Cash Balance

Cash Balance plans have 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 plan.

 WHAT IS A CASH BALANCE 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 pensions.

 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 TO 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:

  1. Pay credit – a set percentage of the participant’s annual compensation; and
  2. 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.

CAN LIFE INSURANCE BE PURCHASED IN A CASH BALANCE PLAN?

Yes.  Since the plan contributions are fairly predictable, life insurance premiums can be paid through the plan.  The insurance subsidizes the plan benefit in the event of a death prior to retirement.  Due to non-discrimination rules, if the plan offers this benefit it must be available to all participants in some fashion.

 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.  The 401(k) can be established for the elective deferrals, and an Employer contribution of up to 6% of compensation.  If the owners of the company wish to participate in the 401(k) plan, we typically recommend that they adopt the “safe harbor” provisions, and contribute between 5% and 6%.  This allows them to avoid the ADP and ACP compliance testing, and often satisfies the top-heavy minimum contribution requirement for both plans.

 CAN A DEFINED BENEFIT PLAN BE CONVERTED TO A CASH BALANCE 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 glorified profit sharing plan.
  • All shareholders or partners need to be committed to the plan.  They should all expect to participate, and expect 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.  There is no graded vesting schedule.
  • 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.

 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. Send us the client’s census data, and the goals to be accomplished with the plan.  We will submit to our actuaries for an illustration.