The Cash Balance Plan for a Business Owner: Why a 55-Year-Old Medical Practice Owner Can Deduct $300,000 a Year and How the 401(k) Stack Works

Yes, your situation is well-suited to a cash balance plan. At age 58 with $400K of W-2 wages and a profitable practice, you can roughly double or triple your current retirement contributions. Here are the numbers and the implementation timeline.

The contribution math.

Your current 401(k) profit-sharing setup: $69,000 maximum 2024 DC plan limit ($70,000 estimated 2026). This is at the §415(c) cap.

Adding a cash balance plan changes the structure. Because the cash balance plan is a defined benefit plan (subject to §415(b) cap, not §415(c)), it doesn’t compete with the 401(k) for the same dollar limit.

New structure recommended:

Cash balance plan: – Actuarial design targeting your §415(b) cap by age 65 – At age 58 with 7 years to retirement, the annual funding needed to reach $280K annual benefit by 65 is large – Estimated annual cash balance contribution: $230,000-$260,000

401(k) plan (restructured): – Employee elective deferral: $24,000 (2026 estimated) – Age-50 catch-up: $7,500 – Employer profit-sharing: $350,000 (compensation cap) × 6% = $21,000 – Total: $52,500

Why 6% profit-sharing (down from your current setup)? The §404(a)(7) combined deduction limit. If profit-sharing exceeds 6%, the combined DB + DC deduction is capped at 25% of compensation. Capping profit-sharing at 6% preserves the §404(a)(7)(C) carve-out, allowing the cash balance plan’s full deduction.

Combined contribution: $282,500-$312,500/year.

Compare to current $69,000: incremental contribution of $213,500-$243,500/year.

Tax savings.

At 37% federal + 8% state (assume CA or NY) = 45% combined:

Incremental tax savings: $213,500-$243,500 × 45% = $96,075-$109,575 of additional tax savings annually.

Over 7 years to retirement (age 58 to 65): $670K-$770K of cumulative additional tax savings.

Staff cost (you may have employees).

If your dental practice has staff (assume 1 hygienist + 1 receptionist + 1 dental assistant, combined $180K of W-2 wages), the cash balance plan’s gateway requirement applies:

– 401(k) safe harbor 3% nonelective: $180K × 3% = $5,400 – Cash balance gateway 5%: $180K × 5% = $9,000 – Total staff cost: $14,400/year

Owner net contribution: $282,500 – $14,400 staff = $268,100 effectively allocated to owner.

Administrative cost: $8,000-$12,000/year for the cash balance plan (actuary + TPA + filing).

Net annual benefit: – Owner contribution: $282,500 – Staff cost: $14,400 – Admin cost: $10,000 – Total cost (deductible): $306,900 – Owner tax savings at 45%: $127,103 – Net cash outlay: $179,797 of after-tax funds going into owner’s retirement – Owner’s pre-tax retirement contribution: $268,100

The math works strongly in your favor.

Year-by-year implementation.

Year 0 (2026, planning year):

Month 1-2: Engage CPA, enrolled actuary, and TPA. Get design proposal showing projected contributions, staff cost, and tax savings.

Month 3-4: Decide on plan adoption. Sign engagement letters with actuary and TPA. Review draft plan documents.

Month 5-6: Modify 401(k) plan (reduce profit-sharing to 6% effective for upcoming year) if currently above 6%. Notify 401(k) recordkeeper.

Month 7: Adopt cash balance plan via board resolution (effective January 1, 2027 or sooner if you want 2026 deduction). Communicate to staff (if you adopt before year-end 2026 with retroactive effect to plan year 2026, ensure adoption documents are signed by December 31, 2026).

Year 1 (2027, first plan year):

Q1: Open plan trust account at custodian. Make first contribution toward minimum (you have until 9/15/2028 to fund the 2027 minimum, but funding earlier is fine).

Q2: Monitor plan investments. Plan investment manager handles asset allocation per Investment Policy Statement.

Q3-Q4: Coordinate with actuary on year-end funding decision. Actuary provides preliminary calculation of minimum and maximum contribution.

December 2027: Make additional contribution if desired to reach maximum deductible amount.

Year 1 + 1 (2028):

Q1: Receive Schedule SB from actuary for 2027 plan year. Coordinate with CPA for 2027 tax return.

March 15, 2028: File S-corp tax return (Form 1120-S) claiming 2027 cash balance plan deduction.

July 31, 2028: File Form 5500 with Schedule SB for 2027 plan year (or October 15 with extension).

September 15, 2028: Final deadline for minimum required contribution for 2027 plan year (if not already funded).

October 15, 2028 (with extension): Maximum deductible contribution deadline for 2027 plan year if business return on extension.

This cycle repeats annually.

Key decisions you’ll face.

Decision 1: Plan investment strategy. Conservative (50-60% bonds, 40-50% equities, lower volatility) or moderate (40-50% bonds, 50-60% equities, higher expected return). Most cash balance plans use moderate-conservative. Avoid aggressive (high equity) because investment volatility creates funded status volatility, which transfers risk to you.

