops.
Who confirms it for you
For your own numbers, a CPA or enrolled agent. This page explains how the rule works for people in general; it does not know your situation and does not tell you what to do.
The official source
IRS: Defined benefit plan. Every figure that changes by year comes from the site's rules table, which the watcher checks against the official page on a schedule; where a figure is not yet verified, this page says so instead of printing a number.
Ask about Defined benefit and cash balance plans at high income
A model reads this page and answers from it. It will say when the answer is not on the page. Education, not personalized advice.
Nearby doors
- After tax contributions and the mega backdoor Roth
This exists for a worker whose plan allows after tax contributions above the deferral cap and allows them to be moved into a Roth account.
- Catch up contributions at 50
This applies when a worker in a 401(k), 403(b), 457(b), or TSP turns 50 during the year, which opens an extra contribution amount above the regular cap.
- Nonqualified deferred compensation
This exists for higher earners, usually executives and senior staff, whose employer offers a plan to defer salary or bonus beyond what a 401(k) allows.
- The health savings account
This applies when a person is covered by a qualifying high deductible health plan and has no other disqualifying coverage, which opens the door to a health savings account.
- The traditional IRA and the deduction phase out
This exists for anyone with earned income who opens an IRA on their own, and especially for a worker who also has a plan at work, since that changes whether the contribution is deductible.
- The Roth IRA and its income phase out
This exists for anyone with earned income below the Roth income lines who wants an account where qualified withdrawals come out tax free.
Education, not advice. Wealthy Habitat explains how rules work and never recommends what to do with your money. The No Advice Disclosure.