Is it Time to Consider a New Plan Design?
You may have heard about a “cash balance plan” and wondered whether it would be something advantageous for your business. A cash balance plan operates differently from other types of traditional retirement plans in that it combines features of both defined benefit and defined contribution plans.
Technically, a cash balance plan is classified as a defined benefit plan, which means it is subject to minimum funding requirements. Likewise, the investment of cash balance plan assets are managed by the employer or an investment manager appointed by the employer. Since cash balance plans are a “benefit,” increases and decreases in the value of the actual plan’s investments do not directly affect the amount promised to employees.
For example, if Jane is promised through a cash balance plan a $10,000 account value, then she is entitled to a $10,000 payment, whereas, the actual value of Jane’s account could be $8,000. The employer is responsible for making Jane’s account whole. Or, vice versa, her account could be worth $12,000, yet she is only eligible to claim the $10,000 that is her accrued benefit .
Typically, however, an employee benefit is expressed as a hypothetical account balance, giving it a defined contribution “feel.” A participant’s account is credited each year with a “pay credit,” usually a percentage of pay, and also with an “interest credit,” either a fixed or variable rate that is tied to an index. When a participant is eligible to receive benefits under a cash balance plan, the plan is treated as if it were a defined contribution plan with distributions available at termination of employment in the form of an annuity or a lump sum that can be rolled over into an IRA.
Who are cash balance plans best suited for?
Cash balance plans are especially suited for self-employed or small business owners with high incomes, since these plans allow high-earning business owners to save more than the $56,000 currently allowed for profit sharing/401(k) plans. Cash balance plans have generous contribution limits – upwards of $200,000 in annual wage deferral.
These plans allow for large annual tax deductions because the limitation is on the annual distribution that the plan participant may receive at retirement ($225,000 for 2019), not on the annual contribution to the plan as is the case with profit sharing or 401(k) plans. Employer contributions to a cash balance plan could potentially be three to four times their profit sharing/401(k) contributions and will vary depending on age, income, employee payroll and how much is currently invested in the plan.
Most cash balance plans are designed for the primary benefit of owners or executives of a company. Some candidates include professional practices (doctors, lawyers, accountants, architects, agencies, family owned businesses, to name a few examples) who would like to minimize taxes by putting away their hard-earned dollars into tax-deferred accounts.