Decision 2: Interest crediting rate. 4% fixed gives cushion against investment underperformance. 5% fixed makes the plan less conservative. The 30-year Treasury rate (currently ~4%) is also acceptable. Most plans I’ve seen for solo practitioners use 4-5% fixed.

Decision 3: Pay credit formula. The actuary designs the pay credit (% of compensation) to meet your funding target. Typically 25-30% for the owner. The cross-test verifies nondiscrimination.

Decision 4: Spouse on payroll? If your spouse is not currently on the payroll, consider adding her with a modest W-2 wage. Her participation in the cash balance plan adds another participant with their own §415(b) cap. If she’s in her 50s, her pay credit could be similar to yours.

Decision 5: Retirement timeline. Plan to operate the cash balance plan until you actually retire (age 65 in your case). Don’t adopt and terminate within 5 years.

Long-term outlook.

7 years of $230K-$260K cash balance contributions at 4-5% interest growth = $1.8M-$2.2M of cash balance plan assets at age 65.

Plus 7 years of $52K 401(k) contributions = $440K-$500K of 401(k) assets at age 65.

Total retirement plan assets at retirement: $2.25M-$2.7M (cash balance + 401(k)).

Plus your existing 401(k) balance (assume $1M currently) growing at 6% for 7 years = $1.5M.

Total retirement plan assets at age 65: $3.75M-$4.2M.

Roll cash balance plan to IRA at retirement. Continue tax-deferred growth. Take RMDs starting at age 73 (born 1968+ falls into the 73 applicable age window… actually wait, you’re 58 in 2026 so born 1967-1968. Applicable age 73 for born 1951-1959; applicable age 75 for born 1960+. So your applicable age is 75). RMDs start at age 75.

QCDs available from 70½ onward.

For your situation, the cash balance plan is one of the highest-ROI tax planning moves available. Engage the actuary and TPA, adopt by Year 0 year-end, and run the strategy for 7-8 years until retirement. Net additional wealth at retirement compared to 401(k)-only: roughly $1.5M-$2M after tax. Well worth the administrative overhead. Coordinate with The Reed Corporation or another firm experienced in cash balance plan design and S-corp owner compensation strategy.

Yes, you can adopt a cash balance plan with a 5-year planned operating window — but the 5-year IRS scrutiny rule is real, and you need to document the business case carefully to avoid problems. Here is how your scenario breaks down.

The IRS 5-year guidance.

There’s no statutory 5-year rule. What exists is informal IRS audit guidance suggesting that cash balance plans terminated within 5 years of establishment receive improved scrutiny. The agency views very short-duration plans as potential ‘tax shelter’ arrangements — established primarily to generate large deductions with no genuine retirement-savings purpose.

If the plan terminates within 5 years and the IRS audits, the agency may challenge the plan’s qualified status. Consequences include: – Retroactive disallowance of all prior deductions – Inclusion of contributed amounts as taxable income in the year of contribution – Penalties and interest – Potential excise taxes

In extreme cases, the IRS has successfully disqualified short-duration plans. The IRS’s position is that plans should have genuine ‘permanency’ — intent to operate indefinitely subject to changing circumstances.

Your 5-year scenario.

You plan to retire at 67. Plan operates from age 62 to 67 — exactly 5 years. This is at the threshold of the audit risk window.

Mitigating factors that strengthen your case:

1. Genuine business reason for the plan. You’re a law firm owner approaching retirement. You have significant income and substantial retirement savings needs. The cash balance plan serves a legitimate retirement-savings purpose — not just a tax shelter.

2. Plan was not adopted with intent to terminate. At the time of adoption, you have a clearly articulated 5-year operating plan. Document this in writing — adoption resolution, plan documents, internal memos. The plan can naturally end at your retirement (a recognized legitimate business reason for termination).

3. Retirement is a permitted termination event. Plan termination at the owner’s retirement is one of the most clearly legitimate reasons. IRS audit guidance specifically lists retirement as a valid reason for termination.

4. Adequate plan funding. Throughout the 5 years, make at least the minimum required contributions. Maintain the funded ratio at or above 100%. Don’t run the plan at a deficit and then terminate to avoid funding obligations.

5. Documentation of operational permanence. Operate the plan as if it could continue indefinitely. Hold periodic plan review meetings. Update plan documents as required by law. Treat the plan with the same rigor as a long-term plan.

Risk-mitigating plan design.

Design option A: 5-year plan with retirement-aligned termination.

Adopt the plan in 2026 (your age 62) with a planned termination at age 67 in 2031 (your retirement). Fund maximum contributions for each of the 5 years. Terminate at retirement and roll the balance to your IRA.

If audited, the legitimate retirement-based termination should withstand scrutiny. Document the retirement decision in plan minutes.

Design option B: Lower contributions over a longer plan life.

