The Cash Balance pension plan has grown in popularity since new rules were published in 2005. Almost all new pension plans will be set up as Cash Balance plans instead of the traditional Defined Benefit plan. There is nothing that a traditional plan offers that can not be delivered better under a Cash Balance pension plan.
WHAT IS A CASH BALANCE PENSION PLAN?
It’s a Defined Benefit Pension Plan (DB plan) with Defined Contribution Plan (DC plan) characteristics. A few of the advantages to these plans include:
- Predictable funding from year-to-year.
- Costs for employees of all ages are determined using a similar formula.
- Contribution rates for targeted individuals (owners) may be significantly greater than in DC plans.
- Employees have a better understanding of the benefits provided by the plan than with traditional pension plans.
WHICH CHARACTERISTICS ARE LIKE A DB PLAN?
- Cash Balance plans provide defined retirement benefits. That benefit is defined by a formula that is spelled out in the plan document.
- Contributions are required each year.
- Actuarial calculations and certifications are required each year.
- The plan Trustees manage all of the assets in the plan.
- Distributions are calculated in the same fashion as a pension plan, and annuity benefits must be offered an option to the participant (in addition to lump sum).
- Plans are covered by the Pension Benefit Guaranty Corporation (PBGC).
- The benefit is not affected by the investment return of the trust.
WHICH CHARACTERISTICS ARE LIKE A DC PLAN?
- Contributions made can be tracked directly to the ultimate benefits paid.
- A hypothetical account is created for each participant, so it’s easier for them to understand the plan. (This is not to be confused with an individual account).
HOW DO CONTRIBUTIONS TO THE PLAN WORK?
During the plan design phase, the formula required to fund the retirement benefit is determined. Then each year a two-part contribution is made to the plan for each participant:
- Pay credit – a set percentage of the participant’s annual compensation; and
- Interest credit – a set amount of interest to be earned within the hypothetical account. This can be a fixed rate of interest, or tied to a market index.
The plan sponsor actually funds the actuarial equivalent of the benefit as determined by the actuary.
Request to talk to one of our Pension Consultants to see if a Cash Balance Pension Plan is right for your company.
HOW CAN A CASH BALANCE PLAN BE USED TO SUPPORT SUCCESSION PLANNING?
Cash Balance plans work beautifully to help business owners accelerate their retirement funding while they are still working. This is a huge advantage to leave room for the next generation to take the reins of the company without the significant cash outlay that the retiring owner may otherwise require without the plan.
WHAT IF NOT ALL OWNERS WANT TO COMMIT TO A CASH BALANCE PLAN?
Many companies have multiple owners. Under a Cash Balance plan, each owner can dial in the contribution he or she wants to have designed into the plan. From a total compensation perspective each owner is the same after the plan as before – it’s just a matter of how that compensation is split between take home pay and retirement contributions. There will be some required contributions to the staff that may end up being shared among all owners. A customized illustration can shed light on how this might look for a particular company.
IS A CASH BALANCE PLAN MORE EXPENSIVE FOR OLDER EMPLOYEES?
No. Cash Balance plans are not age-discriminatory as long as the Pay Credits and Interest Credits are the same for all workers. Contributions are based on a career average benefit patters, so it avoids the heavy weighting of benefits in the final years of work.
CAN THE PLAN SPONSOR BOTH A CASH BALANCE PLAN AND A 401(k) PLAN?
Yes. A Safe Harbor 401(k) profit sharing plan that is paired with a Cash Balance plan provides for the most flexible and powerful plan design in most cases. The top-heavy minimum contribution requirement is typically provided in the Profit Sharing plan.
CAN A DEFINED BENEFIT PLAN BE CONVERTED TO A CASH BALANCE PENSION PLAN?
Yes. The Accrued Benefit under the plan is determined as of the date of the conversion, and compared to what the Accrued Benefit would have been under the cash balance formula.
WHAT MUST A CLIENT BE READY FOR IF THEY ADOPT A CASH BALANCE PLAN?
- Contributions are fixed and mandatory. The client cannot treat this like a high-deduction profit sharing plan.
- All shareholders or partners need to be committed to the plan. They should all expect to participate, even if all choose not to make significant contributions each year.
- Once the contribution has been earned for the year it must be funded, even if the participant has terminated service.
- Accounts must be fully vested after three (3) years of service.
- All plans are individually designed, and must be submitted to the IRS for approval.
- The sponsor should expect to maintain the plan for a minimum of five (5) years.
- For companies with audited financials, additional disclosures are required on the balance sheet. Special actuarial calculations are required to support those disclosures.
HOW CAN I GET A PLAN STARTED?
The plan document must be designed, drafted, and signed no later than the last day of the plan year. Request to have a pension consultant from Benefit Resources contact you about taking the first step toward looking at your options. We will return to you a customized illustration with a full services and cost proposal.
Image courtesy of David Castillo Dominici / FreeDigital Photos.net