Cash Balance Plan

The Pension Studio specializes in unique plan designs to best fit your company’s needs.  See below for Cash Balance illustration examples:

Qualified pension plans and retirement savings programs fall into one of two categories: Defined Contribution Plans or Defined Benefit Plans.

Defined Contribution (DC) Plans include programs such as profit-sharing, 401(k), money purchase, and SEP-IRA plans. DC plans allow owners and employees to make retirement contributions that are allocated to individual participant accounts. Funds available at retirement are the accumulation of those contributions plus investment earnings. Because future investment earnings are unknown, it’s uncertain what the expected amount, or benefit, will be at retirement. These plans are generally more favorable for younger employees who have a longer time horizon until retirement.

Defined Benefit Plans, or Cash Balance Plans, promise participants a specific monthly lifetime benefit amount at retirement (which is usually taken as a one-time, lump-sum payment). A benefit formula is created that targets a level of retirement income that can be supported by your desired annual contribution level (Subject to IRS benefit limits).  Contribution amounts are then actuarially calculated and adjusted annually to ensure that the target goal is reached. Contributions for all the plan participants are kept in a single account that is used to pay the promised benefits. Cash Balance Plans tend to favor long-service, highly compensated business owners, partners and key employees who are in their peak earning years.  Cash Balance plans can also be especially beneficial for those who need to quickly increase their retirement assets.


Advantages of a Cash Balance Defined Benefit Plan

  • Higher contribution limits- Contributions can be significantly higher than those of other business retirement plans.
  • Tax deductions- The contributions made are generally 100% tax-deductible to the sponsoring business. This can translate into substantial tax savings.
  • Targeted income for retirement- Plan contributions are adjusted each year according to investment results to help reach set retirement goals.


Important Considerations

  • Combined Limits– If an employer maintains more than one qualified plan, the IRS has certain limits that cannot be exceeded for each plan. If contributions have already been made to another plan for the current year, an employer may need to wait until the following year to establish a Cash Balance plan.
  • Duration of the plan– The IRS requires that a plan be “permanent” and used for retirement purposes only. The employer should expect to maintain the plan for at least five years.
  • Terminating your plan– Plans can be terminated earlier than your pre-selected retirement age for several reasons, such as serious financial distress, death of the employer, or dissolution of the business. However, due to the permanency requirement, the IRS could disqualify the plan if it is terminated in less than five years. Regardless of when the plan is terminated, an additional fee will apply to prepare the termination paperwork.
  • Amending your plan – Occasionally, the employer may want to change plan provisions in order to increase or decrease future plan contributions. An additional fee will apply to modify the benefit formula and process amendments to the plan.
  • Investment responsibility–  Unless investment authority is delegated  to another party, the Employer will be responsible for investing plan assets to ensure that asset growth will meet Plan funding projections.
  • Deadlines– The Cash Balance Plan must be opened by the end of the business fiscal year to make contributions for that tax year. Contributions are due by the tax year’s filing deadline including extension.
  • Contribution requirements– The IRS has strict required minimum contribution rules. Should investment losses occur, the required contributions may increase. It is important that the business has steady income to meet these needs. Funding is not discretionary.

Receiving Your Benefit at Retirement

When you reach retirement age, you will have three options for receiving your benefit payout:

  1. Roll the assets into an IRA- A participant can roll their balance into an IRA where it will remain tax-deferred until withdrawal. This allows for more flexibility, as distributions from the IRA aren’t required until age 70½.
  2. Set up an annuity- This will provide a monthly benefit from the plan over the lifetime of the participant.
  3. Lump-sum distribution- A lump-sum distribution for the full amount of the Plan benefit due can be elected. The amount is taxed immediately and a 10% penalty may apply if the participant is under age 59½ at the time of distribution.


Why Combine a Cash Balance and Defined Contribution Plan?

A Cash Balance Plan can provide higher contribution amounts; thus for employer deduction purposes and future benefit purposes, this may be better than a 401(k) Plan alone.

An employer can implement a safe harbor 401(k) Plan and be assured of a deferral of $18,000 or $24,000 (if over 50). However, the employer will have to commit to giving the non-highly compensated employees a contribution.

Once this 401(k) plan is implemented, the employer can add a Cash Balance Plan as part of the program.  Typically, different benefit levels are allocated to different employees. We can design a plan to maximize the benefits (thus, the contributions) to the older key employees, while providing a minimum type of benefit formula to the younger employees. Simply expressed, as long as the benefits the highly compensated employees will receive at retirement age are equal to those the non-highly compensated employees will receive at retirement age, expressed as a percent of pay, then the plan will pass compliance.