Alternatively, design the plan with lower annual contributions ($100K-$150K vs. the maximum $250K-$280K) and plan for 7-10 years of operation. The lower contribution rate makes the plan less aggressive. The longer plan life eliminates the 5-year scrutiny concern.

Tradeoff: lower total contribution over time. $150K × 7 = $1.05M vs. $250K × 5 = $1.25M. Difference is modest but the longer timeline provides audit safety.

Design option C: 5-year aggressive plan with documented business case.

Adopt the plan for 5 years with maximum contributions. Document the business case extensively. Accept some audit risk. Most owners in your situation do this.

Contribution math for your scenario.

Age 62, solo law firm owner, presumably high income.

Let’s assume $800K of net business income (revenue minus operating expenses), paid as W-2 wages of $345K (the §401(a)(17) cap for 2024; $350K estimated 2026). The remaining $455K is S-corp distribution (not subject to employment tax).

401(k) plan: – Employee elective deferral: $24,000 (2026 estimated) – Age-50 catch-up: $7,500 – Employer profit-sharing: $350K × 6% = $21,000 – Total: $52,500

Cash balance plan (5-year design): – Plan designed to fund §415(b) target by age 67 – At age 62 with 5 years remaining, the annual funding required is substantial – Estimated annual contribution: $280,000-$320,000 – Note: §415(b) cap actually peaks at $280K but the lump-sum-equivalent funding to reach that benefit can be higher in the final years

Combined annual contribution: $332,500-$372,500.

At 45% combined federal + state tax rate: tax savings $150K-$168K per year.

Over 5 years: $750K-$840K of cumulative tax savings.

Minus 5 years of admin cost ($8K × 5 = $40K).

Net 5-year tax benefit: $710K-$800K.

Plan termination at age 67.

At retirement (December 2031):

1. Adopt board resolution terminating the plan effective December 31, 2031. 2. Cease benefit accruals as of termination date. 3. Calculate each participant’s accrued benefit (just you). 4. Coordinate with TPA on final filings. 5. Roll the cash balance plan balance to your IRA. Direct rollover, no tax consequence. 6. File final Form 5500 with Schedule SB indicating plan termination. 7. Optional: file Form 5310 with IRS to request determination letter on plan termination (provides certainty that the termination doesn’t disqualify prior deductions). Filing fee around $3,500.

The Form 5310 termination determination letter is highly recommended for a 5-year plan. It provides IRS certification that the plan met qualification standards through termination. Cost-effective insurance against future audit.

My recommendation for your situation.

Go with Design A: 5-year aggressive plan with retirement-aligned termination and Form 5310 determination letter at termination.

Specific implementation:

1. Adopt plan in early 2026 with effective date January 1, 2026 (full first year). Document adoption in board resolution stating intent to operate plan through your planned retirement at age 67.

2. Establish plan documents through a major TPA (Pentegra, FuturePlan, etc.) using a pre-approved document for IRS qualification certainty.

3. Engage enrolled actuary for annual Schedule SB and contribution calculations.

4. Open plan trust account at major custodian (Fidelity, Schwab, etc.).

5. Establish Investment Policy Statement with conservative-to-moderate asset allocation (50-60% bonds, 40-50% equities).

6. Fund maximum contribution each year. Aim for $280K-$320K depending on actuarial calculation.

7. Maintain proper compliance: annual Form 5500 with Schedule SB, annual participant statement, plan amendments as required by law changes.

8. At age 67 (December 2031), terminate the plan with appropriate documentation.

9. File Form 5310 termination determination letter request.

10. Roll cash balance balance to your IRA.

Expected outcome:

– 5 years of $280K-$320K contributions plus interest growth at 4-5% – Plan balance at termination: $1.5M-$1.7M – Rolled to IRA, continues tax-deferred – RMDs begin at age 75 (you born 1964, applicable age 75 under SECURE 2.0) – 8 years of tax-deferred growth from rollover at age 67 to first RMD at age 75 – Estimated IRA balance at first RMD: $2.2M-$2.6M

Audit risk management.

Likelihood of audit: low-to-moderate. The IRS audits maybe 1-2% of cash balance plans annually. Short-duration plans have higher audit rates but still under 5%.

If audited, you’d defend based on: – Retirement-based termination (legitimate reason) – Maximum contributions through all years (showed permanency intent) – Annual compliance maintained throughout – Form 5310 determination letter (if filed at termination) – Documentation of plan adoption decision

Audit defense costs (worst case): $25K-$50K for legal/CPA defense.

Compare to the $700K+ of tax savings: even an unfavorable audit outcome wouldn’t fully erase the benefit. And most audits result in favorable resolution.

For your situation, the 5-year cash balance plan is the right move. The tax savings are substantial. The audit risk is manageable with proper documentation. The retirement-aligned termination is a recognized legitimate reason. Engage your CPA, actuary, and TPA team and proceed with confidence.

