Every dollar of profit left in your top bracket can cost you almost 50 cents. The right plan to defer it depends on two questions: do you have employees, and are you planning to sell?
Case Study Summary
Three Ways a 55-Year-Old California Owner Earning $1 Million Can Defer His Taxes, Depending on How His Business Is Set Up
With no employees, a Solo 401(k) and a cash balance plan let him deduct $296,100 a year and cut his tax bill by $145,275. With a small staff, the same pairing works, but he has to make contributions for his employees too. With a large staff, a C corporation and a sale on the horizon, a nonqualified deferred compensation (NQDC) plan can defer his entire $1 million salary, as long as the sale agreement credits him for it.
The Problem: Almost Half of Every Dollar Goes to Taxes
Meet our business owner. He is 55 years old, single, lives in California, and takes home $1,000,000 a year from his business.
At this level of income, every extra dollar he earns is taxed at 37% by the IRS and 12.3% by California. That’s 49.3% on his top dollars. All told, he loses about 45 cents of every dollar he earns to Washington and Sacramento.
Most owners start with a 401(k). But even fully maxed out, a 401(k) tops out at $72,000 a year in 2026. On $1 million of income, that only shelters about 7% of what he earns.
To make a real dent, he needs a plan that lets him defer much more. Which plan fits depends on his business:
Path 1: No Employees, Stack a Solo 401(k) and a Cash Balance Plan
Let’s say our owner runs a consulting practice by himself. His business is an S corporation, and he is its only employee. He pays himself a $360,000 salary and takes the other $640,000 as business profit.
A cash balance plan is a type of pension plan. Like a 401(k), he has an account balance that grows each year. Unlike a 401(k), there’s no flat dollar limit. An actuary works backward from the largest pension the IRS allows, about $3.5 million as a lump sum at retirement age. The fewer years you have left to fund it, the more you’re allowed to contribute each year.
That’s why age matters so much. At 35, an owner might contribute around $90,000 a year. At 55, it’s about $250,000. And a cash balance plan doesn’t replace the Solo 401(k). The two are designed to work together.
Here’s what he can deduct in 2026 when he runs both plans together:
| Contribution | How It’s Figured | Deductible Amount |
| Solo 401(k) employee deferral | 2026 limit, taken out of his paychecks | $24,500 |
| Solo 401(k) profit sharing | 6% of his $360,000 salary (the usual cap when paired with a pension plan) | $21,600 |
| Cash balance plan | Estimated maximum at age 55, set by the plan actuary | $250,000 |
| Total deducted | About 30% of his income | $296,100 |
Why a $360,000 salary? Plan contributions are based on W-2 pay, not on business profit, and only the first $360,000 of pay counts in 2026. Paying himself exactly that much gets him the largest contributions without paying payroll tax on more salary than he needs.
(Because he’s over 50, he can also make an $8,000 catch-up contribution. Since his pay is over $150,000, it has to go in as Roth starting in 2026, so it isn’t deductible and isn’t included above.)
The $296,100 comes straight off the top of his income, the part taxed at 37% federal and up to 12.3% in California. Here’s his 2026 tax bill before and after:
| A: Before | B: After | A – B: Tax Saved | |
| Income subject to tax | $1,000,000 | $703,900 | – |
| Federal income tax | $320,000 | $210,443 | $109,557 |
| California income tax | $102,459 | $66,741 | $35,718 |
| Payroll taxes and SDI | $22,779 | $22,779 | $0 |
| Total taxes | $445,238 | $299,963 | $145,275 |
His tax bill drops from 44.5% of his income to 30%. On average, each dollar he contributed saved him 49 cents in tax. (Payroll taxes don’t change. His salary is the same, and employer contributions to the plans were never subject to payroll tax to begin with.)
Where His $1 Million Goes
Here’s the part most owners miss. He moved $296,100 into his retirement plans, but his take-home pay only went down by $150,825. The other $145,275 is money that would have gone to the IRS and California. Instead, it’s sitting in his own accounts, invested and growing.
Path 2: A Small Staff, Add Them to the Plan
Once a business has eligible employees, a Solo 401(k) is no longer an option. But the same idea still works with a regular 401(k) profit-sharing plan and a cash balance plan.
