Broker Check


January 12, 2022

Split-Funded Cash Balance Pension Plans

For business owners, offering typical qualified plans can be expensive and contribution limits and discrimination testing can make them increasingly less effective.  However, there is a very effective strategy to maximize the value of a qualified plan: adding a cash balance pension plan and split-funding it using pension life insurance.  The pension life insurance can ultimately be a valuable source of tax-free retirement income and/or provide tax-free death benefit liquidity for heirs. 

A Split-Funded Cash Balance Pension Plan is a type of tax-deductible, qualified retirement plan that enables large contributions for business owners while using pre-tax, qualified money to purchase life insurance.  The “split” in its name comes from splitting the funding of the plan between cash value pension life insurance and other investments.  The ultimate goal of this strategy is to efficiently transfer (or sell) the policy purchased inside the plan to:

  1. the participant to provide him or her a source of tax-free retirement income or
  2. the participant’s trust to keep the income tax-free death benefit of the policy outside of the participant’s taxable estate.

How a Split-Funded Defined Benefit Plan Works

Jared is a 53-year-old owner of a highly profitable accounting practice with annual compensation that has risen to more than $1 million.  He is currently able to annually fund his 401(k) profit-sharing plan with $64,500.  Jared wants to save more so he can meet his goal of retiring at age 62 and, at this point, needs a much bigger tax deduction.  Ideally, he wants a qualified plan that will allow him to make significant pre-tax contributions toward his own retirement and provide large tax deductions.  In addition to making large contributions helping him to “catch up” with his retirement plan, Jared wants a plan which gives him the ability to:

  • Maximize tax deductible contributions
  • Provide a source of tax-free retirement income
  • Protect his retirement assets from creditors
  • Use pre-tax dollars to cover personal life insurance needs
  • Care for his family in the event of his premature death

Jared establishes a Split-Funded Cash Balance Pension Plan and makes annual tax-deductible contributions for 10 years targeting an ultimate plan balance of $3,145,609.  During the first five years, the plan purchases a specially designed cash value pension life insurance contract for $131,000 per year in premium for 5 years.  The initial death benefit is $2,145,000 and the initial beneficiary of the policy is the qualified plan.[1]  The remaining $186,349 of Jared’s annual plan contribution is invested in a diversified portfolio.  Over the following five years, Jared will contribute $262,334 per year that will be invested in the portfolio.

After the pension life insurance has been funded, Jared will purchase the policy away from the Cash Balance Pension Plan for its fair market value.  Thereafter, he will own the policy personally and can choose to orient it depending on his priority.  

If Jared wishes to supplement his retirement income by accessing the policy’s cash value, he could take income tax-free policy withdrawals and loans from it.  Starting at age 63, this would provide Jared with an additional $56,658 per year tax free income through his age 90.[2]  This amount would be complementary to the taxable income he could draw from the investment portfolio (that ultimately would be rolled into an IRA).

On the other hand, if Jared desires to use the life insurance coverage for his estate planning, the pension life insurance policy could ultimately be owned by an irrevocable trust where the ultimate $2,544,038 death benefit1 would be outside of Jared’s estate and would pass income and estate tax free. 



The Details

Split-Funded Cash Balance Pension Plans are versatile.  Clients’ final qualified plan designs may consist of a “stand alone” Split Funded Cash Balance Pension Plan or a combination of 401(k), profit sharing, and the Split Funded Cash Balance Pension plans.  Every plan is custom designed based on many factors and the exact contribution amounts for each participant are subject to an actuary’s testing.  These plans should be designed to be permanent while offering great funding flexibility that can even be reevaluated if there are any significant business changes in the future.

There are a number of rules which need to be followed to successfully implement a Split-Funded Cash Balance Pension Plan.  Proper plan documentation is critical with respect to the plan’s ownership of life insurance.  Depending on the plan provisions, most types of policies permanent insurance can be purchased in the qualified plan –typically whole life or indexed universal life.  At any rate, it is critical that a Third-Party Administrator (TPA) who specializes in taking advantage of life insurance as a component of qualified plans is engaged to make sure the documentation, implementation and administration is handled correctly and most efficiently.

The Key to Future Income

Allowing for life insurance to be purchased within a qualified retirement plan can be very valuable for business owners and their employees.  Cedar Point Financial Services LLC and its specialized TPA colleagues can provide business owner clients professional assistance in navigating the number of rules and procedures which, if adhered to, can create maximum tax-deductible contributions while ultimately providing a source of tax-free income and death benefit.

[1] Based upon a policy illustration for a Pacific Life Pacific Discovery Xelerator IUL 2 Flexible Premium Indexed Adjustable Life Insurance Policy

[2] Income tax-free loans available if policy is structured as a non-Modified Endowment Contract.  Access to cash values through borrowing or partial surrenders will reduce the policy's cash value and death benefit, increase the chance the policy will lapse, and may result in a tax liability if the policy terminates before the death of the insured.