Final note: don’t try to extend the plan beyond your actual retirement just to avoid the 5-year scrutiny. If you genuinely retire at 67, terminate the plan then. Extending the plan artificially for 1-2 extra years creates other compliance issues (continuing to fund a plan you don’t need, paying admin costs, etc.). Better to retire at 67, terminate the plan, file Form 5310, and move on.

A multi-partner cash balance plan is more complex than a solo plan, but with 25 staff and a 4-partner ownership structure, it’s manageable. Here are the design considerations and the partner coordination.

The coverage and nondiscrimination challenge.

With 25 staff plus 4 partners, you have 29 total employees. The cash balance plan must:

1. Cover at least 40% of all employees under §401(a)(26). 40% of 29 = 11.6, rounded up to 12. So at least 12 employees must benefit. With 4 partners participating, you need at least 8 staff to also participate. Most plans include all employees for simplicity.

2. Satisfy §401(a)(4) nondiscrimination. The plan benefits to highly compensated employees (HCEs) cannot exceed those to non-HCEs in a discriminatory pattern. With 4 partners all earning well above the $155K (2024) HCE threshold, all 4 are HCEs. The other 25 staff are non-HCEs (assuming none earns above $155K).

Design strategy: cross-test the plan.

Cross-testing under §401(a)(4) compares benefit accrual rates after converting plan benefits to age-65 annuity equivalents. The plan can provide: – Partners (HCEs, older): high pay credits (20-30%) – Staff (non-HCEs, younger on average): lower pay credits (5-7% gateway)

The cross-test verifies that the plan’s benefit pattern doesn’t favor HCEs in a discriminatory way at the equivalent age-65 annuity level.

Gateway contribution. Cross-tested plans typically require staff to receive a minimum ‘gateway’ contribution. Common designs use a 5-7% pay credit for staff in the cash balance plan. Combined with the 401(k) safe harbor 3% or match, total staff cost is 8-10% of staff compensation.

For your practice with 25 staff at, say, average $65K wages, total staff payroll is ~$1.625M. Annual staff cost at 8-10%: $130K-$163K.

This is the ‘cost of admission’ to get the cash balance plan benefits for the partners. It’s significant but justifiable if the partner benefits are large enough.

Partner-specific contribution levels.

Each partner has their own §415(b) cap ($280K annual benefit, 2026 estimated). Each partner’s cash balance contribution is calculated to fund their individual benefit target by their individual retirement age.

Partner age and contribution potential:

Partner A (age 65, planning to retire at 70): 5 years remaining. Very high annual contribution to reach §415(b) by 70. Estimated $300K-$350K/year.

Partner B (age 58, planning to retire at 67): 9 years remaining. Moderate-high contribution. Estimated $200K-$240K/year.

Partner C (age 52, planning to retire at 65): 13 years remaining. Moderate contribution. Estimated $150K-$180K/year.

Partner D (age 45, planning to retire at 65): 20 years remaining. Lower contribution. Estimated $80K-$100K/year.

Total partner contributions: $730K-$870K/year.

Plus 401(k) contributions for each partner: $52K each = $208K.

Plus staff cost: $130K-$163K.

Total annual plan cost: $1.07M-$1.24M.

Tax savings:

At average 42% combined federal + state for the partners: $730K-$870K × 42% = $307K-$365K of tax savings from cash balance alone.

Partner-by-partner breakdown of net benefit:

Partner A (age 65): $300K-$350K contribution × 42% tax savings = $126K-$147K of tax saved. Less staff cost allocation (per-partner basis, $32K-$40K) = $94K-$107K net benefit. Very high ROI for the year.

Partner D (age 45): $80K-$100K contribution × 42% tax savings = $33K-$42K of tax saved. Less staff cost allocation = a few thousand to maybe $10K net benefit. Lower ROI but still positive.

The age dispersion creates uneven benefit distribution. Partner A gets disproportionately large benefit because the plan funds his §415(b) target in only 5 years. Partner D gets modest benefit because his 20-year horizon spreads the funding.

Partner agreement issues.

With uneven benefit distribution, the partners need to agree on how the plan costs and benefits are allocated. Options:

Option 1: Each partner pays their own contribution and gets their own benefit. The cash balance contribution is treated like compensation — each partner’s share of practice profit is reduced by their own contribution. Net effect: each partner makes their own retirement decision and bears their own cost.

This is the cleanest approach. Each partner decides whether the cash balance plan’s benefit is worth the partnership profit reduction.

Option 2: Practice pays all contributions equally; benefits accrue to each partner individually. Practice cost is shared equally; benefit is unequal (older partners get more). Younger partners essentially subsidize older partners.

This is less fair but simpler. Used when there’s strong partnership commitment to keeping older partners (who otherwise might leave for higher individual compensation).

Option 3: Some hybrid — younger partners receive lower compensation in current years in exchange for higher future cash balance accruals as they age into peak earning years.

Discuss with all partners before plan adoption. Conflicts arise when partners feel inequitably treated.

