Retroactive plans are back in the spotlight—and for good reason.
As you may know, way back in 2020 the SECURE act added the ability to adopt qualified plans retroactively for the employer’s prior tax year by the filing deadline for that year. This effectively pushed the adoption deadline well into the following year. While you can retroactively adopt any type of qualified plan, one of the most beneficial moves is to add a cash balance plan for the prior year and boost tax deductions. A cash balance plan can allow contributions for an individual of $300,000 or more!
Let’s explore some common scenarios involving adding a cash balance plan retroactively…
The company has no existing plan.
Since there is no current arrangement, you have a blank slate. A cash balance plan can be retroactively adopted without considering the contributions that may have already been made or are required for other plans.
You can add a cash balance plan by itself or add it in conjunction with a defined contribution plan. If it’s a company with employees, you’ll generally want to add a defined contribution plan for testing purposes. This allows most of the benefit in the cash balance plan to go toward the preferred group and profit sharing contributions in the defined contribution plan to be used to pass testing.
In general, you cannot put in a 401(k) plan retroactively for the prior year. The one exception to this rule is a sole proprietorship with no employees, because the owner can make their 401(k) deferral election retroactively. In any other situation you will have to limit the prior year contributions to being profit sharing, then add a 401(k) provision (if desired) for the current year.
The company has a SEP (Simplified Employee Pension).
The first thing you need to know is whether they’ve contributed to the SEP for the year in which you want to put in the cash balance plan. A SEP IRA is a year-by-year arrangement to contribute to employees’ IRAs. If they haven’t contributed for the current year, there is no SEP.
If contributions to the SEP and cash balance plan will be made for the same year, you need to make sure the SEP is not using Form 5305-SEP. This form requires that the SEP be the only retirement arrangement to which the employer makes contributions for the year. Investment companies have prototype SEP documents that do not have such a requirement (some of them… you need to check the language!). If you find the employer is using Form 5305-SEP, they can switch to a prototype document as late as the contribution deadline.
The company has a SIMPLE IRA.
This is a no-go. You cannot have a SIMPLE IRA and a cash balance plan in the same year, and a SIMPLE IRA can only be terminated for the following year.
The company has a 401(k) plan.
You can absolutely add a cash balance plan to an existing 401(k) plan after the end of the year. In fact, here are some benefits:
- Since the SECURE Act, you can amend a non-Safe Harbor 401(k) plan retroactively to be a 4% nonelective Safe Harbor. Since the nondiscrimination gateway contribution to a combined DB/DC arrangement is usually 7.5% of compensation, you can add Safe Harbor and have it count toward the first 4%. It’s basically pulling double-duty!
- Even if the 401(k) has an undesirable profit sharing formula for combined testing, like pro-rata, a Treas. Reg. 1.401(a)(4)-11(g) amendment can be used to add arbitrary profit sharing amounts to individual participants in order to pass a general test. This can also be done to provide profit sharing to participants otherwise excluded from the allocation due to a last day or 1,000 hours requirement (both bad ideas in a combined arrangement, by the way!). In other words, the existing profit sharing formula or allocation requirements can be disregarded to utilize a general test.
Watch out!
The minimum funding deadline for defined benefit plans is 8 ½ months after the end of the year. This includes cash balance plans. Therefore, for a sole proprietor where the tax filing deadline might be extended until 9 ½ months after the year end, adopting a defined benefit plan after 8 ½ months may result in missing the minimum funding deadline and owing a 10% excise tax. Therefore, even for a sole proprietor, it’s good to just say the deadline is 8 ½ months after the year end.
Also, when a company contributes to both a cash balance plan and either a SEP or defined contribution plan in the same tax year, there is a special combined-plan deduction limit under IRC 404(a)(7). The special limit is:
- If the employer contribution to the DC plan is limited to 6% of participant compensation, the DB plan (cash balance plan) does not have a reduced deduction limit.
- If the employer contribution to the DC plan is more than 6% of participant compensation, the combined deduction limit to both plans if 25% of participant compensation, but the first 6% contributed to the DC plan is disregarded. In other words, if the same people are eligible for both plans, the combined limit is 31% of compensation.
Note that the IRC 404(a)(7) limit doesn’t apply when the DB plan is covered by the PBGC.
Sometimes, especially with SEPs, the employer contribution has been made during the year. This is fine, you can still put in the cash balance plan and either keep the combined contributions under the IRC 404(a)(7) deduction limit or carry any nondeductible amounts forward to the next year.
Summary
When you start receiving data back for the 2025 plan year, see which clients are maxing out their defined contribution limits and consider proposing a cash balance plan. It can triple or quadruple their deductible contributions, plus you get the credit for being a TPA superstar!