The difference is that the plans have to pass nondiscrimination testing. In practice, the owner’s employees typically receive about 5% to 7.5% of their pay, usually through the profit-sharing plan.
Let’s say our owner has three employees who earn an average of $70,000:
| A: Total Staff Pay | B: Typical Staff Contribution | C = A × B: Annual Cost for Staff |
| $210,000 | 5% – 7.5% | $10,500 – $15,750 |
Against a six-figure tax savings for the owner, that cost is small. And those contributions are deductible too, and help him keep good employees.
This path works best when the staff is small and younger than the owner. Because cash balance contributions are age-based, a 55-year-old owner can receive a much larger share of the total than a 30-year-old employee. As the staff grows, the cost grows with it. For a practice with 30 employees, that same 5% to 7.5% could run $120,000 to $180,000 a year.
Path 3: A Large Staff and a Sale Ahead, Defer Your Pay With an NQDC Plan
Now let’s say our owner has spent 25 years building a professional practice with 30 employees. His practice is a C corporation that pays him $1,000,000 a year in salary and bonus, and he plans to sell it next year.
Once he sells and stops working, his tax rate will drop. So he asks: instead of taking my $1 million salary this year at the top rate, can I put it off until after the sale?
A nonqualified deferred compensation (NQDC) plan lets him do exactly that. It’s a written agreement in which he gives up pay he would earn this year, and the company promises to pay it at a set future date. Because he doesn’t receive the money this year, he doesn’t pay income tax on it this year.
- No IRS dollar limit. He can defer his entire $1 million.
- He chooses who is in it. There is no nondiscrimination testing, so he can cover himself alone and not fund accounts for his 30 employees.
- Almost no ERISA burden. A plan for a select group of executives is exempt from most ERISA rules. The company files a one-time notice with the Department of Labor.
- C corporations only. In an S corporation, LLC or partnership, the deferred pay shows up as profit on the owner’s K-1 and is taxed this year anyway.
Before January 1, he signs an election to defer his full $1,000,000 of 2026 pay, to be paid in 10 equal yearly installments after the sale. Here’s what happens to the tax bill this year:
| A: Take the Salary | B: Defer All $1M | |
| His federal income tax | $320,000 | $0 |
| His California income tax | $102,459 | $0 |
| His Social Security, Medicare and SDI | $46,139 | $46,139 |
| Company tax (21% federal + 8.84% California) | $0 | $279,836 |
| Total tax this year | $468,598 | $325,975 |
He pays no income tax on his salary this year. But two things don’t go away. Payroll taxes are still due in the year the pay is earned, so he pays the $46,139 out of his savings. And the company loses its deduction until the deferred pay is actually paid out, so it pays $279,836 of corporate tax on the $1,000,000 it kept.
That’s where the sale comes in. When the company finally pays him and takes its $1,000,000 deduction, worth about $279,836, it’s no longer his company. That tax benefit belongs to the buyer, unless the purchase agreement says otherwise:
| Deal 1: Buyer Counts the Full $1M as Debt | Deal 2: Seller Is Credited for the Tax Benefit | |
| Extra cash left in the company | +$720,164 | +$720,164 |
| Deferred pay subtracted from the price | –$1,000,000 | –$720,164 |
| Change in sale price | –$279,836 | $0 |
| Capital gains tax saved on the lower price (37.1%) | +$103,819 | $0 |
| After-tax effect on the owner | –$176,017 | $0 |
Deal 1 is the buyer’s default: the deferred pay comes straight off the price, and the buyer collects the deduction later. Deal 2 is what a well-advised seller negotiates: the deferred pay is counted as debt net of the tax deduction the buyer will get, so the seller keeps its full value.
The Bottom Line: What He Keeps From His $1 Million
Here’s what he ends up with from his $1,000,000 of 2026 pay, after every tax, once he collects the $100,000 yearly payouts:
If the buyer counts the full $1 million as debt, deferring is roughly a wash at best. If he’s credited for the tax benefit, he comes out $122,459 to $182,459 ahead. The NQDC plan creates the opportunity. The purchase agreement decides who keeps it.
Three payout rules matter just as much:
- The payout schedule is locked in when he defers. Changing it later requires an election at least 12 months in advance, and the new start date must be pushed back at least five years.