Staff cost allocation.

The $130K-$163K of staff cost is shared among the 4 partners. Equally: $32K-$40K each. This reduces each partner’s net benefit but is the cost of accessing the cash balance plan for the partnership.

Partner D may push back if his net benefit (after staff cost) is too small. Consider whether Partner D should participate at all, or participate at a reduced rate that justifies his share of staff cost.

A ‘reduced participation’ design for Partner D: he participates in 401(k) profit-sharing only (no cash balance plan accrual). His share of the staff cost is reduced or eliminated. The cash balance plan accrues only to Partners A, B, C. Cross-testing may still pass; the actuary verifies.

This is a ‘cafeteria’ design for partners who don’t need the cash balance plan benefit. Cleaner than forcing reluctant participation.

Implementation steps.

Month 1-2: Engage actuary and TPA. Get design proposal showing contributions and staff cost.

Month 3: Partner meeting to review proposal. Discuss benefit allocation, staff cost sharing, and individual participation decisions.

Month 4: Finalize plan design. Each partner confirms their participation level.

Month 5: Adopt plan documents. Update partnership agreement if necessary to reflect plan compensation allocations.

Month 6: Communicate to staff. Roll out staff education on the plan.

Month 7+: Operate the plan. Annual funding cycle as in solo plan but with multi-partner coordination.

Long-term considerations.

Partner exits. When a partner leaves the practice (retirement or otherwise), the cash balance plan must distribute their accrued benefit. Coordinate plan terms with partnership agreement to ensure smooth transitions.

New partners. When a new partner joins, they become eligible for the plan. Their cash balance accrual depends on their age and compensation. Plan terms typically specify eligibility (e.g., immediate or after 1 year of service).

Plan amendments. The plan must be amended periodically for law changes. Some amendments may affect benefit accruals (e.g., changing pay credit formula). Partner approval may be required depending on partnership agreement.

Plan termination considerations. If the practice dissolves or partners leave, the plan may need to terminate or transfer to a successor entity. Plan a multi-year strategy with all partners aligned.

My recommendation for your situation.

1. Engage an experienced TPA (Pentegra, FuturePlan, or similar) that specializes in multi-partner medical practice plans. The complexity warrants experienced design help.

2. Run the contribution and benefit projections for each partner. Get clarity on individual benefit levels.

3. Hold a partner meeting to discuss benefit allocation, staff cost, and individual participation. Reach consensus or adjust the design to accommodate dissent.

4. Consider Option 1 (each partner pays their own) as the default. Cleanest and most equitable.

5. For Partner D (age 45), consider reduced or no participation in cash balance plan. Keep him on 401(k) only.

6. Adopt the plan and operate consistently for 5+ years. With your practice’s stability and partner mix, the plan can operate long-term (until first partner retirement).

7. Plan for the eventual partner-by-partner termination as partners retire. The plan continues with remaining partners; departing partners take their accrued benefit as IRA rollover.

Expected aggregate practice benefit:

– $730K-$870K of annual cash balance contributions for the partners – $307K-$365K of annual tax savings at the partner level – Cumulative wealth building of $4M-$5M over 10 years for the partners (combined)

The cash balance plan is the right strategy for your practice. Engage experienced advisors and proceed thoughtfully. The Reed Corporation or another firm experienced in multi-partner cash balance plan design can guide the implementation.

Yes, both you and your wife can participate. A partnership-owned cash balance plan that covers both spouse-partners is very common and tax-efficient. Here is the design.

The spouse-as-partner setup.

Your LLC is taxed as a partnership (or potentially as an S-corp if you’ve made the election). Both you and your wife are owners. Both work in the business. Both are partners for tax and plan purposes.

This structure gives you two separate §415(b) caps. Each spouse has their own $280K annual benefit cap. So combined, the cash balance plan can target benefits totaling $560K of annual annuity equivalent.

For partnerships, partner compensation is in the form of ‘guaranteed payments’ or partnership profits allocated to each partner. For retirement plan purposes, partner self-employment earnings (Schedule K-1 line 14 plus guaranteed payments minus 50% of SE tax) become the ‘compensation’ for plan purposes.

For cash balance plan purposes, each partner’s compensation is capped at the §401(a)(17) limit ($345K for 2024, $350K estimated 2026). With $600K of net business income split equally, each of you has $300K of self-employment earnings (close to but below the cap).

Plan contribution math.

Let me run two scenarios.

Scenario A: Equal split.

Each of you takes $300K of self-employment earnings.

Cash balance plan: – You (age 50): annual contribution ~$110K-$140K (15 years to age 65, longer funding horizon, lower annual contribution) – Spouse (age 48): annual contribution ~$90K-$120K (17 years to age 65, even longer horizon) – Combined: $200K-$260K of cash balance contributions

401(k) plan: – Your elective deferral: $24,000 (2026 estimated) – Your catch-up at age 50: $7,500 (you’re 50) – Spouse’s elective deferral: $24,000 (no catch-up for age 48) – Profit-sharing for both: $300K × 6% × 2 = $36,000 – Combined: $91,500

Grand total: $292K-$352K of retirement plan contributions.

