A Cash Balance Plan for a Seven-Person Manufacturer, and a Wife Working Twenty Hours
Your client is 59 and owns 100% of a small manufacturing company organized as an S corporation. His 2025 W-2 wages are $265,000 and net income is projected at $700,000. The company sponsors a safe harbor 401(k) with a 3% nonelective contribution and a new comparability profit-sharing feature. Census: the owner; his wife, 56, who works 20 hours a week and earns $28,000; a 62-year-old controller earning $95,000 with 18 years of service; an estimator earning $72,000; and three production workers aged 26 to 33 earning $42,000-$48,000 each with one to three years of service. He wants to defer $23,500 plus the $7,500 catch-up and shelter as much income as possible. He asks whether a cash balance plan is worth it and whether he can walk away if business softens.
1. Assess the feasibility and cost of adding a cash balance plan to the existing 401(k).
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The design works because the demographics are favorable. One highly paid 59-year-old owner and a young, short-tenure, modestly paid staff is the classic cash balance profile. The owner's pay credit can be very large at his age while aggregate benefit testing still passes, because the staff accrue small credits over long discount periods.
Rough cost estimate. Combined testing typically requires a gateway contribution to non-highly compensated employees in the range of 7.5%-8% of pay when a DC plan is aggregated with a DB plan. Payroll for the four non-owner, non-spouse employees is roughly $280,000, so gateway cost is approximately $21,000, plus the 3% safe harbor already being funded (about $8,400). Total staff cost is therefore in the low $30,000s.
Owner benefit. Between the 401(k) deferral, catch-up, employer contributions, and a cash balance credit sized to the Section 415(b) limit, total annual funding for the owner and his wife can plausibly approach $250,000, producing a deduction worth roughly $100,000 at his marginal rate. The staff cost is a fraction of the tax saved.
Non-financial costs: an enrolled actuary, annual Form 5500 with Schedule SB, PBGC premiums if the plan is covered, and the loss of funding discretion described below. Confirm the plan is not a professional service employer plan and check PBGC coverage based on participant count.
Verdict: economically compelling, but only if the client can commit to the contribution for at least three to five years.
2. The client asks: 'If business softens, can I just stop funding it?' Explain the constraints.
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No - a defined benefit plan is a commitment, not a discretionary account. This is the single most important thing to tell him.
- Minimum required contribution is set actuarially each year and is mandatory. Falling short triggers an excise tax under Section 4971 on the accumulated funding deficiency, and the deficiency must be reported on the Schedule SB.
- Freezing does not stop the funding. He can freeze benefit accruals prospectively, but the plan must still be funded to its accrued liabilities.
- Termination requires full funding. He can terminate, but only by making the plan whole. Funding a $1 million+ shortfall in a bad year is exactly the scenario he is worried about.
- No reversion to the company. After all liabilities are satisfied, any residual assets returned to the employer face a 50% excise tax (reduced to 20% in some cases if a qualified replacement plan is established).
- Investment risk sits with the company. If plan assets fall short of the actuarial target, the employer writes the check. The owner cannot invest the trust assets aggressively and hope for the best.
Mitigation: adopt a plan design with a modest, sustainable credit rather than the maximum, invest the trust in a conservative liability-hedging portfolio, keep a company reserve equal to two years of required contributions, and build in a formal freeze amendment trigger at a defined revenue threshold.
3. The wife works 20 hours a week for $28,000. How should she be treated for plan purposes, and what should be done about the 62-year-old controller?
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The wife. Twenty hours per week times 52 weeks is about 1,040 hours - just above the 1,000-hour eligibility threshold that most plans use. She is likely eligible and probably already is a participant, which may be unintended. She is a highly compensated employee by attribution as the spouse of a more-than-5% owner, and her compensation counts in the HCE average benefit percentage test. Her own deferral and employer allocations are also part of what the owner is trying to maximize. Determine whether she actually satisfies the plan's eligibility and entry-date provisions and whether a class exclusion is available; do not simply assume she is out.
The controller. At 62 with 18 years of service and $95,000 of pay, she is the most expensive participant in a cash balance design - an older participant's pay credit is close to its present value, so each dollar credited costs nearly a dollar of funding. She cannot be excluded by name or by age; coverage and 401(a)(26) minimum participation require the plan to benefit the lesser of 50 employees or the greater of 40% of employees or two employees, which with seven employees means at least three must benefit. A last-day or 1,000-hour condition will not exclude her, and imposing one that excludes only her invites a discrimination challenge.
Recommendation: model her projected credit and fund it. If the cost is unacceptable, use a modest uniform pay credit for all participants and put the owner's benefit in a separate allocation layer rather than distorting eligibility rules.