- The buyer can cash him out early. A new owner can terminate the plan around the sale and pay everything out within about a year, bunching the full $1 million into one or two high-income years. His purchase agreement should prevent that.
- A 10-year schedule protects him if he moves. Under federal law, California can’t tax NQDC payments to a former resident if they’re paid in roughly equal installments over at least 10 years.
Isn’t This Just Deferring Taxes?
Yes. And that’s where the value comes from.
Whichever path he takes, he deducts the money today at about 49% and pays tax on it later, when his business income has stopped. Here’s what one year of Path 1 contributions is worth if he pays a lower rate on the way out:
| Where He Retires | A: Tax Saved Today | B: Tax Paid at Withdrawal | A – B: Permanent Tax Savings |
| Stays in California (30% rate) | $145,275 | $88,830 | $56,445 |
| Moves to a no-income-tax state (24% rate) | $145,275 | $71,064 | $74,211 |
That’s before any investment growth, and from a single year of contributions. Inside the plans, the money also grows free of the 3.8% Net Investment Income Tax he would pay in a regular brokerage account. And if he keeps the plans running until his mid-60s, he can defer well over $1 million in taxes.
Comparing All Three Plans
Here’s how the three plans stack up side by side:
| Solo 401(k) | Cash Balance Plan | Nonqualified Deferred Comp (NQDC) | |
| Best Fit For | Solo entrepreneurs and self-employed owners with no employees other than a spouse. | Owners age 50+ with high, stable income and a few young, lower-earning employees. | Executives and owners of C corps (or soon-to-be C corps) with many employees. |
| Max Contribution Limits (2026) | $72,000 total ($24,500 employee deferral + employer profit sharing up to 25% of pay). Catch-up: +$8,000 at age 50+, or +$11,250 at ages 60–63. | Age-based: the older you are, the more you can put in. Often $150K–$350K+ per year for owners in their 50s and 60s. Can be stacked on top of a 401(k). | No IRS limit. The plan sets the cap, often up to 50–100% of salary and bonus. |
| Cost for Staff | None. Not available once you have eligible employees. | Moderate. The plan must pass nondiscrimination testing; staff typically receive about 5–7.5% of pay (often through a companion profit-sharing plan). | None required. Can be offered only to the owner and selected key executives. |
| Annual Cost to Run | Low: roughly $0–$500 a year. Form 5500-EZ is required once assets exceed $250,000. | Higher: typically $2,500–$7,500+ a year for actuarial certification, testing and Form 5500. PBGC premiums may apply. | Moderate: legal drafting up front plus ongoing recordkeeping. Often informally funded with corporate-owned life insurance. |
| ERISA Rules | Owner-only plans are generally exempt from ERISA’s Title I requirements. | Fully subject to ERISA once employees participate (fiduciary, reporting and funding rules). PBGC coverage may apply unless exempt (e.g., owner-only plans or professional practices with 25 or fewer employees). | Mostly exempt as a “top-hat” plan (one-time DOL filing), but must strictly follow IRC §409A. Violations trigger immediate taxation plus a 20% penalty. |
| Best Business Entity for Plan | Any: sole proprietorship, LLC, partnership, S corp or C corp. | Any entity. S corp owners’ contributions are based on W-2 wages, so salary planning matters. | C corp. In pass-through entities (S corps, partnerships, LLCs), owners generally can’t defer tax on their own share of profits. |
| Company Tax Deduction | Immediate. Contributions reduce taxable income in the year they are made. | Immediate, and often the largest deduction available to a business owner. | Delayed. The company deducts benefits only when they are paid out, though the executive still defers personal income tax now. |
| Contribution Flexibility | High. Contribute any amount up to the limit each year, or nothing at all. | Low. Contributions are required each year under the plan formula, and the plan should be kept in place for several years. | Moderate. Deferral elections must be made before the year the pay is earned and are locked in for that year. |
| Lead Time Before Sale | Minimal. A new plan can generally be set up as late as the business’s tax filing deadline (with extensions). | Ideally 3–5 years before the sale to build up meaningful deductions and satisfy the plan’s permanency rules. | Must be in place before the compensation year begins. Start several years before the sale to build meaningful deferrals. |