Tax savings at 37% federal + 6% state = 43% combined: $126K-$151K of annual tax savings.

Scenario B: Heavier allocation to older spouse.

The cash balance plan’s age-weighting means you (the older spouse at 50) can contribute more proportionally than your wife (at 48). With a small age difference (just 2 years), the difference isn’t dramatic. But if the age gap were larger (you 60 and spouse 45), the allocation would shift heavily to the older spouse.

For your 2-year age gap, equal allocation works well. The slight bias toward you is captured automatically in the actuarial design.

No other employees.

If the consulting business has only you and your wife (no other employees), the plan is a ‘one-participant plan’ for Form 5500-EZ purposes. Just the two of you plus possibly your spouse-partner counted separately. Simpler reporting (Form 5500-EZ instead of full Form 5500).

If you have any other employees (even 1 part-time contractor who qualifies as a common-law employee), the rules become more complex. The plan must include them at the gateway rate. We’ll assume no other employees for this scenario.

SE tax considerations.

Partnership earnings allocated to you are subject to self-employment tax. The cash balance plan contribution is deductible for income tax but not for SE tax purposes.

Wait — let me clarify. The contribution to a defined benefit plan is deductible against partnership ordinary income at the partnership level. The deduction reduces your K-1 ordinary income, which reduces income tax but not SE tax. The SE tax is calculated on the K-1 line 14a ‘self-employment earnings’ figure, which is the partner’s allocable share of partnership ordinary income.

Actually, the cash balance plan deduction does reduce SE earnings for the partners taking the deduction. Partnership-level deduction flows through to partner-level reductions in ordinary income, which is the basis for SE tax. So both income tax and SE tax are reduced.

Double-check with your CPA — partnership retirement plan deductions for partners typically flow through to reduce SE earnings. This is different from S-corp owner deductions (which don’t reduce SE wages).

The SE tax savings on $200K-$260K of cash balance deduction at the 15.3% combined SE rate (covering both employer and employee Social Security and Medicare): $30K-$40K of SE tax savings.

Total tax savings (income tax + SE tax): $156K-$191K per year.

Funding from partnership cash flow.

The cash balance plan contribution is a partnership expense. It must be paid from partnership cash (not from the partners’ personal funds). The deduction reduces partnership ordinary income, which flows through to reduce each partner’s K-1 income.

Operationally, the partnership writes a check to the plan trust account from its operating account. The expense reduces partnership net income, which reduces the partners’ allocable income.

Make sure the partnership has the cash flow to fund the contribution. With $600K of net income, after the contribution of $200K-$260K, remaining net income is $340K-$400K — still substantial cash flow.

Implementation steps.

Month 1-2: Engage actuary and TPA. Discuss design with both spouses present.

Month 3: Decide on equal vs. age-weighted allocation. Decide on interest crediting rate (4-5% fixed is typical). Decide on investment strategy.

Month 4: Establish plan trust account. Adopt plan documents by year-end (effective for the year if adopted before December 31 with retroactive effect to January 1, OR effective for next year if adopted in November-December).

Month 5: Make first contribution. Allow 8.5 months after plan year-end as final deadline, but funding earlier is fine.

Month 6+: Annual operations.

Key design decisions.

Decision 1: Plan investment strategy. For a 2-person plan with 15-17 year horizons, you can run somewhat more aggressive than a soon-to-retire plan. Maybe 50-60% equities, 40-50% bonds. Adjust glide path as you approach retirement.

Decision 2: Coordination with spouse’s other plans. If your spouse has any other retirement plans (IRA, etc.), make sure the cash balance plan doesn’t create §415(b) issues across multiple plans for her. Single-employer plans typically don’t aggregate across employers, but verify.

Decision 3: Beneficiary designation. Each partner designates a beneficiary for their cash balance plan accrued benefit. Typically each spouse names the other. At one spouse’s death, the surviving spouse can roll the deceased spouse’s balance to their own IRA. Smooth transfer.

Decision 4: Spousal consent rules. ERISA requires spousal consent for non-spouse beneficiary designations in defined benefit plans (joint and survivor annuity rule). If you each name the other as beneficiary, no issue. If you want to name someone else (a child, a trust), the other spouse must consent in writing.

Long-term outlook.

15-17 years of contributions:

You: $110K-$140K/year × 15 years = $1.65M-$2.1M of contributions plus 4-5% interest growth = $2.3M-$3.0M by age 65.

Spouse: $90K-$120K/year × 17 years = $1.53M-$2.04M of contributions plus growth = $2.2M-$3.0M by age 65 (her).

Combined cash balance plan balances at her age 65 (your age 67): $4.5M-$6M.

Plus 401(k) accumulation over 15-17 years: $1.5M-$2M.

