Posted on Apr 23, 2018
Although the traditional annuity defined pension plan has mostly gone the way of the rotary phone, cash balance plans are growing in popularity, especially for small business owners. A cash balance plan is a defined benefit plan in which an employer credits a participant’s hypothetical account with a set dollar amount or a percentage of his/her yearly compensation plus interest. Unlike a 401(k), the final vested benefits received by the participant upon retirement or termination are guaranteed and are not dependent on market fluctuations. Rather, the cash balance plan defines the benefit in terms of a hypothetical account balance, which the employee who is vested can take as a lump sum, annuity, or roll into another qualified plan, such as an IRA. The employer bears the risk of profits and losses in the portfolio.
What are the advantages to the employer and the employee? A cash balance plan may be ideal for businesses demonstrating consistent cash flow and profits, professional practices and family businesses, sole proprietorships or partnerships, owners who want to maximize their retirement contributions, and companies that already make a profit-sharing contribution to their employees. In particular, cash balance plans offer the employer the following advantages:
- Funds contributed to the plan are tax deductible now and can result in significant tax deductions.
- Cash balance plans offer generous contribution limits that increase with age, making these plans ideal for business owners who want to accelerate their retirement savings. People age 55 and older can contribute more than $200,000 annually in pre-tax contributions, compared to the much smaller limit in 401(k) plans.
- The plans offer an easy-to-understand hypothetical account balance.
- The employer can opt to vary contributions by employee, and plan liability is easily defined.
- Assets can grow quickly and can provide large benefits for select employees.
- The employer has the option to offer a cash balance plan in addition to a 401(k) plan.
- Cash balance plans provide the portability and flexibility of a 401(k) plan, but allow for higher contribution limits.
For the participant, the addition of a cash balance plan can boost retirement savings. Taxation on benefits is deferred until the funds are received as income, just as in a 401(K) plan.
Like all qualified retirement plans, assets are protected from creditors. The investments of cash balance plans are managed by the employer or an investment manager appointed by the employer. As noted, increases or decreases in the value of the plan’s investments do not impact the balance that is promised to participants. The benefits in most cash balance plans are protected (within certain limitations) by federal insurance provided through the Pension Benefit Guaranty Corporation (PBGC).
This material is provided for informational purposes only, and is not intended as authoritative guidance, legal advice, or assurance of compliance with state and federal regulations.