| What Happens After Sale/Retirement | The plan is typically closed and rolled into an IRA tax-free, where the money keeps growing tax-deferred. | The plan is usually terminated around the sale (buyers rarely want it) and the lump sum is rolled into an IRA tax-free. | Paid out on the schedule elected in advance. If the plan pays out on a sale, income gets bunched into the sale year, so plan design is critical. Buyers often treat the liability as debt that reduces the price. |
| Safety of the Money | High. Held in trust for you, with strong creditor protection in bankruptcy (outside bankruptcy, protection depends on state law). | High. Held in trust and protected from creditors under ERISA. May be insured by the PBGC. | Lower. An unsecured promise: you are a general creditor of the company (and, after a sale, of the buyer). A rabbi trust protects against a change of heart, not insolvency. |
| Investment Control | Full control. You choose the investments. | Trustee-directed and usually conservative, since returns above the plan’s crediting rate can cause overfunding. | Notional investment choices only; the company owns the underlying assets. |
| Getting Money Out of the Plan | Penalty-free after age 59½ (or 55 if you separate from service and leave the money in the plan). RMDs begin at 73–75. Low-income years after the sale are ideal for Roth conversions. | Once rolled into an IRA, the same flexibility as a Solo 401(k): withdraw as needed and use low-income years for Roth conversions. | Only on the fixed schedule elected in advance (e.g., 10 annual installments after leaving). Can’t be rolled into an IRA. Changing the schedule requires a 12-month wait and at least a 5-year delay. |
| Roth Option | Yes. Roth deferrals (and Roth employer contributions, if the plan allows). | No. Pre-tax only, but the IRA rollover can be converted to Roth later. | No. All payouts are taxed as ordinary income when received. |
Which One Fits?
- No employees, or just a spouse: a Solo 401(k) and cash balance plan. The company deducts every dollar now, and the money is his, protected in a trust, when he sells or retires.
- A small, younger staff: a 401(k) profit-sharing plan and cash balance plan. The staff contributions are a modest cost next to the owner’s tax savings.
- A large staff, a C corporation and a sale on the horizon: an NQDC plan can shelter far more, up to his full salary, without funding accounts for every employee. It’s worth it only if the purchase agreement credits him for the company’s future tax deduction.
- Often the best answer is a combination. A 401(k) for everyone, plus an NQDC plan on top for the owner and a few key people.
- A large staff and an S corporation or LLC: an NQDC plan won’t defer the owner’s own taxes. Other strategies are needed.
What’s the Catch?
- Cash balance contributions aren’t optional. The plan has a required contribution each year, so your income should be steady enough to support it. Plan on keeping it at least three to five years.
- Hiring changes things. Adding eligible employees generally means covering them, and ends the Solo 401(k).
- Timing matters. 401(k) deferrals have to come out of this year’s paychecks by December 31. A cash balance plan can be set up as late as the business’s tax filing deadline. An NQDC election must be made before the year the pay is earned, so waiting until a sale is underway is too late.
- There’s a lifetime cap on the cash balance plan. Once the balance reaches the maximum allowed, roughly $3.5 million at retirement age, contributions stop.
- NQDC money is an unsecured promise. After a sale, he’s a creditor of a company someone else controls. Escrow, a rabbi trust or a parent-company guarantee can help, but none removes the risk entirely.
- Section 409A rules are strict. An NQDC plan must follow its written document exactly. Mistakes trigger immediate taxation plus a 20% penalty and interest.
- Buyers will push back. Expect the buyer to want Deal 1 terms. Raise the deferred pay early in negotiations, with the numbers to show what the deduction is worth.
Who This Strategy Is Best For
- ✓✓ Business owners in their 50s and 60s with high, steady income
- ✓Self-employed professionals looking to reduce current-year taxes
- ✓✓ C corporation owners with many employees who plan to sell in the next one to three years
- ✓✓ Physicians, dentists, attorneys, consultants and other professionals in high-tax states like California
- ✓Anyone who expects to be in a lower tax bracket in retirement, or plans to retire to a lower-tax state
Explore Your Strategy
Speak directly with Rajiv Rebello to see how this strategy fits into your comprehensive tax plan.