(CNNMoney.com) -- For two years, Dr. James Smouse of Atlanta Oral and Facial Surgery tried to convince his younger partners to participate in a cash balance pension plan, a unique defined-benefit plan that offers business owners the opportunity to make hefty, tax-deferred contributions toward their retirement savings. But until the recession hit, they weren't interested.
"They thought they'd be better off investing their money in stocks and other vehicles," Smouse says. "But what happened over the past 18 months showed there's a risk, and after working a few years, they've seen how much money they have to pay in taxes."
With their cash balance plan -- which guarantees an annual return of 4%, compounded over 30 years for the youngest participants -- Smouse's partners realized they could enjoy significant retirement benefits with tax savings now and little risk later. So in 2009, the group worked with actuaries at Jacksonville, Fla.-based Dorsa Consulting to establish their plan.
The cash balance pension plan -- little-known and even less understood -- is growing in popularity. "It's the best-kept secret in retirement planning. Even CPAs don't know about it," says Stephen Dobrow, president of Burlingame, Calif.-based Primark Benefits.
The plans, which involve mandatory annual contributions, work best for small business owners with fewer than 20 employees and excess profits of more than $50,000 per year that they can afford to sink into funding a pension , says Richard Jensen, president of BRS Consulting in Little Rock, Ark. If your company fits the bill, you can enjoy these benefits:
Accelerated Retirement Savings. Most business owners don't begin saving aggressively for retirement until they're five or 10 years away from it, Dobrow says. They tend to plow any extra profits back into the business.
For those owners, a cash balance plan offers an opportunity to catch up quickly. At Smouse's office, owners who are less than five years from retirement can sock away an extra $60,000 each year pre-tax, beyond their investments in the firm's profit-sharing plan. Younger owners only have to put in $10,000 per year.
Security. A cash balance plan is a defined-benefit plan, as opposed to a defined contribution plan like a 401(k). That means that it guarantees a targeted annual benefit beginning when the owner reaches a certain age. Working with an actuary, participants set annual contributions that will yield the set benefit.
And upon retirement, those benefits are guaranteed: "When the market fell, people's cash balance plans didn't drop; their 401(k)s did," says John McCrary of Dorsa Consulting. "People with a cash balance plan didn't lose anything."
Those benefits are guaranteed by the business. As the plan's sponsor, it's responsible for the funding. But most companies shift the responsibility to a financial services firm.
"ING promises to pay that participant the $1,000 per month as long as they live," McCrary says "The only investment risk that the participant now has is that ING stays in business during his lifetime. No matter what the market does, the risk now has shifted from the plan to ING. But they have a pool of money to pay from, so they really have maybe 15 to 20 years for the market to rebound and start growing again."
McCrary compares a defined benefit plan to a loan. "We know how much we want at retirement, we know how many years we have until we reach age 65, and we can estimate a rate of return," he says. "It's not really quite that easy, but that is the big picture."
However, if the investment returns are poor, the plans can be underfunded. Because most cash balance plans for small employers will terminate when the owner retires, the final contribution due is the amount needed to cover any underfunding. In that case, the owner can either contribute the full amount or waive any shortfall, which means they will take a smaller benefit, McCrary says.
But cash balance plans are conservative, aiming for slow, steady growth with a return of 5% to 6% percent, which helps limit losses in a bad market.
Extreme tax relief. A cash balance plan offers business owners a legal vehicle to defer paying taxes on large sums of income. "It's a great way to lower your taxes," McCrary says. "Would you rather save money for yourself or pay off all this [government] spending that's going on?"
For most businesses, the highest expense after salaries "is tax liability," Smouse says. "To legally not pay as much in taxes, there aren't many avenues. [With a cash balance plan], the money you're not giving to the federal government will be put into your own pocket when you retire. It will be taxed then, but hopefully we'll be in a lower tax bracket then."
A valuable employee benefit. Most employers want to help their employees save for retirement, and a cash balance pension plan makes it affordable to do so. Plan owners are required to invest a certain percentage into employees' retirement accounts, but the tax savings can make that cost more attractive.
For instance, Steven Bushman, senior vice president of investments at Raymond James, says one of his clients who was already contributing 6% of their salary to employees' 401(k) accounts opened a cash balance plan as well. He now receives $490,000 in annual tax savings and is required to contribute only an additional $57,000 each year to the employee accounts.
For another Bushman client, his only qualifying employees are his daughter and son-in-law. "So this owner is essentially able to give his kids $50,000 per year and receive a $20,000 tax refund," Bushman says.
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