Total retirement plan assets at retirement: $6M-$8M combined.

Not bad for a 2-person consulting business with $600K of net income — most of it captured through tax-efficient retirement plan contributions.

Plan termination considerations.

If the consulting business winds down (you retire, business changes structure), terminate the plan. Each spouse rolls their accrued benefit to their own IRA. Tax-free direct rollover.

If the business continues but one of you retires while the other works: the retiring spouse can begin distributions while the working spouse continues to accrue. The plan continues with the active partner.

If both retire simultaneously: terminate the plan, file Form 5310 for determination letter, roll balances to IRAs.

My recommendation:

Adopt the cash balance plan for the partnership with both you and your wife as participants. Design for equal allocation given the small age gap. Fund maximum contributions each year. Run the plan for 15+ years until retirement.

The $130K-$190K of annual tax savings (income tax + SE tax combined) is one of the highest-ROI tax planning moves available for a 2-person consulting business with $600K of income. Over 15+ years, you’ll accumulate $2M+ of additional retirement wealth compared to a 401(k)-only strategy.

Coordinate with The Reed Corporation or another firm experienced in partnership cash balance plans and the specific spouse-partner dynamics. The design is straightforward but the execution requires care. Engage actuary and TPA early in the year to allow adequate setup time.

A 3-year termination triggers the IRS scrutiny window I described in earlier sections. Now that you’re in an audit, the defense becomes critical. Here is the situation and your options.

The IRS’s likely position.

The IRS auditor will probably argue that the cash balance plan was established primarily as a tax shelter — generating large deductions with no genuine intent to provide retirement benefits over a sustained period. They’ll point to: – 3-year duration (below the unofficial 5-year window) – Termination coinciding with business sale (sale wasn’t disclosed or contemplated when plan was adopted, OR sale was contemplated but plan was adopted anyway) – Possibly large annual contributions that maxed out actuarial limits each year

The IRS’s remedy: disqualify the plan retroactively. Consequences: – All prior deductions reversed. The $XXX,000 of contributions over 3 years become taxable income in their respective years. – The plan assets become ‘unqualified’ — distributions to you may be subject to ordinary income tax plus 10% early withdrawal penalty (if under 59½). – Interest and penalties on the back tax liability. – Excise taxes under §4972 (10%) on excess contributions to a disqualified plan.

Worst-case scenario: $500K-$1M of additional tax liability across the 3 years.

The defense strategy.

Your defense rests on showing that the plan was established with legitimate intent to provide retirement benefits and that the termination was caused by an unforeseen and legitimate business event (the sale).

Defense Element 1: Documentation of legitimate intent at adoption.

Gather all documentation from the plan adoption period: – Initial consultation memos with CPA, actuary, TPA discussing retirement planning needs – Plan adoption resolution stating the business purpose and intent – Initial communications to staff (if applicable) about the new plan – Financial projections showing the plan as part of long-term retirement strategy

The IRS will look for evidence that the plan was adopted with intent to operate long-term (not just for 2-3 years). Documentation of multi-year intent is key.

Defense Element 2: Documentation of the business sale as an unforeseen event.

The sale of the business is a recognized legitimate reason for plan termination. To strengthen this: – When was the sale first contemplated? If the sale was contemplated before plan adoption, the plan’s legitimacy is weakened. If the sale was a later development (offer received unexpectedly, market changes, owner’s circumstances changed), the legitimacy is preserved. – Documentation of the sale process: when was the buyer first identified, when did negotiations begin, when did the LOI sign, when did closing happen. – Reasons for the sale: retirement, health issues, market opportunity, etc. The reason matters less than whether the sale was foreseen at plan adoption.

If the sale was unexpected (no prior plan to sell, unsolicited offer received), the cash balance plan termination is defensible. The IRS recognizes that business circumstances change and plans must adapt.

If the sale was planned at adoption (plan was adopted knowing sale was coming), the cash balance plan is much harder to defend. The IRS will argue the plan was adopted in bad faith.

Defense Element 3: Plan compliance throughout operation.

Show that the plan operated as a legitimate retirement plan: – Annual Form 5500 with Schedule SB filed timely – Minimum required contributions made each year – Maximum deductible contributions claimed only when supported by actuarial calculation – Plan investments managed prudently (not just sitting in cash) – Participant statements issued annually – Plan amendments made for IRS-required changes

A plan that operated procedurally correctly is harder to disqualify. The IRS focuses on operational defects when challenging plans.

Defense Element 4: The plan’s actual benefit accruals.

Demonstrate that the plan provided genuine benefits to participants. Show: – Each participant’s accrued benefit at termination – Distribution of plan assets at termination (rollover to IRA, etc.) – Plan participants received what they were promised

If participants (you and possibly your spouse and/or staff) received their accrued benefits, the plan’s benefit-providing function was fulfilled. The IRS can’t easily disqualify a plan that delivered on its benefit promises.

Defense Element 5: Comparable industry practice.

