A Specialty Pharmacy Owner Deducts $353K With a Cash Balance and 401(k) Stack
How the owner of a specialty pharmacy, age 62, combined a cash balance plan with a 401(k) profit sharing plan to deduct $353,000 in a single year and reduce tax by approximately $148,000.
Client Profile
| Business | A specialty pharmacy |
|---|---|
| Owner age | 62 |
| Net profit | $1,120,000 |
| Owner W-2 compensation | $345,000 |
| State | Illinois |
| Total deductible contribution | $353,000 |
| Tax reduction | $148,000 |
The Situation
The owner of a specialty pharmacy, age 62, was generating $1,120,000 of net profit and contributing only to a 401(k), leaving the large majority of profit exposed at a 37% federal marginal rate. With retirement roughly 3 years away, the accumulation timeline was short and the tax cost was high.
The Challenge
A defined contribution plan caps what goes in. Even at the maximum, annual additions were limited to roughly $72,000 plus catch-up, which barely moved a $1,120,000 profit figure. The owner needed a materially larger deduction without changing the underlying business.
What We Did
1. Added a cash balance defined benefit plan
A defined benefit plan caps the benefit payable at retirement rather than the contribution, and the required contribution is derived actuarially from the years remaining to fund that benefit. At age 62, the actuary supported an annual contribution of approximately $300,000, an amount no defined contribution plan could approach.
2. Coordinated with the existing 401(k) profit sharing plan
Employee deferrals of $24,500 plus $8,000 in catch-up contributions continued unaffected. Employer profit sharing was limited to 6% of covered compensation, $20,500, under the combined plan deduction limit of Section 404(a)(7).
3. Cross-tested to control staff cost
The plans were cross-tested on a benefits basis, which allows the owner a much larger pay credit than staff while still satisfying the coverage and nondiscrimination requirements of Sections 410(b) and 401(a)(4). Annual staff cost came to approximately $23,000, a fraction of the owner's benefit.
4. Designed for funding flexibility
The plan uses an actual rate of return interest crediting design, which passes investment risk to participants and largely eliminates funding volatility. The actuary computes a minimum and a maximum deductible contribution each year, and the range between them gives the owner room to contribute more in strong years and less in weak ones.
The Result
Total deductible retirement contributions reached $353,000, reducing tax by approximately $148,000 at a 41.9% combined marginal rate. Net of roughly $23,000 in staff contributions and administrative costs, the structure remains strongly positive and is designed to run for at least five years.
Key Takeaways
- Defined benefit plans cap the benefit, not the contribution, which is why the deduction scales with age.
- At age 62, the actuarial contribution reached $300,000 on its own.
- Cross-testing on a benefits basis kept staff cost proportionate.
- Contributions are a funding obligation, so multi-year cash flow stability was a prerequisite.
Frequently Asked Questions
Why is the contribution so much larger than a 401(k)?
Because a defined benefit plan limits the benefit payable at retirement rather than the annual contribution. The required contribution is computed actuarially from the years remaining to fund that benefit, so at age 62 the figure is several times what any defined contribution plan permits.
Did employees have to be covered?
Yes. Coverage and nondiscrimination rules apply, so the plan cannot cover only the owner. Cross-testing on a benefits basis allowed the owner a much larger credit while staff cost stayed at approximately $23,000 per year.
What if profit drops in a future year?
The actuary sets a minimum and a maximum deductible contribution, and the range between them provides real flexibility. In a sustained downturn the plan can be frozen to stop future accruals or terminated with assets rolled to IRAs.
Is this a permanent tax saving?
It is a deferral. Distributions are taxed as ordinary income in retirement. The strategy works because the deduction is taken at a high marginal rate now and distributions are expected at a lower rate later, which we modeled before recommending it.
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