Show that cash balance plans terminated in 3 years are not unusual industry practice. Reference: – Industry articles on cash balance plan termination scenarios – Other cases where IRS has accepted shorter-duration plans – The §404(a)(7) deduction structure that depends on aggregate plan contributions

Defense Element 6: The Form 5310 determination letter (if filed).

Did you file Form 5310 (Application for Determination of Termination of Tax-Qualified Plan) at termination? If yes, the IRS already had an opportunity to challenge the plan’s qualification status and didn’t. The determination letter provides strong defense.

If no Form 5310 was filed, you can still defend the plan, but the absence of the proactive determination letter weakens the defense.

Defense Element 7: Engagement of qualified plan counsel.

This audit is serious. Engage a qualified plan attorney (ERISA specialist) to represent you. The audit will require detailed legal arguments, response to IRS information document requests (IDRs), potentially negotiation with the IRS examiner, and possibly appeal to the IRS Office of Appeals.

Cost of representation: $20K-$75K depending on complexity. Worth it to defend $500K-$1M of potential tax exposure.

IRS audit process.

Stage 1: Initial Document Request. The IRS examiner sends an IDR listing documents to produce. Typical IDRs cover: – Plan documents and adoption resolutions – Form 5500 filings – Plan trust statements – Actuarial valuation reports – Communications with participants – Business records showing the legitimate business purpose – Termination documentation

Respond completely and timely. Don’t volunteer information beyond what’s requested. Have plan counsel review responses before submission.

Stage 2: IRS Interview. The IRS examiner may want to interview you, your CPA, the actuary, and the TPA. Each interview is an opportunity for the IRS to gather information that supports their position. Have plan counsel present for all interviews.

Stage 3: IRS Position. The IRS issues a preliminary position (often called a 30-day letter or NOPA — Notice of Proposed Adjustment). This tells you the IRS’s specific claims and proposed adjustments.

Stage 4: Response and Negotiation. You respond to the NOPA with legal arguments and additional documentation. The examiner may revise the position or stand firm. Possible outcomes: – Full concession by IRS (plan qualification preserved) – Partial concession (some deductions allowed, some disallowed) – Settlement (you agree to some adjustments in exchange for closure) – Full disagreement (going to Appeals)

Stage 5: IRS Office of Appeals. If the examiner doesn’t agree, you can request review by the IRS Office of Appeals — independent of the examiner. Appeals officers have more flexibility to settle cases on a ‘hazards of litigation’ basis. About 80% of cash balance plan disputes resolve favorably at Appeals.

Stage 6: Tax Court. If Appeals doesn’t resolve favorably, you can file in Tax Court. Litigation is expensive ($75K-$200K+) and time-consuming (1-3 years). But the burden of proof is on the IRS in Tax Court, and judges have applied a relatively donor-friendly standard to plan terminations.

Likely outcome of your case.

Without knowing the specific facts (when sale was contemplated, plan size, documentation quality), I’d estimate:

If the sale was unexpected (legitimate unforeseen event): – 70-80% likelihood of full or near-full defense success – Some deductions may be challenged but most likely allowed – Final tax exposure: $50K-$150K of additional tax (much less than full disqualification)

If the sale was contemplated at plan adoption (less defensible): – 30-50% likelihood of significant disallowance – Full disqualification possible but not certain – Final tax exposure: $200K-$700K of additional tax

If documentation is weak (no clear evidence of legitimate intent): – Lower defense success – IRS will press hard for disallowance – Tax exposure: $400K-$1M

Immediate action items.

1. Engage ERISA plan counsel immediately. Don’t try to handle this audit yourself or rely solely on your CPA.

2. Gather all plan documentation. Plan adoption records, Form 5500 filings, actuarial reports, trust statements, participant communications, termination documents.

3. Document the business sale timeline. When did sale conversations begin? What were the circumstances? Documentation supports the unforeseen-event defense.

4. Don’t admit anything to the IRS examiner without legal counsel. Examiners may ask leading questions designed to elicit damaging admissions. Defer to counsel.

5. Consider settlement options. If the case is borderline, settling at the examination level can be cheaper than going through Appeals or Tax Court. Counsel can advise on optimal strategy.

6. Prepare for the worst case. Have funds available to pay potential additional tax liability if the worst-case outcome materializes. Better to plan for $500K of liability and have only $100K materialize than to be surprised by a large bill.

Final note.

The IRS audit of your terminated cash balance plan is a serious matter but typically defensible with proper documentation and legal representation. Most plan terminations involving business sales receive favorable treatment when properly documented.

The lesson for future plan adoption: always document the business case for the plan in writing at adoption. Always file Form 5310 at termination. Always engage experienced ERISA counsel for any unusual plan situation.

For your current situation, the path forward is: engage counsel, gather documentation, respond to the audit professionally, and resolve at the lowest possible level (examination, Appeals, or settlement). The Reed Corporation works with ERISA counsel on audits of this type and can help coordinate the defense.